The latest moves by South Korea and China — not to mention India, Malaysia, Thailand and a swag of other countries — to impose capital or price controls show that the hype over ‘currency wars’ is mutating into a low-intensity battle being waged by countries through a series of unilateral, ‘micro-management’ measures.
In the same week that China announced it would impose price controls to curb inflation comes news that South Korea will reimpose a 14 per cent withholding tax on foreign investors’ earnings from government bonds.
The move, as the FT reports, is just the first of a possible wave of measures aimed at controlling surging capital inflows.
Seoul’s attempts to control what it calls “currency volatility” — rather than appreciation — mirror similar preoccupations in Brazil, Indonesia and Thailand, in the FT’s words. But as South Korea’s case shows, on some levels, such steps can be downright counter-productive.
For one thing, the decision to reimpose the tax has sparked bitter arguments among Korean policymakers. Worse, as the report notes, it could thwart South Korea’s effort to be listed on Citigroup’s World Government Bond Index, which is tracked by some of the biggest foreign investors including Japanese pension funds.
Worryingly for Seoul, points out the Beyond Brics blog, neither the won nor the Kospi stock index took much notice of a move that many in the market had been expecting.
Funnily enough, Seoul’s decision to restore the tax comes just days after its starring role as host of the G20 summit — at which leaders agreed that capital controls could be justified for countries experiencing currency volatility fanned by ultra-low interest rates in the west.
Indeed, as the Wall Street Journal notes:
Across the globe, governments are studying or imposing measures to limit capital inflows from developed economies into fast-growing parts of Asia, Latin America and Africa. In recent weeks, Thailand, Taiwan and China have implemented or strengthened capital controls or taken steps to limit fund flows, while Indonesia is weighing the pros and cons. Such flows have sharply boosted the region’s currencies, which can make their exports less competitive in other markets.
But, the report adds, it isn’t clear how successful measures like these will be. Brazil has implemented an aggressive tax on foreign investors on some assets, and its currency has continued to rise. Already, in South Korea, the direction of the won and stocks on Thursday indicated that the announced measures didn’t go as far as some investors had hoped.
Nomura’s global economics team sums it up very neatly in a note that begins:
There are increasing signs that Asian policymakers are favouring micro managing the economy through interventionist policies to counter too strong capital inflows, property price bubbles and food price inflation. So far this month, China, India, Korea, Malaysia, Indonesia, Taiwan and Thailand have all imposed either new macro-prudential measures or capital controls. These interventionist polices are now starting to spread to the agriculture market. Taiwan plans to cut import tariffs on soy flour, cornstarch and sugar in a bid to increase local supply, while China’s State Council announced it may impose price controls on “important daily necessities” with specific mention of grain, sugar, edible oil and vegetables…
If the shift toward direct interventionist policies is at the expense of using more indirect market-based policies (ie interest rates and exchange rates) then, in our view, the end result could be a delayed, but even bigger burst of inflation next year.
From the viewpoint of Asian policymakers, we think the rationale for using interventionist polices is threefold. First, moving away from an export-led growth model involves structural reforms… Second, Asian policymakers do not want a repeat of the Asian crisis, and so this time around they are taking a more hands-on approach, particularly to cool property markets with macro-prudential measures. And third, the rise in food prices has a disproportionate negative impact on the poor (according to the UN, three-fifths of which globally are in Asia) and so Asian governments are more impelled to intervene directly in agriculture markets, as was the case in 2007-08.
Ultimately, imposing interventionist measures “can be a slippery slope and ultimately do more harm than good to Asia’s economies”, concludes Nomura:
The risk is that these types of measures cascade, either because investors find loopholes and so more measures need to be slapped on, or because the adoption of interventionist measures in one country can force (or encourage) others to follow suit – in other words, they can be contagious, which arguably is starting to happen in Asia. Widespread use of interventionist policies in Asia could be very distortionary, resulting in a misallocation of investment and ultimately impinging on the region’s economic growth potential.
However, you can expect these types of policies to lose their effectiveness over time — “and to the extent that they are used instead of allowing currency appreciation and raising interest rates, there is a rising risk of policy-makers falling behind the curve next year in combating inflation”, Nomura adds. In the end, the bank says, Asia’s rapidly growing economies will experience real exchange rate appreciation – and it will either be through nominal currency appreciation, or inflation.
On the other hand, say some experts, capital controls, as academics Ilene Grabel and Ha-Joon Chang noted in the FT in October, are “not all bad”.
Why QT, not QE, is the risk – FT Alphaville
Capital controls: New front in currency wars – FT Alphaville
Martin Wolf: The global war over currencies – FT
South Korea stalled by bond tax – BeyondBrics