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Financial Repression and Exchange Rate Management in Developing Countries

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  • Renu Kohli
  • Kenneth Kletzer

Abstract

Most developing countries have imposed restrictions on domestic and international financial transactions at one time or another. Such restrictions have allowed governments to generate significant proportions of their revenues from financial repression while restraining inflation. The eventual fiscal importance of the revenues from seignorage and from implicit taxation of financial intermediation pose a challenge for financial reform and liberalization. This paper presents a model of the role of financial repression in fiscal policy and exchange rate management under capital controls. We show how a balance of payments crisis arises under an exchange rate peg without capital account convertibility in the model economy and how the instruments of financial repression may be used for exchange rate management. The model is compared to the experience of India, a country that exemplifies the fiscal importance of financial restrictions, in the last two decades. In particular, we discuss the dynamics leading up to devaluation in 1991 and the role of financial repression in exchange rate intervention afterwards.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/103.

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Length: 42
Date of creation: 01 Aug 2001
Date of revision:
Handle: RePEc:imf:imfwpa:01/103

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Keywords: Exchange rates; exchange rate; financial repression; nominal exchange rate; reserve requirements; exchange rate peg; financial intermediation; exchange rate management; exchange rate regime; exchange rate movements; current account balance; financial intermediaries; foreign exchange; international capital; nominal depreciation; floating exchange rate; reserve requirement; exchange rate fluctuations; exchange rate intervention; bonds; international financial statistics; international reserves; financial sector; interest rate controls; financial liberalization; currency depreciation; exchange rate policy; financial assets; financial system; financial reform; financial reforms; exchange rate regimes; deposit rate; currency units; bond; international capital mobility; deposit rates; domestic financial sector; exchange rate changes; government bonds; real exchange rate; flexible exchange rate; financial capital; domestic capital; access to international financial markets; discount rate; post-devaluation; currency convertibility; interest rate policy; financial structure; international financial markets; floating exchange rate regime; domestic-currency; fixed exchange rate; currency crisis; foreign exchange reserves; exchange rate floats; foreign investment; exchange reserves; access to international capital; bond yields; foreign equity; interest rate ceilings; forward cover; international capital markets; domestic financial intermediation; debt stocks; exchange rate arrangement; international finance; nominal exchange rate depreciation; overvaluation; dollar exchange rate; exchange rate depreciation; financial markets; domestic financial system; equity capital; exchange controls;

References

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  1. Burnside, A Craig & Eichenbaum, Martin & Rebelo, Sérgio, 2001. "On the Fiscal Implications of Twin Crises," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2918, C.E.P.R. Discussion Papers.
  2. Bencivenga, Valerie R & Smith, Bruce D, 1992. "Deficits, Inflation, and the Banking System in Developing Countries: The Optimal Degree of Financial Repression," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 767-90, October.
  3. Panicos O. Demetriades & Kul B. Luintel, 1997. "The Direct Costs Of Financial Repression: Evidence From India," The Review of Economics and Statistics, MIT Press, vol. 79(2), pages 311-320, May.
  4. Courakis, Anthony S, 1984. "Constraints on Bank Choices and Financial Repression in Less Developed Countries," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, Department of Economics, University of Oxford, vol. 46(4), pages 341-70, November.
  5. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  6. Roubini, N. & Sala-i-Martin, X., 1992. "A Growth Model of Inflation, Tax Evasion and Financial Repression," Papers, Yale - Economic Growth Center 658, Yale - Economic Growth Center.
  7. Brock, Philip L, 1989. "Reserve Requirements and the Inflation Tax," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 21(1), pages 106-21, February.
  8. Renu Kohli, 2001. "Capital Flows and their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
  9. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 108(3), pages 717-37, August.
  10. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, Elsevier, vol. 19(1-2), pages 1-24.
  11. Nichols, Donald A, 1974. "Some Principles of Inflationary Finance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(2), pages 423-30, Part I, M.
  12. Paul Cashin & Nilss Olekalns & Ratna Sahay, 1998. "Tax Smoothing in a Financially Repressed Economy," IMF Working Papers 98/122, International Monetary Fund.
  13. Giovannini, Alberto & de Melo, Martha, 1993. "Government Revenue from Financial Repression," American Economic Review, American Economic Association, American Economic Association, vol. 83(4), pages 953-63, September.
  14. Gupta, Kanhaya L. & Lensink, Robert, 1997. "Financial repression and fiscal policy," Journal of Policy Modeling, Elsevier, Elsevier, vol. 19(4), pages 351-373, August.
  15. Demetriades, Panicos O & Luintel, Kul B, 1996. "Financial Development, Economic Growth and Banker Sector Controls: Evidence from India," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 106(435), pages 359-74, March.
  16. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, American Economic Association, vol. 81(4), pages 797-818, September.
  17. Sussman, Oren, 1991. "Macroeconomic Effects of a Tax on Bond Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 23(3), pages 352-66, August.
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Citations

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Cited by:
  1. Renu Kohli, 2001. "Capital Flows and their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
  2. Pasricha, Gurnain Kaur, 2008. "Imperfect Competition in Financial Markets and Capital Controls: A Model and a Test," MPRA Paper 12125, University Library of Munich, Germany.
  3. Singh, Nirvikar & Srinivasan, T. N., 2004. "Fiscal Policy in India: Lessons and Priorities," Santa Cruz Department of Economics, Working Paper Series qt8nx3v467, Department of Economics, UC Santa Cruz.
  4. Renu Kohli, 2004. "Capital Flows and Domestic Financial Sector in India," International Finance, EconWPA 0405012, EconWPA.
  5. Noriaki Kinoshita & Cameron McLoughlin, 2012. "Monetization in Low- and Middle-Income Countries," IMF Working Papers 12/160, International Monetary Fund.
  6. Joshua Aizenman, 2003. "On the Hidden Links Between Financial and Trade Opening," NBER Working Papers 9906, National Bureau of Economic Research, Inc.
  7. Pinto, Brian & Zahir, Farah, 2004. "India : why fiscal adjustment now," Policy Research Working Paper Series 3230, The World Bank.
  8. Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness: Efficiency and Political Economy Considerations," Working Papers, University of Hawaii at Manoa, Department of Economics 200404, University of Hawaii at Manoa, Department of Economics.
  9. Kohli, Renu, 2004. "The Transition from Official Aid: to Private Capital Flows Implications for a Developing Country," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  10. Kletzer, Kenneth, 2004. "Liberalizing Capital Flows in India: Financial Repression, Macroeconomic Policy and Gradual Reforms," Santa Cruz Department of Economics, Working Paper Series qt9h27k0ff, Department of Economics, UC Santa Cruz.
  11. James, Ang, 2009. "Financial Liberalization and the Aid-Growth Relationship in India," MPRA Paper 14411, University Library of Munich, Germany.
  12. Joshua Aizenman, 2004. "Financial Opening and Development: Evidence and Policy Controversies," American Economic Review, American Economic Association, American Economic Association, vol. 94(2), pages 65-70, May.
  13. Kletzer, Kenneth, 2004. "Liberalizing Capital Flows in India: Financial Repression, Macroeconomic Policy and Gradual Reforms," Santa Cruz Center for International Economics, Working Paper Series, Center for International Economics, UC Santa Cruz qt3kj2w649, Center for International Economics, UC Santa Cruz.
  14. Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness," NBER Working Papers 10496, National Bureau of Economic Research, Inc.
  15. Joshua Aizenman & Ilan Noy, 2003. "Endogenous Financial Openness: Efficiency and Political Economy Considerations," NBER Working Papers 10144, National Bureau of Economic Research, Inc.
  16. Kletzer, Kenneth, 2004. "Liberalizing Capital Flows in India: Financial Repression, Macroeconomic Policy and Gradual Reforms," Santa Cruz Department of Economics, Working Paper Series qt3kj2w649, Department of Economics, UC Santa Cruz.

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