Foreign Capital and Economic Transformation

The advanced transition economies in Central and Eastern Europe abolished most restrictions to the free flow of capital. Subsequently, they have been able to attract quite substantial amounts of foreign capital. At the same time, the recent international financial crises have heightened concerns about a speedy liberalization of capital flows, and controls on short-term capital flows are frequently being advocated. The authors of this study trace the experience which the four reform countries, the Czech Republic, Estonia, Hungary, and Poland, have had with capital market integration.
Their main result is that domestic policies can have a substantial impact on the structure of capital flows and on the ability of emerging markets such as the transition economies to deal with adverse external shocks. Taxing capital flows cannot serve as a substitute for prudent policies. The available evidence rather suggests that the imposition of capital controls itself can be a cause of fluctuations of exchange rates and that controls on cross-border capital flows are difficult to enforce.