The Real Effects of Capital Controls: Financial Constraints, Exporters, and Firm Investment

by Laura Alfaro, Anusha Chari & Fabio Kanczuk
 
 

Overview — The massive surge of foreign capital to emerging markets in the aftermath of the global financial crisis of 2008-2009 has led to a renewed debate about the merits of international capital mobility. To stem the flow of capital and manage the attendant risks, several emerging markets have recently imposed taxes or controls to curb inflows of foreign capital. The case for capital controls usually rests on measures designed to mitigate the volatility of foreign capital inflows. However, controls also have an implicitly protectionist aspect aimed at maintaining persistent currency undervaluation. In this paper the authors investigate the effects of capital controls on firm-level stock returns and real investment using data from Brazil. Brazil is important because it has taken center stage as a country that has implemented extensive controls on capital flows between 2008 and 2012. Among the authors' key findings, real investment at the firm level falls significantly in the aftermath of controls. Overall, capital controls can increase market uncertainty and reduce the availability of external finance, which in turn can lower investment at the firm level. Capital controls disproportionately affect small, non-exporting firms, especially those more dependent on external finance. Key concepts include:

  • Capital controls policy measures range from large-scale efforts to reduce the volatility of foreign capital inflows to a protectionist stance on maintaining the competitiveness of the external sector.
  • The intended purpose of controls notwithstanding, evidence in this paper suggests that capital controls can increase market uncertainty and reduce the availability of external finance, which in turn can lower investment at the firm level.
  • Controls affect small, non-exporting firms most, especially those more dependent on external finance.

Author Abstract

In aftermath of the global financial crisis of 2008-2009, emerging-market governments have increasingly restricted foreign capital inflows. The data show a statistically significant drop in cumulative abnormal returns for Brazilian firms following capital control announcements. Large firms and the largest exporting firms appear less negatively affected compared to external-finance-dependent firms, and capital controls on equity have a more negative announcement effect than those on debt. Real investment falls following the controls. Overall, the results suggest that capital controls segment international financial markets, increase the cost of capital, reduce the availability of external finance, and lower firm-level investment.

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