VI Survey of Capital Controls in Developing Countries

Owen Evens, and Peter Quirk
Published Date:
October 1995
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At the end of 1993, one fourth of the 155 developing country members of the IMF were free of restrictions on capital transactions, in the form of either exchange controls on capital movements or restrictions on underlying capital transactions (Table 1). Controls on capital flows appear to have been in place in the rest of the IMF membership to varying degrees. However, definitive statements in this area are difficult because, reflecting the jurisdictional mandate of the IMF, the reporting by members of capital controls is less detailed than that of restrictions on current international payments and transfers. A positive list approach is used by many developing countries so that regulations covering capital transactions permitted freely or subject to an approval process are reported. However, in other countries, capital controls (in the form of either outright prohibitions or provisions on an ad hoc basis) are not specifically reported but are included in a general statement that capital transactions are restricted. The restrictiveness of certain categories of developing countries’ exchange controls on capital is therefore likely to exceed that specifically reported at present.

Capital control structures and enforcement methods vary considerably from country to country, in the forms of transactions and transactors (juridical persons and individuals) that are influenced by the controls. Methods to enforce the exchange controls may involve registration or licensing of capital transactions. The transactions may be subject to an approval process, quantitative restrictions and limitations imposed on the scope of transactions (e.g., the maturity structure restricted), or outright prohibition.96 Given that capital controls most often reflect authorities’ concerns about capital flight, capital outflows tend to be more widely and tightly regulated than inflows. The result is that capital account transactions of residents are typically more restricted than those of nonresidents.

For the purpose of structuring this survey, exchange controls affecting capital account transactions of residents and nonresidents are organized into five different categories: (1) foreign direct investments of residents and nonresidents, (2) portfolio investments, (3) borrowing and lending by residents and nonresidents involving resident and nonresident institutions, (4) transactions effected through deposit accounts, and (5) other capital transfers. Finally, a table provides numerical information about the extent of each category of controls reported in International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions.

Foreign Direct Investment

Regulations limiting foreign direct investment by residents and nonresidents are reported by 91 developing countries.97 Of these countries, investment activities of nonresidents are regulated in 84, and those of residents in 35. Forms of controls include (1) special procedures for the approval of investment applications, (2) regulation of repatriation or reinvestment of profits, and (3) regulated liquidation of the initial investment. Although more developing countries control foreign direct investments by nonresidents, these exchange controls appear to be less restrictive and more flexible than controls affecting investment outflows of residents. For example, foreign funds are relatively easily converted into domestic currency for investment purposes, whereas conversions of domestic funds into foreign exchange by residents for investments abroad are often subject to ceilings or are prohibited.

Controls on inward direct investments are often very selective, being used to limit rather than prohibit investment activities or to try to direct them to specific sectors of the economy (such as export-oriented industries).98 Direct investments of nonresidents in specific industries are, however, frequently prohibited.99 Limits are also often imposed on the minimum amount of capital that must be invested by nonresidents or on the aggregate share of foreign ownership of enterprises. In some cases, the share of foreign equity ownership is tied to the percentage of exports in total production.100 Foreign investments from certain regions may be treated more liberally than investments originating in other parts of the world.101 Activities of majority-owned nonresident enterprises are frequently more restricted than those in which foreign participation is less than 50 percent. Repatriation of profits and initial capital following liquidation is regulated in 34 countries, while in 9 countries taxes are imposed on transfers of capital from direct investment. In one reported instance, the share of foreign ownership arising from foreign direct investment must be lowered one decade after the investment. Different exchange rates are sometimes used in the context of foreign direct investments; for example, two countries apply a more depreciated exchange rate for direct investments.

Specific regulations governing foreign direct investments of residents are reported by 35 developing countries. Prior approval from the ministry of finance, central bank, or investment board is often required to effect such transactions, but a requirement to finance outward direct investments by borrowing the required funds abroad may also be imposed on residents. In most cases, the authorities require that residents provide information on income derived from investments abroad for purposes of taxation or exchange control.

Portfolio Investment

One-fifth of developing countries report exchange controls affecting portfolio investments. Few restrictions are generally imposed on inflows, either because such investments are welcomed or because the domestic financial system is undeveloped and portfolio-type investments are not available. In the case of outflows, investments by residents abroad are often prohibited as part of a comprehensive exchange control system. In this case, the restrictions may not be reported separately.

Issuance of securities by nonresidents in the domestic market is reported to be regulated in 15 countries, while the issuance of securities by residents in foreign markets is regulated in only a few countries. Other forms of control on portfolio investments include limits on the type of domestic, municipal, or public utilities stocks, and on shares of listed private companies. Individual and general limits are imposed on the number of shares that nonresidents can acquire both in absolute terms or as a percentage of paid-up capital. Moreover, the restrictions on repatriation of dividends and capital gains often entail placing the funds in blocked accounts (indefinitely or for a fixed period of time). Some countries restrict transfers of domestic securities between residents and nonresidents.102 A number of developing countries impose a ceiling on the share of foreign securities in the portfolio of pension funds, mutual funds, and investment companies. In a few cases, special rules apply to debt-to-equity conversion,103 and limits are imposed on the acquisition of foreign securities by individual residents.

Borrowing and Lending

One-half of developing counties report regulations on borrowing and lending transactions between residents and nonresidents. Most of these countries restrict borrowing from abroad, with the controls varying from registration with the authorities to meeting certain criteria on loans, including volume, interest rate, term, and grace period.104 About one-fourth of developing countries report that nonresidents are not permitted to borrow from residents in either the domestic currency or foreign currencies. Specific regulations for trade-related financial transactions (e.g., involving maturity) are implemented in a few countries.105 Some developing countries set deposit requirements for foreign borrowing by residents, and in others the controls on borrowing abroad differentiate between public and private sectors, banks and nonfinancial enterprises, and individuals and companies. Special provisions may also be in effect for export-oriented industries and enterprises. Approval of applications for foreign loans is assigned to an authorized bank, central bank, or the ministry of finance, depending on the size and purpose of the loan in question. In a few cases, limits are imposed on total foreign borrowing by private banks.

Deposit Accounts

Deposit accounts opened by residents and nonresidents in either domestic or foreign currencies are reported to be regulated in 83 countries, albeit to varying degrees. By comparison, nonresidents’ accounts denominated in domestic currency are regulated in 52 countries, while nonresidents’ accounts denominated in foreign currencies are regulated in 37 developing countries. To open accounts, certain requirements may be enforced regarding the domicile of the applicant, origin of the funds, and so on. Resident accounts in foreign exchange with domestic banks are controlled in 23 countries, and those with foreign banks in 29 countries. In most cases, the central bank issues positive list regulations permitting certain debit and credit transactions from such accounts, as well as allowing movements of funds between designated accounts.

Restrictions are often imposed on transactions between nonresident and resident accounts, or between local and foreign currency accounts. As a general rule, transfers between similar accounts are not restricted. Administration of all or some transactions that will be effected through these accounts is often delegated to authorized banks. Accounts held by immigrants, emigrants, citizens living permanently abroad, and expatriates are occasionally granted more liberal treatment compared with similar accounts of residents and nonresidents.

Other Capital Controls

Other miscellaneous capital transfers subject to controls include personal transfers of capital and the purchase and sale of land and residential properties. Authorities of 34 developing countries report that they have imposed controls on personal capital transfers, including gifts, endowments, inheritances, remittances abroad by nonresident employees, emigration, and immigration.106 Annual limits on such transfers by an individual or a family are generally set, while the approval of the ministry of finance or central bank is required for amounts exceeding these limits. The following forms of exchange controls involving personal transfers are used most frequently: (1) emigration allowance limits; (2) individual permission and licensing of transfers of personal capital; (3) restriction of annual allocations of inheritances; (4) limits on the share of earnings eligible for remittances abroad by foreign workers; and (5) limits on gifts between residents to nonresidents. Blocked accounts are reported by 24 countries.

Transactions involving land and other real estate are restricted in 45 developing countries; the restrictions apply to residents’ cross-border transactions in 30 countries. Purchase of real estate and its liquidation by nonresidents are governed by special regulations in 23 countries, based on various laws and government decrees affecting ownership of land and other immovable property. Restrictions on the transactions vary from explicit bans on the acquisition of land and real estate by nonresidents or by citizens living abroad, to limits on the size and location of property. Some countries restrict ownership by nonresidents to long-term (up to 50-year) leases on land.

Some capital transactions may be approved by an authorized bank up to a certain amount, while amounts exceeding this limit must be authorized by the central bank (in some countries the ministry of finance). Reporting to the central bank may be required, certain transactions may be subject to notification (ex ante notification), or sometimes notification may be accompanied by inspection.

Regulations on foreign direct investment, where the underlying transaction is restricted but capital remains unrestricted, would not normally constitute capital controls in the context of this discussion.

This is often the case even when no exchange controls are enforced.

The industries typically include defense, petrochemicals, utilities, law, education, communication, transport, and handicrafts.

For example, full ownership is allowed in Malaysia when exports are 80 percent of output or more, 79 percent ownership is allowed when the export share is 51–79 percent, 51 percent ownership is allowed when exports represent 20–50 percent of output, and 30 percent ownership is allowed when the exports are less than or equal to 20 percent of output.

Member countries of the West African Economic and Monetary Union (WAEMU) and the Common Monetary Area (CMA) maintain liberal policies with regard to direct investments from member countries, but foreign direct investments from other countries are regulated more tightly. Another example is Iraq, which treats direct investments from Arab countries more liberally than investments from other countries.

The consent of the authorities may be required for the transfer of domestic shares by residents to nonresidents, or for a stock transfer from a resident to a nonresident, and between nonresidents.

For example, Costa Rica imposed an annual limit of 6.25 percent of the face value of the debt converted on dividend remittances associated with debt-equity conversion. In Venezuela, certain public debt can be converted into equity, and investors are required to deposit a guarantee equivalent to 5 percent of the total investment.

Separate regulations normally apply to financial transactions that are associated with imports and exports. However, regulations may be applied to limit the terms of such contracts (e.g., the maturity of letters of credit).

Within the meaning of the IMF’s Article XXX, such restrictions can apply to current international transactions.

See previous footnote.

Note: This section was prepared by Arto Kovanen, Mark O’Brien, Laura Papi, and Susana de Sosa.

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