The Liberalization Capital Account in Romania and Its Implications

THE LIBERALIZATION CAPITAL ACCOUNT IN ROMANIA AND ITS IMPLICATIONS

Roxana NANU, Lecturer, PhD.

Ramona GRUESCU, Lecturer, PhD.

Radu BUZIERNESCU, Lecturer, PhD.

University of Craiova

Keywords: capital account, liberalization stages, implications

1.Theoretical basis:

In recent years the studies of phenomena linked to the balance of cash payment and especially of capital account have grown seriously both in academic domain and inside international organizations such as International Monetary Capital, OECD, European Commission. I have also seen that although numerous studies on liberalization of capital account have been pursued, there is still controversy regarding the advantages and the means of staging of this operation.

From the theoretical point of view the necessity of the liberalization of capital account is based on the fact that the free circulation of the capital promotes an efficient sharing of the economies at the global level and a better diversification of the financial risks. Thus, the liberalization of the capital account can bring a major contribution to the process of economical growth and social welfare.

In the scientific literature numerous models have been published of competitiveness and financial market highlighted the fact that the opening of capital account can make the process of economical growth more rapid especially through free capital circulation but opposed points of view have emphasized some risks of an open capital account. Thus we have highlighted the fact that due to the existence of an informational asymmetry on the capital market, the liberalization of capital account doesn’t necessarily lead to a better resource sharing, especially when the respective markets are characterized by major distortions.

In economists circle they spread the opinion according to witch an emergent economy shouldn’t liberalize the capital account which can lead to an increase of concentration on the market and the market power of some firms but can generate conditions of economical instability growth, when the periods of enthusiasm and accelerated development are followed by strong crises and stagnation.

Thus, it results that a country should not proceed to completely liberalize the capital account if the country can’t:

-Keep the inflation under control, equilibrate the exchange course and obtain enough external economical credibility.

-Set the budgetary deficiency and the extra budgetary engagements of the state under reasonable limits.

-Ensure the satisfactory level of the financial system and implement efficient prudential rules.

-Strengthen the competition policy.

-Introduce an efficient informational and statistical system.

Understanding the advantage of liberalization of capital account, a series of countries, especially economically developed countries, has proceeded on liberalizing the capital account starting with the second half of 70’s. In a study elaborated and presented in 2001 at Annual Meeting of American Political Science Association from San Francisco by YaleUniversity reaches, they analyze the determining factors that lead countries to the liberalization of capital account.

Thus, they show that countries that practice fixed exchange course are less tempted to liberalize their capital account. The same thing can be discussed about the countries that are strongly connected to the global economy.

In the same study, they demonstrate the fact that the trend of liberalization of capital account is determined, among their factors, by the level of democratically structures of the country, by the amount of the public sector in the economy of that country. Thus, the authors of the study shows that the counties were the amount of the public sector is raised possess in general a reduced trend for the liberalization of capital account.

2. Experience in the liberalization of capital account

The process of like liberalization in OCDE countries started in 1964 with the liberalization of fluxes on long term and the entrance of direct investments; the investments in collective titles have been liberalized only at the beginning of the ‘90s. The five new members of OCDE were asked to open their capital account on their adherence. In three of these countries severe financial crises have been noticed shortly after the opening of the capital account as such:

- Mexico adopted the majority of the liberalization in 1989 and 1990 and has finalized the liberalization until 1994. Untill the end of that year, because of the high over exceeding level of the exchange course, massive capital entrances and in the context of the inconclusiveness, structural and financial macroeconomical problems, Mexico confronted a severe crisis that led to the fall of the exchange course and the declaration of the incapacity of payment of the external debt.

-Korea introduced the liberalization of capital account in 1991 and 1992 and ended the process in 1997. The financial crisis started a year later as a result of the poor managed credit risk and due to some aspect of corruption.

- The CzechRepublic realized in a great amount the liberalization of capital account in 1995-1996. As a consequence capital fluxes have penetrated in the country as 16% of GDP (Grow Domestic Product)witch led to a new currency crisis and to a period of recession.

In the other new OCDE member countries, Hungary and Poland, a series of restrictions have been maintained on short term. Thus, in Hungary they proceeded to a rigorous program of liberalization in 1996 that ended in the middle of 1998; this program has been adjusted and completed by measures of macro-economical adjustment including the growth of budgetary constraints of firms, the acceleration of the private domain, and the introduction of a band of variation of the exchange course. The first stage of liberalization included the direct foreign investments, the selling and buying of the non-residents of titles of maturity older than a year, the financial credits of non-residents and the personal movements of capital. The second stage raised the restrictions over the buying by residents of titles issued in OCDE countries and over the local issue of titles from the OCDE countries with a maturity over a yearlong. The foreign imobiliary buying has been permitted in the third stage and they forbid the external transactions in national currency and the transactions in currency among residents. Also, in Poland, the external financial credits remained restrained, towards non-banking entities with maturity younger than one year ago.

The briefing of the experience regarding the liberalization of capital account suggest that where the liberalization has been very rapid, the financial crisis came shortly after , while a more gradual approach was more successful.

1. The liberalization of capital account in Romania

Starting from the experience of other countries in the process of liberalization in Romania, too, this process started in 1991, with the Law of Foreign Investment, but we can speak about a staging of it only in 1998, at the same time with the assuming by Romania of the obligations held by Article VIII from the State of Monetary Capital, correlated with the adherence to EU.

The stages of liberalization of capital in Romania

The stage of liberalization / Year / Operation representing fluxes of capital
The liberalization of direct and real-estate investments of residents abroad and of personal capital flows and other capital flows.
Stage I. / 2001 / -direct investments of residents abroad
- real-estate investments of residents abroad
- the admission of national mobiliary values on the foreign capital market
- guarantees granted by non-residents to residents
- presents dowry, inheritance and legacy.
- other transfer representing other capital flows.
Liberalization of capital flow linked to the development of insurance contracts and the other capital flows with significant influence over the real economy.
Stage II / 2002 / - the admission of the unities of collective placement organisms on a foreign capital market
- credits on long and medium term, linked to commercial transactions or of services, granted by residents to non-residents
- premiums and payments linked to the development of contacts of life insurance, credit, other transfer in insurance contracts.
- physical import and export of financial assets representing mobiliary values and means of payment, except those in cash.
2003 / - the buying by residents of foreign mobiliary values and unities of collective placement organism
- financial loans and credits with pay-back terms shorter than a year granted by non-residents to residents
- financial loans and credits, guarantees granted by residents to non-residents
- capital movements with personal character representing loans granted by residents to non residents.
2004 / -the admission of foreign mobiliary values on national capital markets.
- the admission of collective placement organisms unities on motional capital market
- the physical import and export of financial assets representing means of payment in cash.
Liberalization of capital operations with significant impact over pay balance.
Stage III / 2005 / - the access of residents to term bank deposits in lei
- the residents right of opening bank accounts abroad and to make a series of operations abroad without the approval of RNB, except derivatives transactions
2006 / - non-residents access to state obligations in lei/national currency issued by Financial Ministry.
- non-residents access to treasury certificates in national currency issued by Financial Ministry.
-up to adherence date / - the access of non-residents to monetary market instruments.

Contrary to the pessimistic expectations expressed by some economical analysts, we can say that the last stage of liberalization of capital fluxes developed under normal limits, without leading to currency seism.

The liberalization of the exchange currency and of capital account stimulated considerable capital entrance, as a result of both short term investments (hot money) and medium or long term investments.

In that which concerns the short term capital entrance, representing speculative fluxes, their evolution must be attentively followed because they are quite volatile and can create instability episodes on the currency market.

Fig, 1. Capital entrance in Romania (mil. Euro)

Source: RNB

These capital fluxes can generate currency crisis as those in South America, South-East Asia. The graphic shows that the highest level of portfolio investments in Romania took place in 1996 and 1997, as a result of the foundation of Bucharest Stock Exchange of Values and RASDAQ market. In the following years the situation changed because of Romania’s problem with the external debt and due to the crisis confronted by Russia and as a consequence in 1999 there were exits of capital from Romania, the balance account of foreign portfolio investments being negative.

Special attention is given in Romania to the efficient management of capital fluxes especially those with impact over the Payment Balance. Thus, taking into consideration the negative effects the liberalization of capital account might generate, but also the international experience, the macro-economical body of decision must ensure a series of measures, considered by specialists, of crucial importance:

-the lowering of internal interest rates to reduce the differential of interest compared to the international environment

- the raising of exchange currency flexibility

- the maintaining of some restrictions and the formulation of capital account

- the sterilization by the central bank of the entrance of capital

- the strengthening of fiscal discipline

Concerning the policy of the usury interest rate applied to Romania in the process of the liberalization of capital account we have noticed that starting with the year 2001 the efficiency of the interest rate channel grows better and better, being able and identify a co-integration relationship between the monetary policy interest and the market interests, witch in fact shows the efficiency of the channel of monetary policy transmission interest rate.

The National Bank of Romania adopted a policy of continuous lowering of interest rates as a consequence of both the necessity of disinflationand especially in order to reduce the risks linked to the liberalization of capital account. Despite all these, the tendency to reduce the interest rates has been interrupted twice, for short periods of time (2000-2001, 2003-2004) to prevent some economical side-slip.

Starting from 2005 as a result of the liberalization of non-residents access to term deposits in national currency, RNB policy interest in national had to face new constraints. The existence a raised differential of internal interest rate in comparison with the external one could have encouraged the speculative entrances of capital witch could have created inflationist pressures and would have led to the appreciation of the exchange course on short term.

According to specialists, RNB confronted the Tosovsky dilemma witch refers to the contradiction appeared between the necessity of reducing the rates of interest in the process of liberalization and the requirements concerning the aggregate demand control from the perspective of the disinflation process, witch could imply higher rates of the interest.

Fig. 2 – The evolution of monetary policy interest starting from 2003 to 2005

Under these circumstances, the strategy adopted by RBN was one of continuing the reducing of monetary policy interest from 20, 75% in may 2004 to 12,5% in April 2005, respectively 7,5% in October 2005 (image 2). At the same time the temporary split of monetary interest from the effective sterilization interest witch had a lowering tendency.

As a result of this strategy, the deferential between interval interest rate and the external one reduced continuously down to a negative level in September-November 2005 as a consequence of the sterilization of the excess of liquidity on monetary market.

1. Conclusions

The liberalization of capital account represents an important step in the economical and financial reform of Romania, but we have to remember the risks that the last stages of this process bring. The full liberalization of capital account of capital account will lead to attraction of important capital fluxes by our country.

As the global experience demonstrates the liberalization of capital account will hold as direct effect a more efficient allocation of capital, directing it to the most productive directions with a reduction of financial costs, a development of Romania’s financial system a good development of the Corporalist Governess and of the business domain and also of the strengthening of macro-economical discipline.

In order to prevent some negative effects generated by the liberalization of the capital fluxes, especially the risk of excessive growth took a series of measures regarding the perfecting of prudential banking standards, the generalization of international accounting standards.

Concerning the risks linked to portfolio investments witch can expose the national economy to sudden entrance and exits of capital, they will be prevented through the growth of the exchange course flexibility and the comfortable level touched by the official currency stocks possessed by RNB.

The policies adopted by the Romanian National Bank, regarding the interests and the flexibility of the exchange course are ment to discourage the entrance of speculative capital. The measures adopted by Romania regarding the reform of public administration, the efficiency of infra-structure, the reducing of the uncertainty degree of economical medium through the stability prices, the rates of interest represent premises of the growth of direct foreign investments in Romania.

BIBLIOGRAPHY

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2.Eichengreen, B.J. Capital Acount Liberalization: What do Cross Country Studies Tell us?, The World Bank Economic Review 15, pg. 341-365, 2001

3.Fischer, S., Capital-Account Liberalization and the Role of the IMF: Should the IMF Pursue Capital-Account Convertibility?, in Essays in International Finance No. 207,Princeton: PrincetonUniversity, 1998

4.IMF, Country Report no.04/2002