This paper discusses the validity of exchange controls to prevent capital flight. We assume that the concepts of exchange control and capital flight are known. The tables presented were prepared in accordance with methodology available from the international economic literature for assessing capital flight. These methodologies, in general created during the 1970s and 1980s, reflect an international financial environment that has changed a lot, since then. Thus, capital flight estimates in conformance with those criteria do not indicate necessarily the best way to evaluate one economy, nowadays.

The presence of controls on cross-border transactions for political, ideological or other economical interests are partially presented in this study just to demonstrate that to avoid capital flight is not the unique reason for exchange controls. The paper does not take position in favor or against controls adopted for reasons not related to capital flight.

Opinions from various authors concerning the goals and consequences of exchange control regimes in the majority of developing countries, including Brazil, support the conclusion that exchange controls are ineffective to retain capital when economic and/or political indicators of one country signalize financial or political problems in near future.

Nevertheless, we discuss shortly the idea of controlling the international capital mobility to avoid world financial instabilities, which seems consistent with the role played by the International Monetary Fund, which has acted like central banks do in their domestic financial markets to face banking liquidity crises.

INTRODUCTION

The purpose of this paper is to complete an assignment for the Institute of Brazilian Issues – IBI, at the George Washington University, Washington, DC, USA, at the conclusion of the VI Minerva Course, November 1997.

The idea of writing about EXCHANGE CONTROLS AND CAPITAL FLIGHT was taken from a group study about the effectiveness of exchange controls in avoiding capital flight, that takes place during the normal activities of the VI Minerva Program. The group was assigned to answer the question Do Exchange Controls Prevent Capital Flight? At the same time we did researches to attend the assignment, Brazil was affected by the downward movement in capital markets across the world and consequently by capital flight.

As my professional activity at the Exchange Department of the Central Bank of Brazil was directly related to analyzing periodically the Brazilian exchange market and my part in the case study was to present a conclusion in order to answer the question Do Exchange Controls prevent Capital Flight? I was motivated by taking advantage of the happenings presents in newspaper headlines everyday during October and November/98, changing the first idea of writing about "transfer pricing" and money laundering.

The paper is divided in the following four chapters: THE FUNCTIONS OF EXCHANGE CONTROLS; THE NEGATIVE CONSEQUENCES OF EXCHANGE CONTROLS; WHY CAPITAL FLIGHT OCCURS (COUNTRY RISK); and ANSWERING THE QUESTION (CONCLUSION).

In the three first chapters the paper provides information and opinions from scholars about the functions and the consequences of exchange controls and the reasons why capital flight occurs in order to answer the question, in the forth. In Why Capital Flight occurs, the paper emphasizes the importance of the Country Risk evaluation as a determinant variable not only for capital flight but also for the shortage in capital inflow.

In each chapter the paper brings some considerations about the Brazilian experience, providing practical examples of using exchange controls. The case of Brazil is important because the country is suggested by some important authors as one good example of success in avoiding capital flight via exchange control policies.

Brazilian case becomes more important, maybe as a counter-example, insofar as the paper mentions that Brazilian economic authorities, especially under purposes from the Central Bank of Brazil, concluded at the end of the last decade for lifting part of the controls once the regime had failed in avoiding capital flight. The most impressive example of that is the creation of the Exchange Floating Market in which capital outflows operation can be carried out without any interference from the authorities.

THE FUNCTIONS OF EXCHANGE CONTROLS

What one government intends with restrictions on exchange transactions is, in general, related to development plans. The first goals are to lessen the negative effects of volatile capital flows and to protect infant industries. In that case, exchange controls structure is part of the macroeconomic policy.

I.1 – International Literature

Many authors have referred to the use of capital controls for developed countries in recent years. Nembhard, for instance, presents tables based on the Exchange Arrangements and Exchange Restrictions [IMF, annual reports 1975 and 1989], showing that among 17 OECD countries, only 3 (United States, Switzerland and Germany) had no kind of restriction at the end of 1975. By the end of 1989, 8 developed countries continued adopting some kind of Exchange Restrictions. Greenwood and Kimbrough [1985, quoted by Nembhard after analyzing the IMF summary tables on restrictions on the capital account, show that France, Italy, Japan, and the United Kingdom used controls virtually throughout the entire period from 1966 to 1982.

In effect, Nembhard argues that "there is a paradox between the use of capital controls in theory and in practice. Although mainstream theory suggests that controls are distortionary and ineffective and should rarely be used – that only rent-seeking, mismanaged governments use them – sensible governments often with successful economies and almost every government in the world at some point, have used them, and some continue to do so".

Krugman [1987, quoted by Nembhard, asserts that capital controls can be justified as a second-best solution, when a government has fiscal problems or "is temporarily committed to the defense of a disequilibrium exchange rate". He demonstrates that when a country uses import controls to sustain a disequilibrium exchange rate, capital controls may improve welfare, and the exchange rate impact of import restrictions is greater.

Bhagwati [1978] , who classifies the exchange control regimes in five phases, shows us that we can also see exchange controls as a sequence of stages from the phase one to five, in a series liberating steps towards a completely open economy. Despite Bhagwati’s book has been written twenty years ago, before the classical capital flight problems faced by Latin American countries in the 1980’s, we understand that the idea of a sequence of stages of exchange controls continues being valid. It is not only because historically it was the case of practically all the nations, but also because we can not imagine a new country raising completely ready, politically and economically, in order to operate in phase five.

In his classification, phase one represents the most restrictive regime, characterized by the systematic and significant imposition of quantitative controls, in order to face unsustainable payments deficit, while phase five occurs when the exchange regime is virtually liberalized. In this stage there is full convertibility on current account and quantitative restrictions are not employed as a mean of regulating the balance of payments.

Moreover, we can also infer from Bhagwati and other authors that the exchange restrictions can be imposed for one country in order to face extraordinary problems reflected on its balance of payment, i.e. the route from phase one to five is not a straight journey. One country in phase four can suddenly impose some unwanted restrictions in response to unexpected financial and economic problems.

In a sequence, based on Nembhard [1996] and other authors, we present a range of arguments which have justified the use of controls for several countries around the world.

We can observe from this list that to prevent capital flight is not the most important purpose with capital controls. However, we have to take in mind that if capital flight occurs in great intensity all the other intentions can not be accomplished, what, virtually, transforms capital flight in the milestone of exchange controls.

I.2 – Brazilian Case

As a developing country, Brazil has historically adopted exchange controls in order to develop its own industry and to avoid its denationalization. In this sense, the most common restrictions have been imposed on international trade transactions, particularly via policies called import-substituting industrialization, and on foreign investment, both on inflows and outflows.

Although stimulated by credit facilities, which eventually compensated not favorable exchange rates, exporters have also faced, at the same time, complex rules, with a lot of variations, normally directed to maintain the foreign currency under the control of the Central Bank of Brazil – CBB.

Until today foreign capital inflows continue having to be registered at the CBB in order to assure the investors and lenders the right to return the principal and the interest (interest rates, profits and dividends) abroad. In some periods, however, the control was so strict that each exchange transaction, both inflow and outflow transactions relate to trade and capital had to be examined and "approved" by a CBB official servant in order to be carried out.

On the side of trade, the main restriction on imports, as well as on exports, has been exerted through the requirement of prior licenses to permit both trade and respective financial transaction from being carried out. Besides, heavy taxation has been imposed on various sorts of products, especially on automobiles, computers, and other products that are considered technologically advanced, which drastically increases the price of foreign product and discourage the transactions.

Bhagwati [1978] mentions as extreme examples of such protective use of quantitative restrictions on imports, the Indian rule of indigenous availability and the Brazilian law of similiars, which virtually ruled out imports when local substitutes were available.

Mahon, Jr [1996] relates the existence of tight exchange controls system in Brazil and Colombia, especially on the exchange rate, to the pressure from the rural elite since coffee was their principal commodity. Analyzing the exchange policies and capital flight in those two countries the author comments:

However, since the beginning of the 1990s, Brazil has been radically changing the rules on foreign capital and international trade in order to reinsert the country in the international community. A good example of the Brazilian exchange market liberalization is the creation of the Floating Market at the beginning of 1989, especially due to the rule known as CC5, which permits the outflow of capital without any intervention from the Central Bank of Brazil - CBB.

This process began to be more effective with the adoption of the Real Plan in July of 1994. Nowadays, the government’s objective is to facilitate the imports in order to increase the competitiveness of industry, control inflation, and attract foreign capital to support new investments as well as to further privatization of state-owned companies and transitory current account deficits.

Despite, as we have learned from Bhagwati that the stages of exchange controls phases is not a straight sequence from phase one to phase five, during 1997 Brazil had to adopt some very imaginative restrictions on imports in order to control the current account deficit. Indeed, the amount of imports was increasing at a rate higher than expected due to the low cost of international capital. Through the very long maturity of payments, not correspondent with the kinds of products transacted, foreigner exporters were conceding to Brazilian importers the opportunity to make money in the financial market via arbitrating the interest rates.

Because of this, since April, 1997, all imports with maturity of payments until 180 days have to be paid before the customer liberalization, and the other ones between 180 and 360 days have to be paid 180 days after the custom procedures. Only the imports with long-term maturity of payment continue being carried out without any restriction.

Concluding, as the most of authors researched base their opinions on the IMF annual report "Exchange Arrangements and Exchange Restrictions", it is appropriated to mention, in conclusion, that Brazil has traditionally taken at least seven pages of that report to describe its arrangements and restrictions on exchange transactions. Symptomatically, during the debt crises of 1980s, Argentina and Mexico, which were in more advanced degree of economic liberalization compared to Brazil at that time, jumped from their two or three pages of exchange control rules to something around seven, between 1982 and 1983, reflecting the tightening of controls.

II – THE NEGATIVE CONSEQUENCES OF EXCHANGE CONTROL REGIMES

In the prior chapter, we summarize the main arguments used by governments and scholars to support the adoption of exchange controls. Upon all of them it makes salient that one that takes a stand for an economy insulated from a supposed negative international competitiveness in order to provide one government with the tools necessary to guide the development of its country.

Since controls, however, are enforced against the willingness of the population and the market agents, participants devise a lot of ways to bypass them, reducing their effectiveness. These ways are always based on illegal actions which, commonly, involve part of the government staff and undermine the confidence of the residents and international investors in one country.

Without exception of any country, the adoption of exchange controls for a long time stimulates the rising of corruption, smuggling and other sorts of crimes, negatively affecting the government institutions as well as its employees. These facts tend to be more common if the restrictions are not felt to be morally justified by the citizens.

II.1 – International Literature

Bhagwati [1978], despite recognizing that the bureaucrats generally sought to follow fair-share rules in their choice criteria for awarding licenses among competing claimants, notes that the breakdowns in the honesty and integrity were not uncommon. As a consequence, the incidence of illegal transactions under exchange control regimes is equally common. Those illegal transactions are divided by this author in three broad classes as following:

• Those relating to capital flows, including both capital flight abroad and inward flows seeking better exchange rates in the black market. When the faked invoicing is related to capital flight, this phenomenon represents a demand for illegal foreign exchange that is fed by the supply created by phenomena such as "leaked" inward remittances and capital flows and primarily by underinvoicing exports and overinvoicing imports.

Varman-Schneider [1991], referring to "Corruption, Bribery and Capital Flight" in India writes that "the history of Indian economy reflects some of the ills that have beset the country: widespread graft and corruption, waste, tax evasion, economic mismanagement and stagnation, and political strife. … These included sales of import and industrial licenses at huge premiums, smuggled raw materials, speculative hoarding of key commodities, real state transactions, usurious lending and other fruits of corruption".

Dunn Jr., Robert M. and Ingram, James C., presents the following opinions about the consequences of exchange restrictions, which are adopted in order to avoid expenditures on nonnecessities:

II.2 – The Brazilian Case

Although Brazil is mentioned by many authors as an example of country with relative efficiency in its exchange controls, most of the facts reported by Bhagwati and Varman-Schneider, for the most part also took place in Brazil, especially during the 1980s, despite the strictness of the exchange controls.

Overinvoicing and underinvoicing practices involving Brazilian international trade are reported by various authors. Study developed by Bhagwati, comparing the Brazilian statistics for exports with those one from respective partnership countries shows that the exports from Brazil presented nearly 14% of underinvoicing in transactions with the OECD countries and 4.1% in transactions with the United States and Canada for the year of 1967.

Meyer, Arno and Bastos Marques, Maria Silvia, in "A Fuga de Capital no Brasil" (FGV/IBRE), assert that exports from Brazil to the European Union, United States and Japan were systematically (12%) lower them the respective imports from that countries during the period of 1985-1987. At the same time, a comparison between the Brazilian imports from the same countries and in the same period were systematically lower (13%) than the respective exports informed by those countries. These facts indicate a practice of underinvoicing in both exports and imports in order to promote capital flight and to avoid taxation over imports.

Accordingly, comparisons made by Jessica [1996], covering the period between 1960 and 1987, indicates for the first seven years of the 1980s discrepancy around 4,9% in imports and 3,7% in exports..

A parallel market for American dollars operates daily especially in the big cities like Sao Paulo and Rio de Janeiro. In accordance with poor statistics eventually published by newspapers, the amount carried out daily is around US$ 30 million US dollars in both cities, which represents approximately 3% of the amount of transactions in the regular markets for the same period.

Despite the small sum transitioned daily, the parallel market receives great attention from the media and has had the power to influence the people’s expectations about the country’s economy. Independently of the amount of transactions, the premium is reported daily by all newspapers and TV news as an important economic index.

A specific and autonomous market – Floating Market – was created in 1989 for tourism operations in order to attract to official market the transactions carried out in the parallel and illegal market. At that time, the premium was above 100% and the people were stimulated to deviate their foreign currency to the illegal market.

A lot of cases of International travel only with the purpose to obtain the right to purchase foreign currency are reported by the Brazilian media. During the 1980s even a round trip between Porto Alegre (Brazil) and Montevideo (Uruguay), no more than 300 miles far from the first city, permitted profits in foreign currency which were diverted to the parallel market.

The use of forged licenses and other documents required to support the payment of imports, in order to gain the premium between the markets, are equally reported by the newspapers based on punishment by the monetary authority published in the Brazilian official newspaper, Diario Oficial da Uniao. It demonstrates that the same practices reported by Bhagwati as taking place in India have occurred in Brazil practically with the same features.

Summarizing, in our point of view, the description made by Dunn Jr., Robert M. and Ingram, James C. concerning one economy under exchange restrictions fits Brazil almost perfectly, despite it has never reached that kind of deterioration we can imply from their prediction.

In addition, for the better understanding of the Brazilian Case during the over past 20 years, we insert the tables below and respective comments as following:

Table II.1 – It presents the estimate of capital flight (KF) in Brazil between 1971 and 1987. We can observe that at the end of the 1980s KF in Brazil began to be more consistent probably in response to tightening in exchange controls. At that period, Brazil centralized the exchange transactions in its central bank and almost all the remittances had to be approved. Consequently, the international market interrupted its investment and loans to Brazil. Besides, Brazil defaulted in meeting its foreign currency obligations insofar as the payments made by private sector via the CBB could not be converted to foreign currency and remitted abroad, what can indicate that the outflow was comprised largely by domestic capital.

Moreover, it is important to emphasize that after a record of 4.75% of GNP in KF in 1977, year in which Brazilian public sector borrowed a huge amount of capital in the European market, the scenario became uncertain and only in 1987 and 1988 it presented the same pace.

Taking the 1996 Brazilian’s GDP [US$ 750 billions], if repeated nowadays, that 4.75% of KF occurred in 1977 would represent something like US$ 35.6 billions a year. Otherwise, the percentages of KF estimated for 1986-87, around 2.85%, would represent an amount near US$ 21.4 billions a year, what would be unsustainable for any developing country.

Table II.1.1 - It presents the estimates of KF in six selected countries. As we can see, the figures from Brazil are not so significant as those relate to Mexico and Venezuela, for instance. This kind of difference is the reason why various authors mention Brazil as a country with low level of KF. It is important to point out that the existence of exchange control, especially on capital market, as mentioned by Mahon, Jr, reduced the presence of "hot-money" in Brazil and consequently the possibility of sources to finance KF.

Nowadays, with a more active and open capital market, stimulated by a privatization plan, Brazil shows more sensibility to international. In fact, as a result of the Asian crisis, Brazilian stock market assets suffered a huge devaluation, and the Brazilian international reserves were reduced by about US$ 8 billions in no more than two weeks of outflows that took place in Oct-97. Besides, the CBB had to almost double the basic interest rate, in order to face the attack against the Real, and to signalize the consistence of its exchange rate.

Table II.1.2 – This table shows the underinvoicing in exports and overinvoicing in imports during the period of 1970-85. The net impact of misinvoicing as a way to promote capital flight is absolutely no significant insofar as the final result after that period is an inflow of US$ 562 millions. However, the practice of misinvoicing in both sides of the international trade operations indicates the failure of the exchange and fiscal controls.

Table II.2 – It shows selected items of the Brazilian Balance of Payments of 1986-96, in order to update the estimates available in the economic literature, which do not go besides 1988. We have to inform that this table presents some inconsistency due to different sources of data. Also, we have had difficult in repeating the same figures presented by some authors researched concerning to years before 1986, what we think is due to modifications in official balance of payments from one year to another. Besides, differences between figures comprised in reports issued by IMF and World Bank for the same title was the commonest problem we faced in our research.

Table II.3 – This table, which was built based on table II.2, intends to give some idea about the behavior of the international capital concerning to Brazil since the end of the last decade. The same warning about the vicious of the figures related to prior table has to be considered for this one too.

As we can observe, based on World Bank measure, after 1987 Brazil continues presenting a tendency of KF although the inflow were very low as shown in table II.2. Only since 1994, when Brazil adopted its stabilization plan called Real Plan and began effectively to open its economy and reduce the controls the international capital began to stay in the country. Despite the situation has been completely reverted in the last two years, when inflows reached huge amounts, in accordance with World Bank measure the total inflow held inside the country in the last eleven years is only US$ 6.804 billions.

Table II.1

III – WHY CAPITAL FLIGHT OCCURS

The main reason we can point out as cause of capital flight, is risk. In this case, it is changing in a level of domestic risk or, from the side of the lender, country risk.

Political and economic elements are considered for specialists to assess the risk of one country. Regularly, institutions like Moody’s, International Investor, Euromoney, Economist Intelligence Unit, and Standard and Poor’s prepare country ratings which influence the foreign investor’s confidence. International banks and big investors have their own structure to assess the risk and can cause problems to one country when they decide to go out or not to lend more money. The figure III.1 below gives idea about how political and economic elements are considered in country risk assessment.

In summary, capital moves from one country to another looking for profit and the possible minimum financial or political risk. The loss of confidence as a consequence of negative economic performance or for political instability increases the sensation of risk what stimulates the investors, including residents, to put their money abroad, moved by fears and suspicion.

As a consequence of problems faced presently by many Asian countries, especially Thailand and Malaysia, the position of the Malaysia Prime Minister stood out against the kind of foreign investors that he called manipulators, instead of speculators or investors, received great attention in the American media.

The Wall Street Journal published in Oct 1997 an article where Mahathir Mohamad, the Malaysia Prime Minister, calls the big international investor George Soros "a moron". He also received space in the media due to his statement in Hong Kong during the World Bank 1997 annual meeting that currency trading was "unnecessary, unproductive and immoral", and his repeated threats to outlaw foreign exchange dealings in Malaysia. His opinion expresses the disgust with the movement of the international capital that goes easily from one country to another provoking serious problems to developing economies, like Malaysia.

Relate to capital flight, there is, in our opinion, a logical economic assumption that has to be considered. In the case of substantial outflow movement, we have a concentration of demand for exchange currency and consequently unexpected supply of domestic currency at the same level determining a devaluation of the exchange rate.

The devaluation tends to attract other investors who are influenced by the idea that the domestic currency can not return to the old equilibrium price. Under this belief are only two possibilities for the domestic currency: stays in its new price consolidating the primary losses for foreigner investors or increases its devaluation, which represents the worst scenario for investors, whose capital decreases indirectly in their currency.

At this moment, to maintain their investments in one country, foreign investors’ confidence in its economy has to be strong and supported by really trusting figures, especially those that signalize the behavior in short and medium-run terms. The tendency is to put their money abroad running quickly away from the increased risk to have their assets reduced not only by the normal forces of the market but also by political measures, in order to restrict outward movements of capital, for instance.

Consequently, the important point is that when the money is coming into the borrowing country it provokes a demand for domestic currency overevaluating it and reducing the international competitiveness of that country’s economy, negatively affecting the export performance. As a consequence, the host country becomes dependent from that capital.

When a concentrated outflow movement takes place, the country is suddenly put in a dependence of money from exports, which responds slower than capital does, provoking tightening of exchange controls, defaults, losing of international creditworthiness, capital flight, and other economic structural problems.

III.1 – International Literature

Cuddington presents the following macroeconomic determinants of capital flight:

• Exchange rate overvaluation, and hence the expectation of major exchange rate realignment;
• High interest rates in the US acting as a ‘magnet’ for foreign capital; and
• The disbursement of new loans to LDCs.

The first determinant we discussed above extensively. About the second one, it seems easy to agree that since investors seek high profit and low risk, the increases in interest rates paid by US Bonds, that is a reference of low credit risk paper in international markets, tends to deviate the money to American financial market.

Regarding the third factor, as supported by other authors as well, would be the major or, at least, a prerequisite for capital flight because new loans increase the availability of foreign exchange needed to effect capital outflows. This kind of relationship between increases in indebtedness and in capital flight is called Asymmetric Risk.

About this third point, Varman-Schneider [1991] asserts that "interest in asymmetric risk associated with developing countries was stimulated when capital-importing countries experienced an asymmetric development in the net foreign asset positions of the public and private sectors. The public sector in capital-importing countries increased its net foreign liabilities by $ 534 billion during 1971-84, while at the same time the private sector strengthened its net foreign asset position by $ 161 billion".

Varman-Schneider continues: "It is generally believed that domestic investors were aware of differences in risks involved in investing at home and abroad". As we can conclude, the asymmetry of risk is in the fact that the more the risk of the country the less the risk of the investors who put their money abroad

Under this opinion, there is an assumption that a dual and contrary movement is necessary to support capital flight movements for a long term. One carrying capital into the country (as a consequence of a public-sector borrowing for example) and other outward supported by the previous borrowing. This idea makes sense with the fact that in general, credits from international organization like IMF are taken just to permit one country to meet their financial compromises.

Interestingly, Mahon, Jr [1996] begins his book with the following observations about the Mexican crises during the 1980s and at the end of 1994:

In addition, Mahon, Jr [1996] continues describing other step of Mexico’s economy history which completes an interesting panel about the behavior of the residents in order to reduce theirs risks of losses: A decade later, in the midst of another financial crisis, the head of Mexico's umbrella group for big business lamented that Mexican nationals were moving their capital out of the country much more quickly than were foreign investors.

Otherwise, nowadays, with the high degree of capital’s mobility, it is very difficult to identify who is the owner of the capital circulating around the world. Mexicans and other Latin American country residents whose countries presented huge amount of capital flight during the 1980s are supposed to have great fortune looking for high profit and low risk in the international market.

Therefore, the central banks and other institutions involved with balance of payments analyzes in all the nations can not affirm consistently which capital comprises the outflow movements. This kind of difficult is deeper in open economies with intense relationship in the international financial community.

For Glyn [1986], quoted by Varmon-Schneider, capital flight occurs when foreign creditors pull their capital out from a country whenever there is a danger of political and economic instability that could lead to the imposition of exchange controls. Domestic residents in general have less to lose than foreigners from the introduction of exchange restrictions.

In conclusion of this part, we present a list of vicious raised by Varman-Schneider [1991], which commonly characterize the political relationship in developing economies and contribute to capital flight:

III.2 – The Brazilian Case

As we have noted before, Brazil is mentioned by many authors as an example of developing country with low capital flight. Therefore, the material explaining the reasons for capital flight in Brazil provided by the economic literature is not sufficiently rich. In general, the specialists in capital flight have preferred to concentrate their studies in our neighbors Mexico and Argentina. As a result, studies concerning capital flight from Brazil, generally, emphasizes discussions over the amounts instead of on its determinants.

Accordingly, the following opinions exemplify our position above. We begin with Lessard and Williamson:

Mahon, Jr [1996], who makes a study concerning mobile capital and development in Latin American, compares the capital flight phenomena in Argentina, Mexico, Venezuela, Brazil, Chile e Colombia and concludes that the different behavior in this six countries during the 1980s can be explained by their different exchange policies.

In the case of Brazil, he suggests that capital flight is related to overevaluated exchange rate, in order to stimulate exports, and to its exchange control regime, especially on capital flow. Also in this case, however, some determinants are examined by the reversal in order to explain why the amounts of capital flight in Brazil’s case differ from the other countries in the study.

Mahon, Jr, who understand the low level of capital flight in Brazil was due to the government intervention (see quotation related to footnote number 4), presents the question "So what accounts for the difference among the six countries considered here?" and answers:

On the other hand, Nembhard points out high inflation and economic instability as cause of capital flight in Brazil. But she also emphasizes that Brazil presents low level of capital flight in consequence of the effectiveness of governmental intervention in the economy with capital control being one of the instruments to accomplish the general intervention.

Her following opinions stresses her position in favor of controls and demonstrates that also in this case the causes of capital flight in Brazil are analyzed incidentally: :

Meyer and Bastos Marques, in "A Fuga de Capital no Brasil", conclude that the accumulation of huge foreign debts, the borrowing allowed fiscal deficit, expansive monetary policy, and appreciated currency were the determinant causes of capital flight in Brazil. Moreover, the authors study demonstrates that capital flight in Brazil responded to the following variables: the real international interest rate, internal economic conditions, changing in politic command, the over past year inflation, and Capital Flight occurred in the year before.

The causes presented by Meyer and Silvia Bastos demonstrate that the capital flight in Brazil had no particular motivation. The reasons they point out indicate that the investors (foreigners and domestics) put their money out of Brazil in order to improve their profits and to reduce their risks, what is perfectly in accordance with the motivations generally accepted as determinants of capital flight elsewhere.

Concerning Brazil risk we present the figure III.2 below which contains some ratings received by Brazil between may-94 and Apr-97. Despite the clear improvements in its political and economical environment, Brazil continues sliding over letter "B" in all the ratings presented. In recent article published by the Brazilian newspaper "Folha de Sao Paulo", Roberto Campos, a former Brazilian Minister of Finance, presents as the main reason for Brazilian classifications the constants failures by the Brazilian government in meeting the obligations, both domestic and international.

IV ANSWERING THE QUESTION

Among the authors we have researched, only Nembhard supports the clear position in favor of exchange controls, in line with other macroeconomic goals, as a way to avoid capital flight. The others in general remark of the negative consequences of exchange control, mainly through illegal operations and corruption, and do not see the exchange control as a solution to retain money inside the countries.

Even Nembhard, however, recognizes that the general economic instability, high levels of inflation, and uncertainty in the exchange rate in the 1980s in Brazil thwarted its ability to adequately control capital flight (which had managed to do in the previous decades). Such high levels of economic instability are believed to be so disruptive that they render capital controls useless. Moreover, this author mentions that "both the economic conditions that may encourage capital flight and capital flight itself increased or worsened in the 1980s in part because of the lack of consistency and coordination of Brazil’s capital control system, and because Brazil’s intervention triad in general was weakened".

In fact, although not agreeing with the general understanding that takes capital flight as a response to economic conditions, we can imply from the Nembhard’s opinion that the validity of capital controls is a dependent variable of macroeconomic conditions. She affirms that exchange controls themselves do not work well if the governmental intervention does not produce good economic conditions in order to stimulate the maintenance of the capital inside the country. In other words, her position would be in accordance with the majority if there was not an ideological vies suggesting that policymakers can avoid economic problems.

Sometimes we can see questions like the following, presented by Bhagwati, that reflects partial effectiveness in exchange controls: "Whether, of course, such flight is still below the level that would occur in the absence of exchange control is an issue that is difficult to settle empirically. We would be inclined to assume that the extra costs of illegal methods of capital outflow tend to reduce its level". This kind of interrogation does not mean, off course, agreement with control policies insofar as the author presents a lot of negative consequences of exchange controls.

On the other hand, we can imply from the various opinions a common sense about "hot-money" which does not create roots in one country and can go out with exchange control or not. Eventually, countries try to avoid huge inflow of this kind of money via taxation or exchange barriers like compulsory deposit, as a classical example of Chile at the beginning of this decade and Brazil, during the Real Plan.

In Chile, at the beginning of this decade, financial authorities imposed a compulsory deposit of 20% over all inflows to the Chilean capital market to reduce the risk of the "hot" money that is invested within the country to profit upon the difference of interest rates. Accordingly that, between August, 1995 and June, 1997, Brazil charged with aliquots of IOF, varying between zero and 7% (discounted from the principal value at the moment of entrance, as a toll), many sort of capital inflows. The aliquot decreased in accordance with increases in maturity.

That kind of attitude were attempts to reduce the amount of money that, conversely, can also run quickly out from one country in a concentrated outflow movement causing macroeconomic problem. That kind of phenomenon was faced by many Asian countries, in particular Thailand, Malaysia, South Korea (that is receiving a financial support from IMF near US$ 50 billions as circulated in various newspapers). In the same domino’s effect, Hong Kong and Brazil were affected as well.

Therefore, authors like Basevi [1985], quoted by Nembhard, suggests that in a world of flexible money and financial markets, and rigid labor and product markets, overshooting reactions of the exchange and interest rates imply that "free trade and perfect capital mobility are a second best solution". He proposes that "efficient international capital markets and freedom of choice in the international allocation of investment are consistent with – and indeed may require – taxation of international capital movements in order to be conducive to the most efficient overall functioning of an economy".

Despite the complexity of this matter to be discussed in this paper, the idea makes sense with the existence of the International Monetary Fund as an organism involved with stabilizing currencies and economies in general. Since the IMF has been expected to act like a world central bank, helping countries with financial problems due to capital flight as well as do central banks with their banks, it [or other similar organism under a new framework] should have to have certain power over international capital mobility. Indeed, as one central bank establish domestic rules to orient its financial market, in order to avoid bankruptcy, we imply we should have international rules with the same purpose concerning countries in this era of total globalization.

About Brazil, we note that the amounts of capital flight presented in the tables included in third chapter occurred under rigid exchange control regimes, i.e. in the case of Brazil the exchange controls did not prevent capital flight. Every time the economic conditions were not able to generate confidence about its future, the capital went away despite the controls.

Moreover, we can imply that the Brazilian authorities had the same opinion at the end of 1980s insofar as we note that, officially, the Floating Market was created in order to, among other important reasons (as to reduce the Parallel Market, for instance), to bring back resident’s money invested abroad.

A common feature in all studies is the acceptance that capital flight is a response to an unstable and uncertain political and/or economical environment. There are fears and suspicions. Instability and uncertainty could arise due to domestic macroeconomic policies, deterioration in the external climate, and/or exogenous political shocks. It is motivated by a desire to avoid domestic financial market.

The conclusion, therefore, is that capital flight is a response to increases in country risk, affecting both international and domestic capital. The form that international investors and part of the residents use to put their money abroad when the sensation of financial crisis take over the minds can vary from country to country in accordance with the level of controls that is adopted. The more tightened and strict is the control the more is the possibility of illegal transactions.

In conclusion, one important lesson we have to take from the large cases of capital flight since the beginning of the 1980’s is that one economy can not be evaluated correctly during the affects of this phenomenon. The movement of capital in specifically concentrated periods of time is more an indicative of the sensibility of investors to short-term problems as well as the facility of transferring money across the world. The capital investors who work arbitrating interest rates and speculating in stock markets and the newspaper headlines taking advantage of their decisions are not the better way to analyze the perspective of one economy in long-terms.

CONSIDERATIONS ABOUT EXCHANGE CONTROLS, CAPITAL FLIGHT AND COUNTRY RISK

BIBLIOGRAPHY

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