International Borrowing, Capital Controls and the Exchange Rate: Lessons from Chile

Abstract

This paper analyzes the Chilean experience with capital flows. We discuss the role played by capital controls, financial regulations and the exchange rate regime. The focus is on the period after 1990, the period when Chile returned to international capital markets. We also discuss the early 80s, where a currency collapse triggered a financial crisis in Chile, despite stricter capital controls on inflows than the 90s and tighter currency matching requirements on the banking sector. We conclude that financial regulation and the exchange rate regime are at the center of capital inflows experiences and financial vulnerabilities. Rigid exchange rates induce vulnerabilities, which may lead to sharp capital account reversals. We also discuss three important characteristics of the Chilean experience since the 90s. The first is the fact that most international borrowing is done directly by corporations and it is not intermediated by the banking system. The second is the implication of the free trade agreement of Chilean and the US regarding capital controls. Finally, we examine the Chilean experience following the Asian-Russia crisis, showing that Chile did not suffer a sudden-stop, but a current account reversal due to policy reactions and a sudden-start in capital outflows.

Systemic Sudden Stops: The Relevance Of Balance-Sheet Effects And Financial Integration

“…12 This analysis does find that under some definitions of currency crisis, and particularly excluding African countries, current account deficits are a significant determinant of the probability of experiencing currency crises. Cowan and De Gregorio (2005) that for the case of Chile, much of the movement in the capital account balance is due to changes in gross flows stemming from residents. For a restricted sample of countries, they find that many of the net capital flow reversals are due to transactions made by residents (although more than half of their episodes are still due to transactions made by foreigners).…”

Flexible Exchange Rate with Inflation Targeting in Chile: Experience and Issues

“…See Cifuentes et al (2002) for a review of the Chilean financial market. See Cowan and De Gregorio (2005) for discussion of capital controls and their interplay with exchange rate policy.…”

A New Taxonomy of Sudden Stops: Which Sudden Stops Should Countries Be Most Concerned About?

“…Cowan and De Gregorio (2007), Calderón and Kubota (2013), Rothenberg and Warnock (2011) and Forbes and Warnock (2012) are examples of recent papers that consider the role of Gross Capital Flows in the determination of Sudden Stops. These papers have established that there are different determinants of Sudden Stops that are caused by domestic vis-à-vis foreign investors, depending among other things on the roles of external vis-à-vis country idiosyncratic factors.…”