In theory, capital account liberalisation should allow more efficient global allocation of capital, from capital-rich industrial countries to capital-poor developing economies. This should yield widespread benefits. It will provide a higher rate of return on people's savings in industrialised countries and increasing growth, employment opportunities and living standards in developing countries.
Capital account liberalisation promotes a more efficient allocation of capital, which enhances growth. It allows net transfers of resources, which permit smooth consumption, risk sharing and inter-temporal capital formation. It favours technology transfers from abroad and improves corporate governance. In countries with weak institutions, it signals commitment to sound macroeconomic policies. However, the concrete experience of some developing economies has been far less clear-cut regarding the beneficial effects of capital account liberalisation.
By opening the capital account, a country can allow the home investors to tap the global capital market. This will provide them with a relatively higher return than that at home. As a result, the portfolio diversification can be possible because firms and investors need not confine their investment in a single country. Hence, if our country opens the capital account, it will lead to a higher portfolio investment in the global capital market and will ultimately increase the investors' return and wealth level. The country's overall balance of payment will be improved.
A number of measures were adopted since 1990s towards liberalisation of foreign exchange transactions. Bangladesh currency, the Taka, was declared convertible on current account transactions (as on March 24, 1994) in terms of Article VIII of IMF Article of Agreement (1994). As Taka is not convertible in capital account, resident-owned capital is not freely transferable abroad. Repatriation of profits or disinvestment proceeds on non-resident FDI and portfolio investment inflows are permitted freely. Direct investments of non-residents in the industrial sector and portfolio investments of non-residents through stock exchanges are repatriable abroad, as also are capital gains and profits/dividends thereon. Investment abroad of resident-owned capital is subject to prior approval of the Bangladesh Bank, which is allowed only sparingly. Bangladesh adopted the floating exchange rate regime since May 31, 2003.
Since capital controls limit domestic residents' ability to hold foreign currencies, in Bangladesh nobody can illegally hold foreign currency. They also limit their ability to avoid inflation taxes, which in turn may impart an expansionary bias to monetary policy. Similarly, to the extent that capital controls can enforce lower domestic interest rates, they lower the cost of domestic borrowing and hence may impart an expansionary bias to (debt-financed) public expenditures. Weak macroeconomic fundamentals can also pose a problem. For instance, capital account liberalisation can aggravate risks associated with imprudent fiscal policies by providing access to excessive external borrowing. Bangladesh may put in place sound monetary, fiscal and other macroeconomic policies and practice financial discipline to pave the way for capital account convertibility.
The question of whether Bangladesh should go for full convertibility is being debated since the country took the bold step of declaring Taka as convertible for current account transactions. Contrary to what many feared, the step did not pose any serious threat to the foreign exchange reserve or balance of payments. On the contrary, excepting the temporary brake put in by the 1998 flood, the country has witnessed a steady improvement of the GDP and relative stability in balance of payments and foreign exchange reserve. The evidence in favour of the policy discipline argument is slightly better. In all cases, the sign of the effect is negative, with more open economies having lower inflation. This is attributable to Bangladesh as well. Bangladesh has been suffering a relatively higher inflation rate which in turn largely affects the investment opportunity.
Usually, if the GDP is high enough to induce lucrative projects to be undertaken in the foreign country, then the country's government will open the capital account.
The writer is an MBA. [email protected]
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