Capital controls may have stopped Greek banks from bleeding out, but how long can they stave off the panic?
As the people of Greece are learning, without functioning banks, the daily lives of citizens and businesses come screeching to a halt. Capital controls—limitations on the free movement of money—are seen as desperation measures, and whether they work depends on how well the medicine suits the disease. If currencies or banks themselves are harming an economy, capital controls may work; otherwise, watch out. These five stats explain some of the most recent implementations of capital controls and how Greece compares.
When the global financial crisis hit in 2008, Iceland’s banks were caught with assets valued at over $185 billion, roughly 14 times the size of the country’s annual output, giving a whole new meaning to the phrase “too big to fail.” Fearing exposure to the overleveraged banking sector, investors started fleeing the krona. Iceland’s currency lost over 50 percent of its value against the euro in just months. Assessing the situation, the government in Reykjavik decided stopping the flow of money out of the banks was the only way to prevent a bad situation from turning into utter catastrophe. Iceland’s GDP fell by 10 percent from 2009 through 2010. But the exchange rate stabilized shortly after capital controls were introduced, and Reykjavik eased its monetary policy, making borrowing cheaper. For the past three years, Iceland has been growing at about a 2 percent rate per year.
After years of growth, the economies in East Asia started to sour in 1997 when Thailand was forced to unpeg its currency from the U.S. dollar. The crisis spread to neighboring countries, and global investors started selling Malaysian assets to bet on the depreciation of the currency, the ringgit. By mid-1998, the ringgit’s value had fallen 40 percent, the stock market’s value had plummeted 75 percent, and Malaysia imposed capital controls that September. The government had tried raising interest rates to keep money from fleeing the country, but the move hurt businesses and the economy, which contracted by 7.4 percent in 1998. Capital controls allowed the Malaysian government to spend money on public works projects without injecting too much liquidity into the Malaysian money supply. By 1999, Malaysia was growing again at 6.1 percent.
At its height, Cyprus’s banking sector was 7.5 times the country’s annual GDP of roughly $23 billion, largely fueled by Russian investors using Cypriot banks as tax havens. But Cypriot banks also held a significant amount of Greek government debt. In 2011, Cyprus’s banks were required to accept a 50 percent write-down on that debt. With its banks severely weakened, Nicosia was forced to request its own bailout from Europe in March 2013, to the tune of 10 billion euros. But harsh conditions were attached: first, Laiki Bank—at the time the island’s second largest financial institution—would be shut down and its “good” assets would be merged with the Bank of Cyprus. Following that, all deposits in the Bank of Cyprus above 100,000 euros would be subject to a 47.5 percent haircut, with depositors receiving bank shares in exchange for their lost cash. In this case, capital controls were imposed to give Cypriot authorities time to restructure the banking sector. Nearly two years later, those controls have finally been lifted and Cyprus’ economy has started to recover.
Like Greece, Argentina had a long history of government overspending and weak institutions. Despite growing for most of the 1990s, by 1999 the Argentine economy was mired in recession and saddled with 14.5 percent unemployment and unsustainable government debt. But unlike Greece, Argentina had its own currency, the peso, which was pegged at an exchange rate of one peso to one U.S. dollar. In December 2001, Buenos Aires imposed capital controls while it forced a conversion of its banks’ dollar deposits into pesos, but at a new exchange rate of 1.4 pesos to the dollar (the adoption of a floating exchange rate ultimately dragged the peso’s value down almost 90 percent overall). The government limited withdrawals to 250 pesos a week in a move known as El Corralito, or “the little fence.” Even with these draconian measures, Argentina defaulted in 2002 on more than $81 billion owed to external creditors, though notably it paid its debt to the International Monetary Fund. The immediate aftermath was miserable: unemployment went north of 20 percent, with over 50 percent of the population living in poverty. But Argentina started to recover by June 2002 as domestic growth was boosted by its newly devalued peso and its traditionally strong agriculture sector. Argentina has been limping on since.
And now, Greece. Last week, Athens decided to shutter banks in a defensive move to prevent a bank run as the government’s negotiations with its creditors collapsed. Upward of $45 billion has been pulled out of Greek banks since mid-December over fear that deposits would be seized and forcibly converted from the euro to a new drachma. If this conversion were to happen, things would get much worse for the Hellenic Republic—Standard & Poor’s recently estimated that Greece could lose 20 percent of its GDP over the next four years if it were to leave the euro, on top of the 25 percent it has already lost since the crisis started. Unlike Argentina, Greece doesn’t have a strong export industry that can benefit from the competitiveness of a devalued currency, meaning unemployment would climb even higher than the current rate of roughly 26 percent. What’s worse is that even if Greece went the way of the drachma, it would still have a mountain of debt that’s denominated in euros—Greece needs to make payments worth another 10.33 billion euros to the European Central Bank and the IMF in July and August alone. And that’s not including the IMF payment of 1.5 billion euros it just missed last week. So while capital controls may have stopped Greek banks from bleeding out, the Greek economy overall is still critically wounded.