Financial Sector Assessment

Capital Account Liberalization

Capital account controls can have a significant effect on the way that external shocks are transmitted to the domestic financial system and on how domestic financial develop­ments affect the macro-economy. When one considers the effect of the capital account on domestic financial stability, it is important to be aware of existing capital controls, including the nature and scope of recent liberalizations and any plans to relax them.33 Experience has demonstrated that liberalizing the capital account before the home-coun­try financial system has been adequately strengthened can contribute to serious economic problems.34 For example, studies have shown that a significant number of countries that suffered from a financial crisis have liberalized their financial systems, including their capital accounts, within the past 5 years before the crisis.35 These experiences have high­lighted the importance of (a) appropriate sequencing and coordination when opening capital accounts and (b) domestic financial liberalization policies to preserve financial stability. See box 3.2 and chapter 12 for additional discussion.