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Liberalisation of capital flows
Sorin Hadarca, 16 March 2004
Liberalisation of capital flows has been right from the beginning a rather controversial issue in the Moldovan foreign exchange policy. Restrictions on capital flow imposed on Moldovan citizens stem from the efforts undertaken by authorities at the dawns of independence in order to keep a stable exchange rate of the national currency. At that time, still ravaged by hyperinflation that had outburst before the introduction of the Moldovan Lei and conversion of Moldovan Rubbles, coupons and, finally, Lei into US Dollars or goods, putting obstacles to the currency outflow was deemed quite legitimate.
Later on, in the aftermath of the regional crisis that culminated in Moldova with the floating of the Leu, liberalisation of capital flows became a rather thorny issue and has remained ever since a taboo. Noteworthy, Moldova is not alone in this experience; almost all the former soviet countries do have a rather restrictive foreign exchange policy. Teetering between Turkmenistan and Belarus at one end and Armenia and Baltic States on the other, Moldova is somewhere in the middle with a relatively opened foreign exchange regime. Indeed, existing restrictions are somewhat asymmetric in that they envisage mainly the citizens of the Republic of Moldova, whereas non-residents are free to pull away their capital.
This "asymmetry" of right was aimed at establishing a favourable climate for the foreign investments. Indeed, non-residents may freely make direct and portfolio investments and they may also credit domestic businesses. Similarly, non-residents are guaranteed the right to unconditionally repatriate investments at their own will. The only thing non-residents might complain about is the obligation to form the registered capital in Moldovan Lei (that has been scaring away foreign banks for many years) and limitations on their participation in the T-bills auctions at less than one third of the face value. The latter is rather formal given that since 1998 the share of non-residents holders of T-bills has been almost null. Binding registration of any foreign obligations is frequently cited as a restriction on capital inflow, however one should admit that it is more of statistics and refers explicitly to the debtor resident's obligation to register the credit under the established terms rather than that of the non-resident.
Under a closer scrutiny one might find that such type of restriction on foreign currency flow has proven to be inefficient. The countries that in the past had (or even now have) closed foreign exchange regime have pursued such economic policies for some reasons.
One of those reasons was to limit the free circulation of capital across the border in order to protect foreign currency and financial market from external currency fluctuations. In this respect, a number of countries (such as Chile) have limited one way or another, the short-term portfolio and credit investments. For instance, Chile used to require a deposit equal to one quarter of the investment to be made in the central bank for a one-year period. The reasoning behind those measures was that short-term investments are the first to flee the country at the slightest sign of danger, thereby severely affecting foreign exchange and financial markets. Other countries have limited foreign capital access to certain industries of strategic importance for the country. Venezuela and Turkey are eloquent illustrations in this respect.
Moldova is totally different from the two groups. The incipient financial market is in itself a shield against any foreign currency shocks. Similarly, any investment, regardless of the industry it goes to, is more than welcomed. Under these circumstances, foreign currency restrictions are targeted at those citizens of Moldova able to invest their savings solely within the Republic. Natural entities are entitled to open deposits in the commercial banks of Moldova both in US Dollars and Lei, whereas businesses are entitled to make investments only in Moldovan Lei. They have access to foreign exchange market only in as far as satisfying their demand for foreign currency so as to cover for import transactions, whereas the sale of foreign currency is absolutely free. Another restriction somehow related to capital account is the obligation to repatriate revenues earned from exports. To conclude, Moldova is the one and only destination for domestic capital.
This state of affairs has a number of drawbacks, in particular:
- Asymmetric liberalisation of the capital account does not shield foreign exchange and financial market from the foreign shocks;
- Forbidding access to foreign financial markets infringes on the domestic investor's freedom and reduces the value accrual capacity at the local level;
- Impossibility to open deposits abroad decreases the competition between domestic commercial banks and foreign ones, that in turn brings about wide-scale coalitions that set fat commissions;
- Distortion of the exchange rate via asymmetric access of participants to foreign exchange market;
- Restrictions boost black market of services of the kind as well as ingenuity in evading the law, thereby playing against the honest ones;
- Bureaucratic burden stemmed from the need to keep costly system of tracing transactions with non-residents, which decreases banks' overall efficiency and incurs additional costs to businesses;
- Finally, existing restrictions run against the EU spirit, which Moldova seeks to join and therefore are to be abolished anyway sooner or later.
It is all-too-clear that the current system bears a number of strong points as well, among others the system is operational, to say the least, it is familiar to businessmen and banking clerks alike. It also allows keeping an updated record of clients and helps fight money laundering. However, the aforesaid benefits miss the target as initially the restrictions were established for totally different reasons.
We should give the credit to the National Bank, which has recently developed a number of modifications to the legal provisions with an eye towards, if not total liberalisation of the market, then at least modernisation of existing mechanism. It refrains from radical changes of the legal framework, though sets the course on liberalisation. In my opinion, liberalisation should be done at a large scale. Interconnectedness of economic processes impairs the efficiency of a partial liberalisation and imposes new requirements. Moreover, partial liberalisation would allow using the opened channels to avoid still existing restrictions. Total liberalisation would enable us to avoid those handicaps. Noteworthy, the effects of wide-scale liberalisation would not affect us immediately as normally economic transactions are tied to rigid terms of maturity.
The current situation on the foreign exchange market provides a unique opportunity to implement such a policy. Sooner or later, upon EU accession, liberalisation of capital flows would be a must for Moldova anyway. Therefore, we might as well consider undertaking such a step while we still can, without being under pressure which is the common case here. Therefore Moldova might want to seize this opportunity and be back on track in the global capital marketplace, which it has gone astray for so long.