Capital Controls in Chile

Capital Controls in Chile

FIN626 Emerging Markets Finance

Li Wang

2015. 03. 14

Why did Chile institute capital controls in 1991? Did the controls meet their objectives? What was the role of other policies in Chile’s economic success in the 1990s?

The capital controls in Chile basically experienced three stages: 1974-1982, 1983-1989, and 1991-1997.

After the debt crisis in 1982, Chile recovered quickly which was based on a rapid expansion of exports, driven both by Chile’s trade liberalization strategy and the country’s ability to maintain a depreciated exchange rate. Chile’s well-performed growth rates encouraged foreign investors to invest in Chile which led to Chile’s economy overheating.

The excessive capital inflows threatened the Chile Central Bank’s ability to manage the exchange rate within a crawling band, which aimed eventually to lower Chile’s rate of inflation to international levels. To reduce the massive flows of foreign investment coming into the country, Chile in 1991 adopted a framework of capital control. In other word, Chile kept out the short-term hot money to prevent rising inflation of its own currency.

At the heart of Chile’s capital controls framework was unremunerated reserve requirement known as the encaje, which required foreigners to make a deposit equivalent to a percentage of the value of their investments with the central bank at zero interest for one year. The capital control can be seen as successful because it shifted the composition of inflows to a longer maturity and curbed the flow of speculative funds into the country. Until the Asian financial crisis of 1997 and the Russian debt crisis of August 1998, the Chilean economy performed spectacularly under the controls. However, some people argued that “the objectives were only partially achieved and only in the short run” (Edwards, 2005)

Other policies included prudential financial regulation, strong fiscal and monetary policy. They pointed to the apparent ineffectiveness...