Capital Controls Work: Lessons From Brazil

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Capital Controls Work: Lessons From Brazil

Losing access to capital markets is a major problem for any market, but a flood of foreign capital creates its own problems as prices go up and EM exporters become less competitive and the prospect of the hot money flowing out just as quickly can destabilize a fragile economy. But countries can defend themselves with capital control rules and, according to new research, they may be able to fine tune their response by targeting different types of capital.

“There is a significant decline in cumulative abnormal returns for Brazilian firms following the imposition of capital controls on foreign portfolio inflows in 2008–2009 consistent with an increase in the cost of capital,” write Laura Alfaro of Harvard Business School, Anusha Chari of the University of North Carolina Chapel Hill, and Fabio Kanczuk of the University of Sao Paulo in their paper The Real Effects of Capital Controls: Financial Constraints, Exporters, and Firm Investment. “Controls on debt flows are associated with less negative returns, suggesting that the market views equity and debt flows as different.”

Quick reversals in Brazil’s capital controls ruling

Brazil provides a particularly good case study because it flicked capital controls on and off multiple times in a relatively short period of time. The combination of a commodi