Controlled Capital Account Liberalization: A Propasal
Eswar S. Prasad
Cornell University - Dyson School of Applied Economics and Management; Cornell University - Department of Economics; Brookings Institution; NBER; Institute for the Study of Labor (IZA)
Raghuram G. Rajan
University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)
IMF Policy Discussion Paper No. 05/7
In this paper, we develop a proposal for a controlled approach to capital account liberalization for economies experiencing large capital inflows. The proposal essentially involves securitizing a portion of capital inflows through closed-end mutual funds that issue shares in domestic currency, use the proceeds to purchase foreign exchange from the central bank and then invest the proceeds abroad. This would eliminate the fiscal costs of sterilizing those inflows, give domestic investors opportunities for international portfolio diversification and stimulate the development of domestic financial markets. More importantly, it would allow central banks to control both the timing and quantity of capital outflows. This proposal could be part of a broader toolkit of measures to liberalize the capital account cautiously when external circumstances are favorable. It is not a substitute for other necessary policies such as strengthening of the domestic financial sector or, in some cases, greater exchange rate flexibility. But it could in fact help create a supportive environment for these essential reforms.
Number of Pages in PDF File: 17
Keywords: Capital inflows, foreign exchange reserves, closed-end mutual fund, international portfolio diversification
JEL Classification: F3, F4, G1
Date posted: July 29, 2010
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