The real effects of capital controls: Firm-level evidence from a policy experiment

After the 2008-09 crisis, very low interest rates in advanced economies pushed capital into emerging markets, and several governments taxed the inflows; in December 2012 the IMF endorsed limited use of capital controls. This paper asks what those controls cost the firms in the country imposing them, using Brazil – “seen as a poster child for the recent policy changes” – and a feature of Brazilian tax law that turns the policy into something close to an experiment. The Imposto Sobre Operacoes Financeiras (IOF) is set by decree rather than statute, so it needs no Congressional approval and “the Finance Ministry can overnight change the IOF tax that becomes effective immediately from its enactment date”; investor interviews in Forbes, Fratzscher, Kostka and Straub (2016) confirm investors did not anticipate the changes. The authors collect the announcement dates for Brazil’s IOF changes between 2008 and 2013, along with which instruments each covered, and run an event study on listed Brazilian firms, matching Datastream prices and Worldscope financials to proprietary export data from Brazil’s trade secretariat (Secex). The theoretical prediction comes from Black (1974) and Stulz (1981): a discriminatory tax on foreign investors segments markets and “drives up the expected return relative to the benchmark return under full integration,” so prices should fall and cumulative abnormal returns should be negative. They are. Two-day CARs computed against a market model with Scholes-Williams betas fall about 0.28 percent on average, significant at 1 percent; controlling for firm size the average effect rises an order of magnitude to -2.66 percent, while size itself enters positively – so the average masks large heterogeneity. Fitted CARs rise monotonically with size, stay negative through the 75th percentile, and turn positive at the 90th and above; exporter status is positive and significant at 5 percent, concentrated in the larger export-revenue bins; and external finance dependence, measured as the Rajan-Zingales gap between capital expenditure and internal cash flow, is negative and significant at 1 percent. Controls on equity inflows hit harder than controls on debt, with the equity-event dummy negative and significant at 5 percent, which the authors attribute either to surprise – Brazil had previously taxed only debt flows, extending the IOF to equity for the first time in October 2009 – or to the market viewing debt controls as a legitimate macroprudential response to systemic risk. On mechanism, five-year market interest rates rise 11.8 basis points around the announcements (significant at 5 percent), “against the backdrop of quantitative easing in the US and other developed countries that put downward pressure on the world interest rate,” and an implied cost of capital computed from IBES forecasts via the Easton (2004) modified PEG ratio rises significantly at the 10 percent level in short windows. The exchange rate moves in the direction the policy intended – depreciation – but insignificantly, so “the lack of statistical significance precludes us from drawing robust inference.” Two scope conditions matter most. Only listed firms are observable, so the smallest firms are missing entirely and the authors treat their estimates as “a lower bound estimate of the adverse impact.” And the design measures announcement-window asset prices, not realized investment: the source text reports no regression of firm capital expenditure on the controls, despite the paper’s title and abstract framing.

Laura Alfaro | Macro Paper Warehouse

The real effects of capital controls: Firm-level evidence from a policy experiment