BY DR SOHA MAAD
Capital control is the set of measures taken by a government, central bank, or other regulatory body to limit the flow of foreign capital in and out of the domestic economy. In this article, we consider various case studies of capital control from around the world during the financial crisis in the Eurozone. Countries considered are Cyprus, Greece, Iceland, Italy and Spain. The article concludes with a wrap up and lessons learned.
CAPITAL CONTROL MEASURES
There two broad categories of capital control:
- Capital outflow control: This involves policies to restrict the ability of domestic citizens to acquire foreign assets.
- Capital inflow control: This involves policies to limit foreigners’ ability to buy domestic assets.
Capital control may limit economic progress and efficiency but is considered as a way to increase the economic safety. Most of the world’s largest economies have liberal capital control policies.
CYPRUS CASE STUDY
Cyprus was the first Eurozone country to apply capital controls, imposing limits on credit card transactions, daily withdrawals, money transfers abroad and the cashing of cheques. This capital control was intended to prevent a vast outflow of euros during the period of the financial crisis that hit the Eurozone.
In 2013, Banks in Cyprus were shut down, and depositors had only limited access to their cash. Depositors were queuing at ATMs in Cyprus trying to get their cash money as soon as they can. Capital controls measures were imposed on banks in Cyprus in order to prevent bank run. The imposed capital controls were last resort measures undertaken by policy makers to prevent a financial collapse. Confidence in Cyprus banks has been negatively impacted by the financial crisis.
Capital Control Measures taken
Capital control measures undertaken in Cyprus included:
- Depositors withdrawal limit of €300 in cash per day
- Transfers of more than €5,000 required permission from the central bank.
- Overseas credit card transactions were limited to €5,000 per month but unrestricted in Cyprus.
- A ban on taking more than €3,000 of bank notes out of the country per trip.
- The government and Central Bank of Cyprus were exempt from the capital controls.
- All savings accounts were run until their expiry date and no early withdrawals allowed.
- No cheques could be cashed, although cheque deposits were allowed.
- Importers were allowed to pay for goods only after showing supporting documents, while students studying abroad were able to receive only up to €10,000 a term, and only if the money is transferred by their immediate family.
The measures were applied to all accounts, regardless of the currency used.
Security enforcement needed
The capital controls, applied to all banks in Cyprus, required a big enforcement effort, including extra checks at airports. Police were monitoring the situation at bank branches across Cyprus and armed guards were guarding the banks. In Nicosia, demonstrators were gathering at the presidential palace protesting against international lenders who are behind imposing these capital controls.
Compliance with EU regulations
The free flow of money is one of the four fundamental freedoms of the European Union. It can be restricted only in an emergency case of serious economic and financial difficulties. Restrictions may be applied only for a limited time to enable businesses to regain access to needed capital as quickly as possible.
Some analysts considered capital control measures implemented in Cyprus as non-compliant with European Union monetary rules. Capital controls in Cyprus were subject to legal challenges.as they violated articles 63 and 65 of the EU treaties that stated that capital controls could only be justified on grounds of public policy or public security and that measures should not constitute a mean of arbitrary discrimination or a disguised restriction on the free movement of capital and payments.
The urgent necessity of the capital control
Without restrictions on the movement of money, Cyprus authorities feared that the scale of capital flight would destroy banks in the country. Deposit accounts were loaded with foreign money, which in the case of some banks were taxed at 40%.
Spending limits for tourists
Cyprus desperately needed tourists and to help tourists and citizens short of cash, the authorities increased the daily ATM withdrawal limit from €100 to €300.
Impact on businesses
Large firms in Cyprus were obliged to get clearance to pay their workers and must apply for a licence from the central bank to import goods and services. If they have cash in Bank of Cyprus they lose 40% of their funds over €100,000, while deposits in other Banks were taxed at 80%. Deposits of more than €100,000 at some banks were frozen. As a result, purchase of overseas services were impacted.
Duration of the capital controls
The government initially planned the capital controls for four days. But this was a short period for banks or government finances to be in good shape. The controls stayed in place for quite a long time in Cyprus, and were only gradually withdrawn over a two-year period. The last of them was lifted in April 2015.
Indirect capital control
In addition to direct capital controls, there were also indirect ways of controlling the movement of capital in Cyprus. For example, transfers to foreign bank accounts were charged a special transfer tax, which tends to discourage transfers.
Cyprus received a €10bn bailout from the European Union and International Monetary Fund after its biggest banks nearly collapsed in 2013. Cyprus Popular Bank (Laiki Bank), was wound up and deposits worth more than €100,000 in the largest bank, Bank of Cyprus, were seized.
GREECE CASE STUDY
In 2013, Cyprus showed that capital controls are useful in crisis prevention and can help in recovery. This was an example to follow by other countries. As such, Greece imposed restrictions on withdrawals of money from Greek bank accounts, and on financial transfer out of the country.
Greek had bank run problem during its financial crisis that started in late 2009. Similar to the case of Cyprus, nervous depositors were lining up to withdraw cash from Greek ATMs in the face of interlinked sovereign debt and banking system solvency crises. Many Greeks now prefer to keep their money at home, in cash, rather than in a bank.
Help from the European Central Bank
Greek banks had to turn to the European Central Bank ECB for emergency assistance, within the framework of the ECB Emergency Liquidity Assistance (ELA) program. The latter has granted troubled banks in Greece liquidity assistance as cash loans against collateral that may be covered bonds or government bonds. ELA loans are meant to run for a limited period and provide limited sums. However, over the course of Greece economic and banking crisis, the ECB Governing Council has repeatedly raised the ceiling on total ELA loans available to Greek banks. The ceiling now stands at around 90 billion euros. In order to ensure that Greek banks remain liquid, the government of Greece imposed the capital controls putting limits on the amount of money that people can withdraw from their accounts or transfer to banks outside Greece.
Capital Control Measures
The capital controls imposed in Greece were similar to the ones implemented in Cyprus. However, the situations of the two countries were different. Cyprus has substantially recovered from the economic depths it faced in the aftermath of the 2008 global financial crisis, but Greece did not recover. In the case of Greece, the dilemma is whether the country will or should remain a member of the European Union. As long as Greece remains dependent on emergency loans or transfers, the durability of its membership in the EU is uncertain.
ICELAND CASE STUDY
Iceland is another country that implemented capital controls. Following the 2008 crisis, Iceland imposed strict controls on the movement of money out of the country. In some ways it was in a worse situation than Cyprus. Its banking sector amounted to 10 times GDP compared with eight times in Cyprus. Capital controls similar to the ones implemented in Cyprus were in place for five years in Iceland. Businesses were negatively impacted because few foreign firms were investing in the country. If they make any profit they cannot get their money out. Also, foreign workers were discouraged and decided to go back home and people in Iceland who want to work abroad must get clearance from the government.
Following the capital controls in Iceland, the reconstruction of the banking sector created more well-capitalised and profitable lenders. The clean-up of the financial services sector allowed the creation of new banks from old ones, and the economy was growing and resolving its debts related to the banking crash.
CAPITAL CONTROL IN SPAIN AND ITALY
Banks in Spain and Italy were suffering a flight of funds to safer Eurozone countries during the financial crisis. However, banks in Italy had a clean bill of health from the IMF. Spain’s banks were in difficulties. Spain and Italy did not resort to bailout. If they resorted to bailout then the European Union would have requested Cyprus-style capital control including upfront payment from bank depositors.
Capital control should be a last resort mean. It may help in some cases at short or long term detriments. However in other cases it may be destructive and lead to economic collapse. Hence capital control should be supported by fair policies that can protect vulnerable people, be applied and removed moderately and gradually and accompanied by measures that can keep the business and economic activity up and running despite the challenges. If badly implemented, capital control may damage the banking system and reduce people trust in it and prevent inflow of capital and investment into the country. As we have seen, capital control gave the aspired good results in Cyprus, but in Greece it damaged the banking system and its reputation despite the fact that the two countries, Cyprus and Greece, implemented almost similar capital control measures. However in one country, Cyprus, they were beneficial and in the other country, Greece, they were destructive.
Capital control was in some countries requested by entities, like the Troika (IMF, World Bank, and European Central Bank), offering bailout to help the local banking system. They might violate local and regional laws as in the case of Cyprus were capital control violated EU regulations. Capital Control implementation was sometimes imposed by security forces. This is of course oppressive to citizens, but unfortunately capital control is not an easy experience to banks and individuals.
In some countries like Iceland, capital control had a negative impact on businesses and investment and on foreign workers who were obliged to leave the country during the capital control period.
We can conclude that planning for a healthy and sustainable economy may be the ultimate way to avoid capital control.
Article References: New York Time, Financial Times, Investopedia, Wikipedia, Wall Street Journal, BBC, Euro News, the Economist, Reuters