Reining capital in

Egypt is liberalising trade, but, Salah El-Amrousy argues, it does not need to liberalise capital movements
One of the ironies of monetary policy in Egypt is that, at a time when we are complaining of foreign exchange shortages and griping over the attending woes of the Egyptian pound, we are keeping various channels wide-open for foreign currency to leave the country, thus complicating the crisis.
During the crisis (or crises) of 2001, bankers estimate that $3bn have been transferred abroad from Egyptian bank accounts within the period of three months (August-October). The transfers were made in many forms, but all of them passed through a perfectly legal channel that is in place due to the liberalisation of capital account. Some of the transfers may have been tainted with fraud, as in the case of the loans obtained by politically influential business magnates. But all the funds found their way abroad through this legitimate channel.
There is another channel that may be considered an indirect form of capital flight. The income accrued through exports and tourism is under no obligation to return to the country. And, there is a tacit official admission that exporters and tourist agents tend to keep their earnings abroad. Economist Mohayya Zeitun notes that the gap between the revenues of tourism (as estimated by the Ministry of Tourism) and the actual foreign funds going through the banking system was approximately $3bn in 1999/ 2000. The figure, however, could have been inflated due to exaggerated estimates by the Ministry of Tourism.
The question is: Can we close these channels without jettisoning liberal economic and monetary policy as a whole? In other words, is the Egyptian government obliged to keep these channels open in the context of the liberalisation of capital and current accounts in the balance of payments? Also, what are the benefits accrued from the types of liberalisation that keep these channels open? And, are these benefits real or imaginary?
First of all, it is necessary to point out that liberal economic policies should not be viewed as an indivisible whole, or as involving equal degrees of international commitment. For example, the crucial liberalisation of trade (mostly goods) was a requirement of the GATT and, later on, the WTO. In contrast, the liberalisation of capital (capital account, transfers related to the balance of payments), is not required by any international treaty to date. The latter involves a number of elements and forms that can be selectively liberalised.
There is also confusion between the liberalisation of the capital movement and the liberalisation of monetary exchange. The removal of control on the exchange rates has been viewed as equivalent to the removal of control on the movement of capital. This is not the case. It is possible to liberalise the exchange rate and retain certain forms of control on capital movements. There are many countries that have taken large strides toward economic liberalism (abandoning restrictions on the exchange rate in the process) but still regulate capital movements. I will go back to this point further down.
Egypt liberalised its exchange rate in 1991. It simultaneously engaged in near liberalisation of the current account and capital account transactions. This happened despite the fact that the commitments concomitant with Egypt's IMF membership do not entail all these liberal measures. In a study entitled "The Conduct of Monetary Policy with Open Capital Account: A Case Study on Egypt", Fayqa El-Rifa'i, a former senior official of the Central Bank, notes that the IMF Articles of Agreement do not entail commitments about the liberalisation of the capital account or about allowing exporters of goods and services to keep their earnings of foreign currency abroad. Article VIII of the said agreement merely calls for the removal of restrictions on current payments, the avoidance of discriminating treatment of various currencies, and the transferability of foreign currency earnings. Egypt, Al-Rifa'i points out, liberalised not only the current account, but the capital account as well. The reason for this extra measure, which is not required by official international commitments, as everyone knows, is pressure from the World Bank and the IMF, as well as from the US government, the latter forever eager to defend the interests of multinationals and encourage the hegemony of financial capital.
The liberalisation of the capital account was not completely without reason. Certain gains were expected. The move was seen as an incentive for foreign investment in the country and a signal for Egyptians keeping their money (totalling $100bn, in one estimate) abroad to bring it back home. The outcome of the move was disappointing. According to figures cited in the above- mentioned Al- Rifa'i study, foreign direct investment (FDI) decreased after the introduction of monetary deregulation and the liberalisation of the capital account. With the exception of 1993/ 94, FDI continued to drop steadily, reaching in 1995/ 96 half its level in 1989/90. In later years, FDI did not exceed what it was in the year previous to the liberalisation of the capital account. (see table)
This provides solid proof that the legal climate, tax exemptions, preferential treatment, and excessive economic liberalism are not decisive in attracting foreign investment. What is crucial for capital is to achieve the highest possible rate of return. This can only happen in an economy that is vibrant and growing. It does not happen in a slumberous economy that is waiting for foreign capital to inject life in it.
Not only have the expected gains failed to materialise, but a reverse flow of capital has occurred. Bank savings were transferred abroad and export and tourism earnings were kept outside the country. There is another negative factor, although its perils remain in check due to the weakness of the Egyptian economy. The liberalisation of the capital account gives local companies the opportunity to contract short-term loans in international markets. It also allows foreign capital to keep a portfolio of Egyptian securities. This kind of investment, by its very nature, is short- term. In Egypt, it amounts to 30-45 per cent of total stock market transactions. The negative effects of this form of investment have not been significant due to the small scale of stock market transactions. In other words, what protected the Egyptian economy from the perils associated with the flight of speculative capital is the stagnation and weakness of the Egyptian economy. This does not mean that we can ignore the perils associated with such transactions in a developing (or hopefully developing) country such as Egypt.
Let us take a look at the case of India, a country that took big steps, as Egypt did, toward economic liberalism in the early 1990s. In 1991, India devalued the rupee by about 20 per cent. In March 1992, it adopted a dual market system. In 1993/94, it introduced a unified exchange rate and liberated current account transactions, making it possible for exporters and foreign exchange earners to transfer 100 per cent of their foreign currency earnings at market rate. It simultaneously cancelled import licences, lowered customs duties, etc. But the government was cautious about liberalising transactions in the capital account. It wanted to liberalise this account at a later stage, once the right conditions for such a move were met. Capital transfers, inside and outside the country, were freed only for non- residents and FDI. Portfolio investment was allowed but only for foreign institutional investors: e.g. investment and insurance funds.
In early 1994, the Indian government signed an international agreement making the current account completely free. But, after the Mexican crisis, there has been a substantial slowdown in the flow of capital into the country. Current account deficit and the dollar rose simultaneously. The rupee was devalued by 9 per cent between August and October 1995. These setbacks did not weaken the government's resolve to press ahead with liberalisation. In order to make up for the losses of currency reserves and attract foreign capital, the Indian government took several deregulatory measures, but held back on certain points. First, transfer of funds by residents abroad was strictly controlled. Second, portfolio investment remained the domain of foreign investment institutions, and their activities remained confined to listed securities and government bonds. Third, borrowing from abroad by Indian companies was placed under the strict supervision of the Ministry of Finance. Fourth, restrictions were placed on the use of loans (productive purposes only) and on the terms of loans (long-term only). Fifth, a nationwide ceiling of foreign borrowing was introduced, with banks prohibited from maintaining foreign obligations without government approval, and with short-term borrowing altogether banned.
These precautionary measures were crucial in protecting the Indian economy from the Asian crisis. Following the crisis, India reconsidered its previous plans to press ahead with the liberalisation of the capital account of the balance of payments. In general, the Indian case tells us that it is possible to introduce a selective liberalisation of capital movements, by encouraging the flow of investment into the country and banning or restraining its departure; by encouraging long-term investment (FDI) and limiting short-term investment (portfolio); and by banning short-term loans and allowing loans for strictly productive purposes.
Hot money (short-term loans, portfolio investment) has been the prime suspect in the Asian crisis, which devastated the economies of Thailand, Indonesia, Malaysia, and South Korea in the second half of 1997. The crisis later affected Brazil and Russia and was set to cripple world economy. The Asian countries involved are the same ones that liberalised the capital account in the early 1990s, under pressures from the IMF and the US administration. Hot money flowed into these countries at breakneck speed, prompted by the spectacular rates of growth achieved there. But at the first sign of a slowdown, the trend was reversed. The staggering speed of capital flight from these countries brought their currencies crashing. Of course, the Asian crisis was at heart one of excess production, a profoundly capitalist phenomenon rather than a mere monetary hiccup. But the removal of restrictions on the movement of capital, particularly hot money, and other measures associated with global liberalism, deepened the crisis and enlarged its scale.
The Asian crisis triggered a debate within the so-called Washington Consensus. A group of neo-classical economists, including Joseph Stiglitz, deputy director of the World Bank, made scathing remarks about the liberalisation of capital movements and the way the World Bank continued to press Asian countries, already reeling from the crisis, for further liberalisation. In an open letter to Fortune (September 1998), Paul Krugman, a staunch neo-classical writer, supported Malaysia's rejection of IMF conditions to a rescue package. Malaysia opted for a belated control of capital movements and was thus able to survive the crisis, without IMF loans and conditions.
Writing in Foreign Affairs (May-June 1998), another neo-classical economist, Jagdish Bhagwati, waged a broadside assault on the free movement of capital. Renewing his commitment to free trade, Bhagwati pointed out that, prior to the Asian crisis, many viewed free capital movement as something of common benefit to nations, just as free trade in goods and services. The argument was that restrictions on capital movement, just as trade barriers, constitute a harmful economic practice to all countries, rich and poor. The Asian crisis cast a shadow on the perceived benefit of free capital movement.
Bhagwati mentioned the effect a certain ideology and interests had on this policy. The free market ideology flourished with the abandonment of central planning systems. This ideology, Bhagwati maintained, may be promising for world prosperity, but it enhanced the self-satisfaction of Washington-based economists and decision-makers, making them unable to identify the problems associated with certain markets. There are also vested interests in the US Treasury-Wall Street-IMF complex that press for the removal of restrictions on capital movement.
Wall Street, Bhagwati pointed out, exercises extraordinary influence over Washington for a simple reason. There is an influential, like-minded elite that controls the key positions in the US Treasury, the US administration, the IMF, and the World Bank. Bhagwati's mildly- worded criticism confirms one of the old Marxist premises concerning the hegemony of financial capital on world economy. Financial capital is engaged in worldwide speculation and, therefore, seeks to remove barriers to its cross- border movement.
Based on all the above, it is clearly possible, in theory, to take apart the chain of liberal policies and adopt its elements selectively. It is especially feasible to continue regulating the movement of capital even after large strides have been made toward the liberalisation of trade and foreign exchange. There are no international agreements forcing any country to cede control on capital movements. The whole issue is one of submission to the pressures of the World Bank and the IMF, both influenced by the US interests. National interests in developing countries are in direct and complete opposition to the freedom of capital movement, for the latter only benefits multinational and international financial capital.
Some would argue that any change in the current policy, by placing restrictions on the transfer of savings abroad or by bringing back the earnings of tourism and exports, would be a disaster, for it would undermine confidence in the health of the domestic economy. It is almost certain that foreign business confidence will be shaken, but this will not amount to a crisis, and will only be temporary. If such measures are linked to a viable strategy of development and industrialisation, confidence will be restored.
The question, in fact, is one of political dimensions. It is related to local as well as international class alliances. It is related to the measure of independence the state has versus the capitalist strata, those with the vested interest in maintaining the status quo.
The writer is a researcher with the Arab Research Centre.
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