Capital Account Liberalization and Financial Sector Stability

Occasional Papers, April 12, 2002

Source details

Canonical URL

Capital Account Liberalization and Financial Sector Stability

Other formats

• Markdown version
• Structured JSON version
• Bundle manifest

Bibliographic details

• Published: April 12, 2002
• Series: Occasional Papers
• DOI: https://doi.org/10.5089/9781589060852.084

Summary findings

• The paper analyzes the linkages between capital account liberalization and other policies influencing financial sector stability.
• Drawing on country experiences, the paper develops an operational framework for sequencing and coordinating capital account liberalization with other policies aimed at maintaining financial sector stability.
• Financial systems that have been weakened by inappropriate government involvement also face additional risks when operating in international financial markets.
• The absence of significant macroeconomic imbalances and the high level of official international reserves at the outset of the crisis also appear to be important factors preventing a full-blown exchange crisis.
• Nevertheless, the prolongation of the crisis lowered economic growth and ultimately led to a recession and increased the total cost of the crisis resolution.

Methodology and operational framework

• Presents a methodology for sequencing capital account liberalization based on general principles.
• The methodology involves:
  • An assessment of capital controls.
  • An assessment of macroeconomic and financial sector vulnerabilities.
  • The design of a plan for sequencing capital account liberalization with financial sector reforms and other policies.
• The methodology is illustrated by an example (illustration provided within the paper).

Risks and preconditions identified

• Key risk: financial systems weakened by inappropriate government involvement face additional risks in international financial markets.
• Key preconditions for avoiding a full-blown exchange crisis:
  • Absence of significant macroeconomic imbalances.
  • High level of official international reserves at the outset of the crisis.

Crisis dynamics and costs

• Prolongation of a crisis can:
  • Lower economic growth.
  • Ultimately lead to a recession.
  • Increase the total cost of crisis resolution.

Policy implications and sequencing recommendations

• Capital account liberalization should be sequenced and coordinated with:
  • Financial sector reforms.
  • Other macroeconomic and structural policies designed to maintain financial stability.
• Operational sequencing requires country-specific assessment of:
  • Existing capital controls.
  • Macroeconomic vulnerabilities.
  • Financial sector vulnerabilities.
• Design a concrete plan that links liberalization steps to milestones in financial sector reform and macroeconomic stabilization.

Subjects and keywords highlighted in the paper

• Subjects: Balance of payments, Banking, Capital account liberalization, Capital flows, Commercial banks, Economic sectors, Financial crises, Financial institutions, Financial sector, Foreign exchange.
• Keywords: Africa, bank, capital account liberalization, Capital account liberalization, Capital flows, Commercial banks, Financial sector, financial system, foreign currency, Global, liberalization, liberalization process, market, market discipline, market liquidity, North America, OP, policy advice.

International Monetary Fund. Capital Account Liberalization and Financial Sector Stability. Occasional Paper No 2002/005.