Capital control is defined as a type of measure governments can use to regulate and restrict the amount of money flowing from capital markets in order to keep inflation under control while maintaining a competitive real exchange rate. International Monetary Fund (IMF) has been slowly shifting its beliefs to where capital control policies can be deemed useful for countries during a potential crisis. Some countries, especially the developing ones that implemented capital control policies have experienced success in the recovery of the economy upon the face of unfavorable economic conditions. This paper will explore on the cost and benefits of developing countries adopting capital controls during a recession, a case study on Malaysia’s…show more content… As a result, it raises volatility in consumption and income for these investors, as the investment portfolios is not fully diversified due to a lack of international investments to reduce other systematical risks.
II. Benefits of developing countries adopting capital controls
Capital restriction on inflows helps avoid foreign financing, restricting developing countries from being too dependent and vulnerable to sudden stops of capital inflow, which may lead to a financial crisis if the country is too reliant on such financing. The implementation of capital controls may help with the expansion of financial markets with improved development objectives, as well as reducing the growth and fuelling of asset bubbles (Cordoro and Montecino 4). Capital controls omits the possibility of investing in capital inflows inefficiently, thus does not triggers market distortions in a situation of over-investment in certain markets such as the recent burst of the dot com and housing bubble within the economy.
Adopting capital controls have allowed developing countries with the ability to pursue a more independent monetary policy. This has led to positive GDP growth due to the promotion of stability in prices and reaching the level of sustainable output and employment growth. The implementation of capital controls prevents a large volume of capital inflow, avoiding the appreciation of the