et al 1997; Ishii et al 2002). Even when appropriately sequenced, a partial liberalization of one type of flow can erode the effectiveness of other controls (Ostry et al 2011).

However, there are certainly benefits to capital account openness – especially with regard to long-term investment flows. FDI inflows are generally the first to be targeted for liberalization in an appropriate sequencing, as they are the most stable and the most correlated with growth (IMF 2012b). Research has shown that developing economies with open capital accounts tend to attract more FDI, and that this effect has increased over time (Reinhardt et al 2010; Asiedu and Lien 2004). Broadly, there is acknowledgment that capital controls do impose costs, including affecting the real economy such as by distorting trade, and that even controls justified by balance of payments needs should be temporary in nature (Johnston et al 1999). A general liberalization of capital transactions continues today even amidst the tightening of some controls in response to recent global financial disturbances (IMF 2012a).

The assessment of foreign exchange restrictions that underpins the CTC indicators is fully grounded in this macroeconomic context. The indicators cover restrictions related to current international business payments and the type of long-term FDI flows that fall outside the scope of controls referenced above to manage potentially volatile short-term capital flows. The assessment of restrictions<sup>v</sup> considers legitimate needs for some regulation of cross-border transactions – such as the need to collect statistical data on capital flows or to ensure the legality of cross-border payments – and subsequent sections identify when such goals could be accomplished in a less restrictive way. Macroeconomic and financial sector needs may still justify temporary foreign exchange restrictions in some situations. CTC assesses foreign exchange restrictions in this context, while introducing a new perspective of the foreign investor to also consider the implications of the foreign exchange regime for the investment climate for FDI.

# 3. Design of the Converting and Transferring Currency indicators

Considering the macroeconomic context described above, CTC classifies foreign exchange regulations based on how restrictive they are to cross-border transactions from the perspective of a foreign investor. CTC measures the legal regime governing foreign exchange transactions, and incorporates the experience of lawyers, bankers, and accountants from the private and public sectors regarding how the laws and regulations are implemented in practice. The data also draws on and complements the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), as elaborated in the text box. This section provides an overview of the data and scoring methodology used to develop the CTC indicators; full detail on this methodology is presented in Annex 1.

Data on foreign exchange regulations were gathered across 98 economies<sup>vii</sup> using a standardized case study of FDI in the manufacturing sector (see text box below). The use of a case study enables comparability of the assessment and indicators across economies. It also focuses the indicators on a specific set of foreign

## The IMF AREAER

The IMF’s AREAER is the most comprehensive global database of foreign exchange arrangements and restrictions. The data include a wide range of de jure restrictions on current and capital account transactions, as well as de facto data on the exchange rate regime, and are gathered from country authorities and supplemented by IMF staff.

CTC is designed to complement the AREAER. The CTC indicators focus on capital flows and current payments most relevant for FDI, just one subset of the transactions covered by the AREAER. The CTC data also reflect the views of the private sector of the foreign exchange regime, complementing the official de jure data in the AREAER. Despite these differences, the correlation between the CTC indicators and one index of openness based on the AREAER is a very high 0.818.<sup>vi</sup> This suggests that CTC accurately reflects the overall level of openness across economies, while still adding value through its private sector perspective focusing on FDI.

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