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Capital Controls and Foreign Investor Subsidies Implicit in South Africa's Dual Exchange Rate System

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  • Huizinga, Harry
  • Schaling, Eric
  • van der Windt, Peter C

Abstract

Both in theory and practice, capital controls and dual exchange rate systems can be part of a country's optimal tax policy. We first show how a dual exchange rate system can be interpreted as a tax (or subsidy) on international capital income. We show that a dual exchange rate system, with separate commercial and financial exchange rates, drives a wedge between the domestic and foreign returns on comparable assets. As a borrower, the government itself is a direct beneficiary. Secondly, based on data from South Africa, we present empirical evidence of this revenue implicit in a dual exchange rate system; a revenue that amounted to as much as 0.1 percent of GDP for the South African government. However, this paper also shows that both the capital controls and the dual exchange rate system in South Africa gave rise to many perverse unanticipated effects. The latter may render capital controls and dual exchange rate systems unattractive in the end and, thereby, provides a rationale for the recent trend in exchange rate liberalization and unification.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6347.

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Date of creation: Jun 2007
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Handle: RePEc:cpr:ceprdp:6347

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Keywords: capital controls; Dual exchange rate systems; financial repression;

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  1. Aizenman, Joshua & Guidotti, Pablo E., 1994. "Capital controls, collection costs and domestic public debt," Journal of International Money and Finance, Elsevier, vol. 13(1), pages 41-54, February.
  2. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  3. Jean-Christian Lambelet & Alexander Mihailov, 2006. "The Triple-Parity Law," Computing in Economics and Finance 2006 33, Society for Computational Economics.
  4. Harry Huizinga, 1996. "The Taxation Implicit in Two-Tiered Exchange Rate Systems," IMF Working Papers 96/120, International Monetary Fund.
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  10. Joshua Aizenman, 1985. "On the Complementarity of Commercial Policy, Capital Controls and Inflation Tax," NBER Working Papers 1583, National Bureau of Economic Research, Inc.
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  12. Huizinga, H.P., 1996. "The Taxation Implicit in Two-Tiered Exchange Rate Systems," Discussion Paper 1996-100, Tilburg University, Center for Economic Research.
  13. Schaling, E., 2005. "Capital Controls, Two-tiered Exchange Rate Systems and the Exchange Rate Policy: The South African Experience," Discussion Paper 2005-110, Tilburg University, Center for Economic Research.
  14. Adams, Charles & Greenwood, Jeremy, 1985. "Dual exchange rate systems and capital controls: An investigation," Journal of International Economics, Elsevier, vol. 18(1-2), pages 43-63, February.
  15. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
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