REMOVE EXCHANGE CONTROLS – BARBADOS NOT READY

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1. The Removal of Exchange Controls

David Thompson states, “The Prime Minister main economic strategy outlined in the budget is the removal of all exchange controls with respect to CARICOM by the end of the year and the further removal in respect to the rest of the world to follow. By doing this he is making a significant gamble (quite similar to all those Barbadians who invested significant amounts of money in the local lottery with the hopes of winning the multimillion dollar jackpot). He is making the assumption that the freeing up of exchange controls and thereby increasing our financial openness would result in a greater flow of capital into our domestic economy, which would give, rise to increased domestic investment and economic growth. However, this is a very bold and risky assumption in which I have some fundamental problems.

The experience of the past two decades of many developing countries have has found this assumption to be false and many of those potential benefits desired have placed these countries at significant financial risk and collapse.

Firstly, there is ample historical evidence to suggest that periods of strong cross-border capital flows tend to be highly concentrated to a small number of recipient countries. The increase in capital inflows in recent times, for instance, was directed to only a small number of large, middle-income countries of Latin America and Asia. Thus, despite Barbados may liberalize its financial system to attract capital it may not benefit from any influx of foreign capital but what is likely to happen is that capital might flow out of the country seeking better investment opportunities. Recently we heard of some large local investors indicating that they are seeking new investments in other regional economies in appose to Barbados, this will unfortunately increasing become the trend. Thus instead of attracting capital we may find ourselves even more capital scarce.

Secondly, if we follow the Minister’s assumption that greater capital will flow into the country and will have a positive impact on domestic investment (an assumption that is very faulty), the impact of those investments on long-run growth in Barbados may be limited, if such inflows are used to finance speculative or low-quality domestic investments such as investments in the real estate sector. Over time low-productivity investments in the non-tradables sector may reduce the economy’s capacity to export and lead to growing external imbalances.

Thirdly, if the large capital inflows are in fact achieved induced by our greater financial openness this can have some significant undesirable macroeconomic effects, including rapid monetary expansion, due to the difficulty and cost of pursuing aggressive sterilization policies, further inflationary pressures, resulting from the effect of capital inflows on domestic spending, real exchange rate appreciation, and widening current account deficits. Under a flexible exchange rate, growing external deficits tend to bring about a currency depreciation, which may eventually lead to a realignment of relative prices and induce a self-correcting movements in trade flows. By contrast, under Barbados’ fixed exchange rate regime, losses in competitiveness and growing external imbalances can erode confidence in the viability and sustainability, of the exchange rate peg, thus precipitate a currency crisis and increased financial instability.

Fourthly, small developing economies such as Barbados are often rationed out of world capital markets. Barbados may indeed be able to borrow only in ‘good times’, whereas in ‘bad times’ the country may face credit constraints. Access may thus be pro-cyclical. Clearly, in such conditions, one of the alleged benefits of accessing world capital markets – the ability to borrow to smooth consumption in the face of temporary adverse shocks – is not probable. Pro-cyclicality may, in fact, have a perverse effect and increase macroeconomic instability. Furthermore, favourable shocks may attract large capital flows and encourage local consumption and spending at levels that are unsustainable in the long term, forcing the country to over-adjust when an adverse shock hits.

Fifthly, a the removal of our exchange control arrangements may also be conducive to a high degree of volatility in capital movements, a specific manifestation of this being large reversals in short-term flows, associated with speculative pressures on the domestic currency. The possibility of large reversals of short-term capital flows raises the risk that borrowers may face costly “liquidity runs”. The higher the level of our short-term debt is, relative to Barbados’ international reserves, the greater the risk such runs will occur. High levels of short-term liabilities intermediated by the financial system also create risks of bank runs and systemic financial crises.

I want to say that despite we may see an initial inflow of capital into the banking sector, if the financial sector continues to engage in its present lending practices, this will have very little benefits to the ordinary Bajan and small businesses and entrepreneurs. The local banks may continue to ration credit to small firms, which tend to operate in the non-tradables sector and concentrate instead on larger and stronger ones companies. If banks do indeed continue to follow a strategy of concentrating their lending operations only to the most creditworthy corporate (and, to a lesser extent, households) borrowers, their presence will be less likely to contribute to an overall increase in efficiency in the financial sector. More importantly, by leading to a higher degree of credit rationing to small business and entrepreneurs, they may have an adverse effect on output, employment, and income distribution in our economy. He finds support with his assertions with a letter to the editor. (see letter below)

Exchange controls aiding in fight against money laundering
Web Posted – Mon Apr 02 2007
I BELIEVE I am correct in saying that in the most recent budgetary proposals, the Prime Minister declared his intention to liberalise exchange controls so as to bring Barbados in line with its regional counterparts. Others, better qualified than I am, have commented on the implications this could have for Barbados fixed exchange rate, that is, the likelihood of a devaluation of the Barbados dollar. However, I wish to examine this matter from a different angle. The liberalisation of exchange controls will facilitate the free movement of capital. In essence, persons will be able to move money in and out of the country at will and without reference to the Central Bank of Barbados or anybody else. Such freedom is a dream for investors, as well as others who have an interest in the quick and easy movement of money. Governments the world over have had to erect elaborate structures in order to track money that is directed towards the financing of terrorism and to prevent or detect money laundering. For Barbados, one ally has been well appointed exchange control mechanisms.

The definition of money laundering used by Barbados includes a person who brings into or sends out of Barbados any money or other property that is proceeds of crime. This approach was used because it was recognised that for a country like Barbados, the devastating effects of money laundering were as likely to be felt through the cross border movement of money as in its domestic occurrence.

Barbados promotes itself as a regional financial hub, which it can do successfully, for as far as offshore financial centres go, Barbados has a sterling reputation. This reputation has been won through the excellent quality of the public servants who manage this sector and the transparent nature of most of our operations. Our checks and balances that facilitate legitimate business while making effective due diligence possible have been a strong selling point for this country, for this is the ideal mix for persons with a genuine interest in conducting legitimate business through an offshore jurisdiction. Our exchange control provisions have probably calmed the fears of many persons who may have otherwise laboured under the misinformation put out by First World jurisdictions with an interest in sullying our fine reputation.

These same exchange controls have allowed us to defend ourselves against the prying of external agencies such as the International Monetary Fund and the World Bank, as well as the Caribbean Financial Action Task Force, who would otherwise have found fault with our system.

The disappearance of exchange controls will mean that the small staff of the Financial Intelligence Unit will have little opportunity to prevent the movement of dirty money out of Barbados or identify clean funds that may be directed towards unwholesome purposes. The best they may be able to do is to say where the money went, and this may only be possible where there is no financial institution complicity in the illegal process.

This is not the forum for delving into the specifics of the many challenges that may be presented. Suffice it to say, the removal of exchange controls could make Barbados a considerably softer jurisdiction for successful money laundering and potential terrorism financing.

This should be viewed against the background of persistent rumours of a number of persons who may be wealthier than their known income could justify, and this is not limited to political figures. This should all be seen in the context of the absence of integrity legislation and the fact that such legislation, even where it exists, usually targets only public individuals.

A Transparency Interna-tional report rated Barbados highly in terms of the perception of corruption. That is good for Barbados, but we must bear in mind that it was a measure of perception and not reality. Further, it merely tells us that there is a perception that others are more corrupt than we are. If we had a good understanding of what happens in some other countries that we are rated above, we may understand that a superior rating to them may not be anything to write home about.

Guyson Mayers:

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