metadata: authors: 0: author: Anderson,John Millies
count: World
docna: 0: docna: Converting and transferring currency :
            benchmarking foreign exchange restrictions to foreign direct
            investment across economies
docty: Policy Research Working Paper
subtopic: Investment and Investment Climate,Construction Industry,Common Carriers Industry,Food & Beverage Industry,General Manufacturing,Pulp & Paper Industry,Plastics & Rubber Industry,Macroeconomic Management,Business Cycles and Stabilization Policies,Financial Sector Policy
teratopic: Finance and Financial Sector Development
abstracts: cdata!: The ease of converting and transferring
            currency is a crucial consideration for firms investing in a
            foreign economy. The Converting and Transferring Currency
            data and indicators measure foreign exchange restrictions
            most relevant for foreign direct investment across economies
            to identify common policies and benchmark the
            restrictiveness of economies' foreign exchange regimes.
            Of 98 economies included in the analysis, 53 economies
            maintain generally unrestricted foreign exchange regimes for
            foreign direct investment. But 24 economies impose moderate
            to heavy restrictions across most transactions covered by
            the Converting and Transferring Currency indicators, with
            another 21 economies imposing administrative or procedural
            requirements. All high-income economies measured by the
            Converting and Transferring Currency data maintain
            unrestricted foreign exchange regimes for foreign direct
            investment, and the two poorest regions of South Asia and
            Sub-Saharan Africa are the most restrictive regions on
            average. Still, there is significant variation in
            restrictiveness across economies at similar income levels:
            38 percent of low-income and lower-middle-income economies
            impose moderate to heavy restrictions on transactions
            covered by the Converting and Transferring Currency data,
            but another 38 percent of such economies maintain fully
            unrestricted regimes. The Converting and Transferring
            Currency indicators are significantly correlated with
            measures of remittances risk, foreign direct investment, and
            exports, and especially with inflows of foreign direct
            investment per capita. The paper concludes by identifying
            common areas for regulatory reform that could be considered
            across economies, depending on country-specific conditions
            and the macroeconomic context of potential foreign exchange reforms.
repnme: repnme: Converting and transferring currency :
            benchmarking foreign exchange restrictions to foreign direct
            investment across economies
display_title: Converting and transferring currency
            : benchmarking foreign exchange restrictions to foreign
            direct investment across economies
listing_relative_url: /research/2013/09/18293636/converting-transferring-currency-benchmarking-foreign-exchange-restrictions-foreign-direct-investment-across-economies
topicv3: Capital Account m1326277 1134,Investment Climate m1326293 405,Manufacturing Sectors m1326521 1281,Financial Sector Development m1327681 1920,Investment Entry m1504647 2544
publishtoextweb_dt: 2016-08-18T00:00:00Z
historic_topic: Finance and Financial Sector Development
no_of_pages: 41
author_keys: 0: author_key: 1160887
model_extractions: WPS6601 Policy Research Working Paper 6601 Converting and Transferring Currency Benchmarking Foreign Exchange Restrictions to Foreign Direct Investment across Economies _John Anderson_ The World Bank Financial and Private Sector Development Network Global Indicators and Analysis Department September 2013
Policy Research Working Paper 6601

# **Abstract**

The ease of converting and transferring currency is a crucial consideration for firms investing in a foreign economy. The Converting and Transferring Currency data and indicators measure foreign exchange restrictions most relevant for foreign direct investment across economies to identify common policies and benchmark the restrictiveness of economies’ foreign exchange regimes. Of 98 economies included in the analysis, 53 economies maintain generally unrestricted foreign exchange regimes for foreign direct investment. But 24 economies impose moderate to heavy restrictions across most transactions covered by the Converting and Transferring Currency indicators, with another 21 economies imposing administrative or procedural requirements. All high-income economies measured by the Converting and Transferring Currency data maintain unrestricted foreign exchange regimes for foreign direct investment, and the two poorest regions of South Asia and Sub-Saharan Africa are the most restrictive regions on average. Still, there is significant variation in restrictiveness across economies at similar income levels: 38 percent of low-income and lowermiddle-income economies impose moderate to heavy restrictions on transactions covered by the Converting and Transferring Currency data, but another 38 percent of such economies maintain fully unrestricted regimes. The Converting and Transferring Currency indicators are significantly correlated with measures of remittances risk, foreign direct investment, and exports, and especially with inflows of foreign direct investment per capita. The paper concludes by identifying common areas for regulatory reform that could be considered across economies, depending on country-specific conditions and the macroeconomic context of potential foreign exchange reforms.

This paper is a product of the Global Indicators and Analysis Department, Financial and Private Sector Development Network. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http:// econ.worldbank.org. The author may be contacted at janderson9@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# Converting and Transferring Currency

Benchmarking foreign exchange restrictions to foreign direct investment across economies

## John Anderson<sup>1</sup>

September 2013 Keywords: FDI; foreign exchange restrictions; investment climate; regulatory reform; benchmarking JEL classification codes: O24; O16; F21; K20; E58

> 1 The author is in the Global Indicators and Analysis Department of the Financial and Private Sector Development Network, World Bank Group. Email address: janderson9@worldbank.org. Full acknowledgments are provided on the following page.
# Acknowledgments

Converting and Transferring Currency (CTC) is part of the FDI Regulations database of the Global Indicators and Analysis Department (GIA) of the World Bank Group (WBG). The lead author, John Anderson, is a Private Sector Development Specialist working in GIA. The author is grateful for valuable peer review comments received from Jeff Chelsky and Swati Ghosh (WBG PRMPI); Stephan Dreyhaupt and colleagues in MIGA; Pablo Furche (Central Bank of Chile); Pierre Guislain, Christine Qiang, and colleagues in the WBG Investment Climate Department; Barry Johnston (consultant); Annamaria Kokenyne (IMF MCM); and Sarah Sanya (IMF SPR). Additional valuable comments were received on earlier drafts of the paper from Carolin Geginat, Melissa Johns, Augusto Lopez-Claros, Tanya Primiani, and Federica Saliola from GIA. The author is also grateful for contributions to the analysis and writing made by consultants Diane Pallez and Zeynep Caglar.

Two groups of people provided pro-bono contributions to CTC without which the data and indicators could not have been gathered and developed.

The first is the group of lawyers, accountants, bankers, and government regulators in each of the 98 economies covered by the report who responded to the CTC legal questionnaire. Their input about the foreign exchange regime for foreign direct investment in their economy was the fundamental source of data for the analysis. Grateful acknowledgment of the contributors across all topics of the FDI Regulations database is made at iab.worldbank.org. Particular acknowledgment is made of the contribution of KPMG’s Global Tax Practice, which responded to questionnaires in more than 40 economies.

The second is the expert consultative group formed to provide technical input to the development of the CTC topic. This group of global experts in foreign exchange, investment regulation, and political risk provided input on the focus of the CTC legal questionnaire and on the methodology to develop the CTC indicators. Members of the expert consultative group include:

|Paul Barbour, MIGA, Washington DC|Annamaria Kokenyne, IMF, Washington DC|
|---|---|
|Alick Bruce-Brand, formerly with South African|Peter Kusek, IFC, Washington DC|
|Reserve Bank|Sebastien Lieblich, MSCI, Geneva|
|Stephan Dreyhaupt, MIGA and IFC, Washington DC|Paulo Marcelo Cavalcanti Muniz, Central Bank of|
|Pablo Furche, Central Bank of Chile|Brazil|
|Richard Gordon, Case Western Reserve University<br>School of Law, USA|Julie Martin, Marsh, Washington DC<br>Latifah Merican-Cheong, Malaysian Securities|
|Hannah Ha, Mayer Brown JSM, Hong Kong SAR,|Commission|
|China|Hoda Moustafa, MIGA, Washington DC|
|Laura Hills, Hills Stern & Morley, Washington DC|Kleddao Sungnet, Bank of Thailand|
|Rick Jenney, Morrison Foerster, Washington DC|Emilio Wills, Lewin & Wills Law, Colombia|
|BarryJohnston,formerlywith IMF,Washington DC||
# 1. Introduction

In Angola, it can take longer than a month for a foreign-owned firm to transfer foreign exchange abroad to make a dividend payment to foreign shareholders. The commercial bank making the transfer must review documentation of the payment, which must then be submitted to the central bank for review and issuance of a license before the transfer may be made. Government approval is also needed for firms to receive a long-term foreign loan, or to hold export earnings in bank accounts abroad. To the northeast, in Uganda, firms may convert and transfer currency freely, and making a dividend payment abroad only takes a couple of days. No approvals or procedural steps are required, and firms may similarly conduct other foreign exchange transactions for international business without restriction.

This difference between Angola and Uganda reflects why the ease of converting and transferring currency abroad is a crucial consideration for firms investing in a foreign economy. The ability to bring in foreign capital, freely convert local currency and foreign exchange, and repatriate investment returns back home are fundamental aspects of foreign direct investment (FDI). Access to foreign exchange is necessary to pay for imports of goods and services, and being able to use export proceeds freely is an incentive for firms to engage in international business.

Perceptions of global business leaders confirm the importance of converting and transferring currency. In response to a recent survey by the Multilateral Investment Guarantee Agency, 40 percent of senior executives from multinational firms investing in developing economies identified ‘transfer and convertibility restrictions’ as the most concerning type of political risk to their cross-border investments in the next three years.<sup>i</sup> Nearly 28 percent of companies report having actually withdrawn or cancelled planned investments due to such restrictions in the previous 12 months.

Converting and Transferring Currency (CTC) measures the foreign exchange regime relevant for FDI across 98 economies to provide comparable and actionable information about this regulatory space. There are numerous components of the investment climate that governments may want to reform as they increasingly seek to attract FDI as a driver of long-term development.<sup>ii</sup> The foreign exchange regime is one such component, and the CTC indicators identify restrictions affecting foreign exchange transactions that are relevant for FDI and related international business to benchmark economies and identify good practices. The specific indicators cover:

1. Receiving investment inflows, including whether restrictions exist on receiving inflows of foreign equity or long-term foreign loans.

2. Repatriating investments and income, covering whether there are restrictions on repatriating liquidated investments or restrictions on making dividend payments or loan repayments abroad.

3. Making payments abroad, including whether there are restrictions on paying for imported goods; paying for imported services; paying for international travel; and making personal payments/transferring wages abroad.

4. Holding foreign exchange, identifying whether export proceeds must be repatriated and surrendered and whether a firm can hold foreign exchange bank accounts at home and abroad.

The rest of this note presents the results and policy implications of the CTC indicators. The macroeconomic context of foreign exchange restrictions is discussed, followed by a description of the design of the indicators. An overview of the results is presented, as well as the common types of foreign exchange restrictions identified across economies. Evidence that the CTC indicators are correlated with economic outcomes such as FDI flows is shown, and the note concludes with policy recommendations.

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# 2. Macroeconomic context of foreign exchange restrictions

The underlying premise of the CTC indicators is that a more-open foreign exchange regime is more conducive to FDI and international business transactions, all else being equal. From the point of view of a foreign investor, every required approval or procedural step is an additional cost to doing business, and hence represents a disincentive to invest in a given economy. But governments may have policy goals beyond attracting FDI that justify, in their view, certain restrictions on foreign exchange transactions. There is a broader macroeconomic context and policy debate that therefore needs to be considered when evaluating restrictions on converting and transferring currency.

Why do countries impose restrictions? The primary reason that countries impose exchange restrictions is to protect weak balance of payments positions (Leckow and Strauss 2010). If countries have limited foreign exchange reserves, they may try to direct the existing foreign exchange towards economic transactions considered to be vital. Macroeconomic and prudential policy goals are motivations for controls specifically on capital flows, such as to reduce the volatility of short-term capital flows or to protect underdeveloped financial markets (Johnston and Tamirisa 1998). Countries may also impose controls during economic crises to prevent capital flight.

There is general policy consensus that payments for ‘current transactions’ should be allowed freely. These transactions include payments such as for imported goods and services or making interest or dividend payments abroad, and are differentiated from capital transactions such as investment flows.<sup>iii</sup> Avoiding restrictions on payments for current transactions is a founding principle of the International Monetary Fund (IMF),<sup>iv</sup> and the number of governments committing to remove all such restrictions has steadily increased to 168, representing 90 percent of IMF member economies (IMF 2012a). Research has shown that some such restrictions, specifically restrictions on holding foreign exchange earned from exports, have increasingly served as a deterrent to inward FDI (Asiedu and Lien 2004). Restricting current transactions is also an inefficient and often ineffective way to achieve certain intended policy goals (Johnston et al 1999), such as to prevent current payments from being used to circumvent controls on cross-border capital flows. A general trend has resulted over the past several decades of liberalization of foreign exchange with the removal of restrictions on current transactions, which continues today (IMF 2012a).

The Argentine crisis of the early 2000s provides an example. A reversal of capital flows in 1998 shocked the Argentine economy. Numerous structural factors, including a fixed exchange rate, prevented the economy from adjusting, and the economic situation deteriorated (IMF 2003). By 2001, large-scale withdrawals were being made from local bank accounts, depleting international reserves as dollars were purchased with pesos at the fixed exchange rate. To prevent massive capital outflows, the government imposed banking and foreign exchange controls. Limits were set on withdrawals from individual bank accounts. Restrictions were established on foreign exchange for travel abroad. Exporters were required to sell their foreign exchange proceeds to the central bank. Following severe adjustments, the Argentine economy stabilized, and the restrictions were gradually removed. Although the restrictions may have avoided massive capital flight, some capital controls imposed are thought to have exacerbated the consequences of the crisis (IMF 2003).quences of the crisis (IMF 2003).uences of the crisis (IMF 2003).(IMF 2003).IMF 2003).)..

Liberalization of the capital account, which includes Argentine economy stabilized, and the restrictions were cross-border capital flows such as foreign loans or gradually removed. Although the restrictions may have portfolio investment, is less straightforward. There avoided massive capital flight, some capital controls has been a long debate over whether the benefits of imposed are thought to have exacerbated the free movement of capital, such as the more efficient consequences of the crisis (IMF 2003).quences of the crisis (IMF 2003).uences of the crisis (IMF 2003).(IMF 2003).IMF 2003).).. allocation of resources, outweigh the costs, such as the risk of financial instability caused by volatile capital flows (see for example Eichengreen 2001). Recent analysis of countries’ experiences during the global financial crisis has led the IMF to determine that full capital account liberalization is not an appropriate goal for all economies at all times (IMF 2012b), and to identify circumstances in which temporary controls on some short-term capital flows may be appropriate and desirable (Ostry et al 2011). When liberalization of the capital account is pursued, it is important to appropriately sequence the removal of capital controls with other macroeconomic and financial sector developments (Johnston 2
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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The CTC case study exchange transactions. The foreign exchange regime regulates a wide range of important economic activities, such as portfolio investment and the foreign exchange operations of commercial banks, but CTC measures transactions most relevant for FDI in manufacturing. The relative importance of restrictions on certain foreign exchange transactions may vary across sectors; FDI in mining may rely more on large-scale inflows and outflows, for example, while FDI in tourism may rely more on smaller but more frequent current payments abroad. CTC’s focus on manufacturing avoids sectors in which there may be stronger justification for regulation of FDI, such as the financial sector.<sup>viii</sup> CTC gathered data about the laws and practices that would affect a locally registered subsidiary of a multinational firm engaged in manufacturing with an initial investment of US$ 5 million in equity and a US$ 5 million long-term foreign loan. Restrictions are measured on these capital flows and on standard cross-border transactions associated with manufacturing and trading basic consumer products, assuming the firm does not operate in a special zone or benefit from non-automatic incentives.

Restrictions on converting and transferring currency identified on a transaction covered by CTC are classified into five types, as presented in Figure 1. A transaction is considered ‘unrestricted’ if there are no restrictions other than notification or documentation requirements following established practices for statistical or anti-money laundering purposes. ‘Administrative requirements’ cover procedural regulations that may serve as important monitoring mechanisms, but may also cause undue delays if not implemented efficiently. ‘Moderate restrictions’ are identified when a government authorization or certification is required or when a substantive timing or quantitative limit is placed on a transaction. Heavy and extreme restrictions cover progressively more restrictive regulations, such as if there is no rules-based mechanism in place to reduce discretion in approval processes or if a transaction is not allowed at all. Additional details on the classification of restrictions are provided in Annex 1.

Quantitative scores are assigned to each transaction based on its classification (Figure 1). An additional deduction of 10 points is applied if the time required to complete the transaction exceeds a threshold (for some transactions for which time data were gathered). Indicator scores are calculated by averaging across the transactions comprising each indicator (see Annex 1 for details), and average indicator scores are also calculated at the economy level to enable comparison of the relative degree of restrictiveness. Data on restrictions identified across transactions and indicator scores at the economy and regional level are presented in Annex 2. The data were gathered and reviewed from late 2011 through mid-2012; subsequent reforms to the foreign exchange regime are not captured by the CTC indicators.

Figure 1: Overview of CTC indicator development and scoring methodology

|CTC restriction<br>classifications|Nature of restrictions|Score|
|---|---|---|
|Unrestricted|No restrictions are placed on the transaction at all, other than notification<br>requirements for statistical purposes or documentation requirements<br>followingbestpractices to show the legitimacyof the transaction.|100|
|Administrative<br>requirements|Requirements such as procedural steps or documentation for all transactions<br>that are not substantive restrictions but may represent an unnecessary cost<br>to doingbusiness.|75|
|Moderate<br>restrictions|Substantive limits on the nature of a transaction, such as timing restrictions<br>on when payments may be made; or if government authorization is required,<br>but isgranted for all legitimate requests.|50|
|Heavy restrictions|Government authority over whether a transaction is allowed, such as an<br>approval requirement with no rules-based mechanism to remove discretion,<br>or no indication that all legitimate requests aregranted.|25|
|Extreme restrictions|The transaction or operation is not allowed by law, or does not occur at all in<br>practice due to excessive regulations.|0|

4
An important qualification is that the scores are not designed to rank economies, and a higher score does not necessarily reflect a better overall policy environment, since the latter is a function of a broad range of other factors, many of them beyond the scope of CTC. The scoring methodology is designed to objectively reflect how open or restrictive a given foreign exchange regime is for FDI, while acknowledging that there may be legitimate policy motivations for a given restriction, especially considering the macroeconomic context described in the section above.

It is also important to note that foreign exchange regulations are not the only way that FDI can be restricted. Foreign equity ownership limitations for example may restrict FDI even if the current and capital accounts are fully open.<sup>ix</sup> CTC focuses on restrictions to converting and transferring currency for a given transaction, not on restrictions to the underlying transaction itself – approval may be required for a foreign investor to start a FDI project, but this falls outside the scope of foreign exchange regulations.<sup>x</sup> The foreign exchange regime for FDI as measured by CTC is therefore one component of the overall FDI regime, and foreign exchange reforms may supplement and complement other FDI reform measures.

# 4. Summary results

This section presents the average degree of restrictiveness identified across economies, along with stylized results in terms of average restrictiveness by economy size, income level, and region.

# Average economy-wide restrictiveness

Most economies covered by CTC maintain generally unrestricted foreign exchange regimes for FDI, but nearly half of the economies impose administrative requirements or moderate to heavy restrictions on cross-border transactions. Figure 2 below groups economies by their average degree of restrictiveness across the transactions measured by CTC, following the quantitative methodology described in Annex 1. Specific examples of foreign exchange regimes classified into each of the categories include:

- Chile’s foreign exchange regime is classified as unrestricted. Chile has no substantive limitations on purchasing foreign exchange for FDI-related transactions. Transfers abroad greater than US$ 10,000 must be conducted through a formal financial institution, which must notify the central bank of the transfer, but firms may otherwise conduct cross-border transactions freely.

- Converting and transferring currency is generally allowed in the Russian Federation, but many administrative requirements are imposed. Firms are required by law to submit specific documentation to commercial banks to justify many cross-border transactions. Export proceeds must be repatriated to a Russian bank account, unless the funds are used for certain transactions.

- Chad imposes a range of administrative and substantive restrictions on foreign exchange transactions. To receive a foreign loan, firms must obtain approval from the finance ministry and regional central bank, and specific documentation is required by law to justify many transactions. Exporting firms must repatriate their foreign exchange earnings back to Chad and surrender them.

- Nepal’s foreign exchange regime has heavy government involvement. Approval from the central bank is required to convert and transfer currency for most transactions, ranging from receiving a foreign loan, to repatriating investment income, to paying for imported goods or services. Approval is also required for firms to hold bank accounts in foreign exchange, either in Nepal or abroad, and all export proceeds must be repatriated to Nepal.

5
Figure 2: Economy <u>groupings, by average degree of restrictiveness to convert and transfer currency</u>

|Average restriction<br>type|Number of<br>economies||Econ<br>|omies<br>||
|---|---|---|---|---|---|
|Unrestricted<br>(or with minor<br>administrative<br>requirements)|53|Afghanistan<br>Armenia<br>Australia<br>Austria<br>Bolivia<br>Bulgaria<br>Cambodia<br>Canada<br>Chile<br>Congo, Dem.<br>Rep.<br>Costa Rica<br>Croatia<br>Cyprus|Czech Republic<br>Dominican<br>Republic<br>Ecuador<br>Egypt, Arab Rep.<br>France<br>Georgia<br>Germany<br>Greece<br>Guatemala<br>Hong Kong SAR,<br>China<br>Indonesia<br>Iraq|Ireland<br>Italy<br>Japan<br>Jordan<br>Kenya<br>Kosovo<br>Kyrgyz Republic<br>Malaysia<br>Mauritius<br>Mexico<br>Montenegro<br>Netherlands<br>New Zealand<br>Nicaragua|Peru<br>Poland<br>Romania<br>Saudi Arabia<br>Singapore<br>Slovak Republic<br>Spain<br>Taiwan, China<br>Turkey<br>Uganda<br>United Kingdom<br>United States<br>Yemen, Rep.<br>Zambia<sup>2</sup>|
|Administrative<br>requirements<br>(or with occasional<br>moderate<br>restrictions)|21|Albania<br>Azerbaijan<br>Bosnia and<br>Herzegovina<br>Brazil<br>Burundi|Colombia<br>Ghana<br>Honduras<br>Kazakhstan<br>Korea, Rep.<br>Macedonia,FYR|Madagascar<br>Moldova<br>Nigeria<br>Papua New<br>Guinea<br>Philippines|Russian<br>Federation<br>Rwanda<br>Serbia<br>Tanzania<br>Thailand|
|Moderate<br>restrictions|19|Algeria<br>Argentina<br>Bangladesh<br>Belarus<br>Burkina Faso|Cameroon<br>Chad<br>Côte d'Ivoire<br>India<br>Mali|Morocco<br>Mozambique<br>Pakistan<br>Senegal<br>South Africa|Sri Lanka<br>Tunisia<br>Ukraine<br>Vietnam|
|Heavy restrictions|5|Angola<br>Ethiopia|Nepal|Solomon Islands|Venezuela, RB|

Note: see Annex 1 for the quantitative methodology used to establish the classifications.

# Restrictiveness by economy size and income level

Economies that are larger and that have higher incomes per capita tend to have fewer foreign exchange restrictions as measured by CTC. The relation between the average indicator score per economy and GDP per capita (Figure 3) is much stronger than the relation between the CTC indicators and economy size (Figure 4). This suggests that a relaxation of foreign exchange restrictions related to FDI tends to happen as countries progress to higher overall levels of development.

Despite this trend of higher-income economies being more open (Figure 5), there is significant variation in restrictiveness between economies at similar income levels. All high-income economies do have unrestricted regimes as measured by CTC. But many upper-middle-income economies impose substantive restrictions on many FDI transactions (Figure 6). The foreign exchange regimes are unrestricted in 45% of the 29 upper-middle-income economies covered, but 24% impose moderate or heavy restrictions across most transactions related to FDI (per the economy classifications in Figure 2).

2 Reforms to Zambia’s foreign exchange regime in 2013 introduced new regulations that would be scored as restrictions per the CTC methodology. As the CTC data were gathered and reviewed through mid-2012, Zambia’s classification here as ‘Unrestricted’ is based on the previous regime.

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There is also substantial variation in restrictiveness across lower-income economies. Of the 45 low- and lower-middle-income economies covered by CTC, 38% impose moderate or heavy restrictions across most transactions measured by CTC, but another 38% have unrestricted foreign exchange regimes for FDI (and the remaining 24% have only administrative requirements across most transactions). This benchmarking suggests that easing the process of converting and transferring currency may be a viable regulatory reform consideration for economies at all levels of development.

Figure 3: Higher-income economies have fewer restrictions on converting and transferring currency <!-- Start of picture text --> 50,000<br>40,000<br>30,000<br>20,000<br>10,000<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>Note: the Pearson correlation is 0.450, which is highly<br>significant. Source: WDI for GDP data.<br>Figure 5: Average CTC indicator scores, by economy<br>income classifications<br>100<br>90<br>80<br>70<br>60<br>50<br>40<br>30<br>20<br>10<br>0<br>GDP per capita, 2011 (USD)<br>Average economy CTC score<br><!-- End of picture text --> Figure 4: Larger economies have fewer restrictions on converting and transferring currency <!-- Start of picture text --> 16,000<br>14,000<br>12,000<br>10,000<br>8,000<br>6,000<br>4,000<br>2,000<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>Note: the Pearson correlation is 0.176, which is moderately<br>significant (at the 10% level). Source: WDI for GDP data.<br>Figure 6: Percentage of economies with moderate or Percentage of economies with moderate or<br>heavy restrictions on average, by income classification<br>100%<br>90%<br>80%<br>70%<br>60%<br>50%<br>40%<br>30%<br>20%<br>10%<br>0%<br>GDP, 2011 (billion USD)<br>Percentage of countries<br><!-- End of picture text --> Figure 6: Percentage of economies with moderate or Percentage of economies with moderate or heavy restrictions on average, by income classification Note: income groups are based on standard World Bank operational classification by <u>gross national income per capita from 2012.</u> 7
# Restrictiveness by region

Economies that restrict converting and transferring currency are found across regions, with countries in South Asia and Sub-Saharan Africa tending to impose the heaviest restrictions (Figures 7 and 8). Highincome OECD economies are the most open according to CTC; the average score across economies is nearly 100, implying that these economies impose virtually no restrictions at all on the foreign exchange operations of firms. As suggested in the section above, the other high-income economies covered by CTC that are not members of the OECD all similarly maintain open foreign exchange regimes for FDI.

Economies in East Asia and the Pacific (EAP); the Middle East and North Africa (MNA); Europe and Central Asia (ECA); and Latin America and the Caribbean (LAC) tend to be more restrictive. The four regions have average CTC scores across economies between 78 and 87, implying administrative requirements on most transactions, though these averages mask significant variation across economies within the region. Two economies out of 11 in EAP and 3 economies out of 8 in MENA for example have moderate or heavy restrictions on average, including several upper-middle-income economies.

The most restrictive regions are South Asia (SAR) and Sub-Saharan Africa (SSA), also the poorest regions. Five of the six economies in SAR covered by CTC have moderate to heavy restrictions across transactions on average; only Afghanistan has an unrestricted foreign exchange regulatory regime. Economies in SSA include some like Mauritius and Uganda that impose no restrictions on foreign exchange transactions, while nearly half of the economies are classified as imposing moderate to heavy restrictions.

Figure 7: Average CTC scores, by region Figure 8: Percentage of countries with moderate or heavy restrictions on average, by region <!-- Start of picture text --> 100 100%<br>90 90%<br>80 80%<br>70 70%<br>60 60%<br>50 50%<br>40 40%<br>30 30%<br>20 20%<br>10 10%<br>0 0%<br>OECD LAC ECA MNA EAP SSA SAR OECD ECA LAC EAP MENA SSA SAR<br>Percentage of countries<br>Average regional CTC score<br><!-- End of picture text --> Note: regional abbreviations, and the number of economies covered by CTC per region, are as follows: EAP=East Asia and the Pacific (11 economies); ECA=Europe and Central Asia (21 economies); LAC=Latin America and the Caribbean (14 economies); MNA=Middle East and North Africa (8 economies); OECD=high-income economies in the Organization for Economic Cooperation and Development (17 economies); SAR=the South Asia Region (6 economies); SSA=Sub-Saharan Africa (21 economies).

# 5. Common types of restrictions by indicator

The following sections describe the most common types of restrictions identified across transactions that are covered by the four CTC indicators, considering potential motivations for such restrictions and how policy objectives could be achieved in ways that are less restrictive to firms.

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# Indicator #1: Receiving investment inflows

Restrictions on receiving investment inflows are measured for two types of transactions: inflows of foreign equity capital, and inflows of long-term foreign loans. These capital transactions are the types of long-term capital flows considered the most stable and beneficial to growth from a macroeconomic perspective, and most economies allow these transfers to be made freely (72% for equity inflows<sup>xi</sup> and 61% for foreign loans, spanning all regions and income groups). Some of these economies do require notification of the inflow or registration of the capital with the government for statistical purposes, but do not impose any requirements that could hinder the transaction.

An additional 14% of economies impose administrative requirements on these inflows, such as requiring that the inflow be registered with the central bank in order for subsequent interest and principal repayments to be allowed. Such requirements may not substantively limit the investment inflows, but could be simplified for example to a notification requirement if Common restrictions on the goal is to maintain statistical information about the stock Receiving investment inflows of foreign capital in the economy.

- Approval required to receive a foreign loan (in 21% of economies)

However, about 25% of economies measured by CTC impose • Official government documentation some moderate or heavy restriction on these investment required to receive an equity inflow (in inflows, such as approval requirements or interest rate ceilings 9% of economies) on foreign loans (see text box). One motivation for such • Interest rate, term, or usage limitations restrictions may be to ensure that inflows of foreign debt are on long-term foreign loans (in 8% of for investment and not speculative purposes, such as via an economies) approval requirement for a firm to receive a foreign loan. But given the general interest across economies of attracting FDI, minimizing the administrative burden of such restrictions may be ideal. Again, approvals could be replaced by notification requirements if the goal is simply to monitor the stock of foreign debt in the economy.

Another approach may be to have a rules-based mechanism whereby loans that conform to certain terms are automatically approved or allowed, as is the case in India and South Africa. This is different than for example in Vietnam and the Philippines, where no such legal mechanism is in place, and the process of receiving the required approval takes around a month. Approval requirements may exist in some economies due to authorities’ lack of experience with risk-based mechanisms, reflecting an opportunity for regulatory reform support.

|Approvals rela<br>take more th|ted to foreign loans<br>an three weeks in:|
|---|---|
|Angola|Philippines|
|Bangladesh|Sri Lanka|
|Cameroon|Tunisia|
|Chad|Venezuela, RB|
|Madagascar|Vietnam|
|Nepal||

Decreasing the time required to comply with restrictions is another way to minimize their burden on firms. CTC finds that in half of the 21% of economies where approval or authorization to receive a foreign loan is needed, the process takes three weeks or less; but in 11% of economies more than three weeks, or even several months, is normally required to receive the requisite approval. Governments of economies that require firms to receive official government documentation (such as investment approval documentation or tax certification) before transferring in capital may also consider whether such restrictions may unduly delay firms’ cross-border transactions.

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Common restrictions on Repatriating investments and income Indicator #2: Repatriating investments and income Restrictions on repatriating investments and income are measured for three types of transactions:

- Making dividend payments abroad

- Making repayments of foreign loan principal and interest

- Repatriating liquidated capital and capital gains at the end of an investment project

- Approval required to transfer the outflows

- Official government tax certification required to make the transfer

- Timing restrictions on when foreign exchange may be purchased or loan <u>payments made</u>

These are the outflows that enable foreign investors to earn profit and recoup their investment, making them essential aspects of FDI. Government control over these transactions reflects a significant risk to a foreign investor. Seventy five percent of economies accordingly do not impose any restrictions on firms’ ability to purchase foreign exchange and make these transfers abroad. One third of these (24% of economies measured) do require that firms present documentation justifying the transaction or comply with other administrative requirements, which may be justified given the relatively large size of these outflows to ensure their legitimacy.

The remaining economies impose some moderate to heavy restrictions on these outflows, such as approval requirements or timing restrictions (see text box). Strong justification for such restrictions would be appropriate, given the risk that they pose to potential foreign investors. The goal of ensuring appropriate tax revenues are collected is a clear motivation for requiring official government tax clearance before foreign exchange may be transferred abroad; but governments may want to ensure that such clearances are given efficiently and without discretion, to avoid undue delays and limit opportunities for corruption.

|Economies w<br>restriction on r|ith at least one m<br>epatriating invest|oderate or heavy<br>ments and income:|
|---|---|---|
|Albania|Honduras|Senegal|
|Algeria|India|Serbia|
|Angola|Mali|Solomon Islands|
|Argentina|Morocco|South Africa|
|Bangladesh|Mozambique|Sri Lanka|
|Belarus|Nepal|Tunisia|
|Brazil|Nigeria|Ukraine|
|Burkina Faso|Pakistan|Venezuela, RB|
|Burundi|Papua New|Vietnam|
|Côte D’Ivoire|Guinea||
|Ethiopia|Philippines||

The macroeconomic and financial sector context of any given economy would need to be evaluated when considering removing restrictions on these outflows, especially considering the implications for controls on other capital transactions. But governments should also be aware that these restrictions do impose costs on foreign-owned firms; see the text box below for an example of the significantly longer time required to make income payments abroad in economies imposing moderate or heavy restrictions.

# Indicator #3: Making payments abroad

|Days required to make investment<br>income payments abroad|
|---|
|In economies with moderate or|
|heavy restrictions (on average):|
|• Loan repayments: 9 days|
|• Dividend payments: 16 days<sup>xii</sup>|
|In other economies:|
|•<br>Loan repayments: 3 days|
|•<br>Dividendpayments: 2 days|

Restrictions on payments abroad are measured for four types of transactions:

- Paying for imported goods

- Paying for imported services

- Paying for international travel

- Making personal payments or transferring wages abroad

As basic current account transactions, most economies allow firms and individuals to make these payments and transfers abroad freely. The most common type of restriction on these payments is documentation requirements, whereby firms are required by law to present corporate or transactional documentation to the remitting commercial bank that justifies the underlying transaction. Twenty nine percent of economies require that specific documents be provided 10
to justify certain payments abroad, or that documentation be provided to the remitting bank for all purchases or transfers of foreign exchange.

These types of administrative or procedural requirements are not direct limits on a firm’s ability to convert or transfer currency, and monitoring cross-border transactions is a legitimate policy goal. But legally specified documentation requirements may cause Common restrictions to Making payments abroad

- Documentation requirements

- Advance payment restrictions

- Quantitative limits on allowable payment amounts

- Government approval requirements to make some payments abroad

procedural delays affecting real transactions, and are noted as a minor obstacle to foreign investors by respondents in some economies. One approach to achieving cross-border transaction monitoring goals while minimizing these administrative costs is risk-based mechanisms (such as only requiring documentation for transactions exceeding certain thresholds) that are implemented by the private financial sector (as opposed to having specific justifying documents required by law). The Financial Action Task Force recommends such an approach for anti-money laundering purposes,<sup>xiii</sup> and such mechanisms are in place in economies such as Indonesia; Malaysia; and Taiwan, China.

Sixteen percent of economies do impose moderate or heavy restrictions on some of these payments, including:

- Advance payment restrictions on payments for imported goods or services. In Sub-Saharan Africa, firms in Angola, Burkina Faso, Côte d’Ivoire, Mali, Mozambique, Nigeria, and Senegal may only purchase and transfer foreign exchange up to a certain percentage of the final payment in advance of receiving an import, or within a certain amount of time before receiving the final good or service.

- Quantitative limits, such as caps on the amount of foreign exchange that may be purchased for international travel or used to pay for medical or educational expenses abroad. In Bangladesh and Pakistan, foreign expatriates are limited in the amount of their salary that they may convert and transfer for personal expenses abroad.

CTC and transfer pricing Given the increasing global importance of multinational enterprises, the need has grown to regulate payments between different branches of the same enterprise to ensure appropriate pricing and tax liability. Transfer pricing is how prices are set for the transfer of goods, services, and property between associated enterprises when market forces are not present (OECD 2010). Best practices include the ‘arm’s length principle’ to set prices as if they were established between independent enterprises.

Service payments to shareholder firms are related to transfer pricing. CTC does not consider transfer pricing rules associated with such payments, viewing them as a tax policy issue outside the scope of foreign exchange regulations.

- Government approval is required to pay for imported goods or for some service imports in Algeria, Angola, Ethiopia, Nepal, the Solomon Islands, and Venezuela.

# Indicator #4: Holding foreign exchange

The fourth CTC indicator area measures restrictions not on specific transactions but on firms’ ability to hold foreign exchange, along two dimensions:

- Whether a firm can hold bank accounts in foreign exchange, either domestically or abroad

- Whether export proceeds must be repatriated and surrendered (converted into local currency)

Most economies allow firms to hold foreign exchange bank accounts freely. But government approval is required in 12% of economies for firms to open a domestic account in foreign exchange, or such accounts are not allowed at all for most firms (in 3% of economies). These restrictions are even greater for offshore bank accounts: approval is required in 27% of economies, or offshore accounts are not allowed at all (in 5% of economies). Many economies also restrict what types of transactions are allowed 11
to be conducted through foreign exchange accounts; the Philippines and Thailand limit the amount of foreign exchange purchased with local currency that may be held in such accounts, for example.

There may be justification for restrictions on opening offshore accounts in some economies at early stages of capital account liberalization, since such accounts can be used to circumvent other capital controls. But the ability to hold at least domestic foreign exchange accounts is very important for firms engaged in international business, for example to be able to manage exchange rate risks. Even if there is a perceived justification for limiting firms’ ability to hold foreign exchange accounts, one way to minimize the restriction would be to give rules-based automatic authorization, such as for any firm with cross-border operations. But no such mechanism is in place to reduce discretion in many of the economies that require approval to open a foreign exchange account, and the time required to receive the approval can vary significantly.

Another restriction is requirements for firms to repatriate export proceeds earned abroad back to the home economy, and to then surrender those foreign exchange earnings by converting them into local currency. Surrender requirements in particular represent a significant disincentive for firms to export, as can repatriation requirements, depending on firms’ ability to hold domestic accounts in foreign exchange. As mentioned in Section 2, these requirements have been found to deter FDI inflows. About half of the economies covered by CTC allow firms to keep export earnings abroad in foreign exchange freely. But 44% of economies restrict firms’ ability to hold foreign exchange export earnings:

- In 25% of economies, firms must repatriate some or all export proceeds, but may hold them in foreign exchange domestically.

|Export proceeds must be|
|---|
|repatriated and surrendered in:|
|Argentina<br>Honduras|
|Burkina Faso<br>Mali|
|Cameroon<br>Pakistan|
|Chad<br>Senegal|
|Côte d’Ivoire<br>Solomon|
|Ethiopia<br>Islands|

- In 8% of economies, firms must repatriate all export proceeds, and must surrender some for local currency or only use the repatriated foreign exchange for certain kinds of transactions.

- In 11% of economies (see text box), firms must repatriate and surrender all export proceeds, with few exceptions.

# 6. Correlation analysis of CTC indicator scores and other data

The results presented thus far have been primarily descriptive in nature, to show the new comparative insights offered by the data regarding foreign exchange restrictions across economies. This section presents preliminary quantitative analysis of the data, demonstrating that the CTC indicators at the economy level are significantly correlated with other indicators of interest. It should be stressed that these correlations do not imply causality, and more rigorous econometric analysis will be necessary to better understand the relation between the CTC data and these and other economic variables. But these correlations provide a useful starting point by showing that the indicators are significantly associated with measures of economic performance.

A first correlation finds that the CTC indicators are associated with broader measures of investment risk across economies (Figure 9). The Remittances Risk Index, generated by a private risk analysis firm, measures the likelihood of external trade restrictions, capital controls, or artificial currency devaluation being imposed by national authorities, based on a range of macroeconomic and legal indicators. The average CTC score across indicators per economy has a positive and statistically significant correlation of 0.388 with this risk index, reflecting that the CTC indicators are associated with the broader national remittances regime. The CTC indicators are also very highly correlated with the perception of CTC questionnaire respondents regarding how much of an obstacle issues of converting and transferring currency are to foreign investors in their economy.<sup>xiv</sup> 12
- The CTC indicators also correlate with measures of actual cross-border investment and trade. Figure 10 plots the CTC indicators at the economy level against a five-year average of inflows of FDI. The correlation of 0.269 shows that countries with more-open foreign exchange regimes also receive more FDI inflows on average, and this association is statistically significant. Figure 11 plots the CTC indicators against exports of goods and services across economies. The correlation is 0.271 and statistically significant, showing that countries with less-restrictive foreign exchange regimes tend to export more on average. This does not suggest that a more open foreign exchange regime would necessarily lead to more FDI inflows or exports; the size of an economy’s GDP is another determinant of investment flows and exports, and the CTC correlations with FDI and exports disappear once the size of GDP is accounted for in the analysis.

Figure 9: Economies with fewer restrictions measured by CTC are scored as having lower remittances risk <!-- Start of picture text --> 10<br>9<br>8<br>7<br>6<br>5<br>4<br>3<br>2<br>1<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>Remittances Risk Index<br>(Extreme risk → Low risk)<br><!-- End of picture text --> Note: the Pearson correlation is 0.388, which is highly significant at conventional levels. Source: Maplecroft Global Risk Analytics Figure 10: Economies with fewer restrictions measured by CTC receive more FDI inflows <!-- Start of picture text --> 100<br>80<br>60<br>40<br>20<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>(Billion USD)<br>Inward FDI flows, 2007-11 average<br><!-- End of picture text --> Note: one economy is omitted as an outlier with more than $200 billion in inflows (the United States). The Pearson correlation is 0.269, significant at the 1% level. With the outlier included, the correlation is 0.236, significant at the 5% level. Source: UNCTADstat for FDI data.

Figure 11: Economies with fewer restrictions measured by CTC export more goods and services <!-- Start of picture text --> 900<br>800<br>700<br>600<br>500<br>400<br>300<br>200<br>100<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>Exports of goods and services, 2007-11 average (billion USD)<br><!-- End of picture text --> Note: two economies are omitted as outliers with more than $1.5 trillion in average exports (Germany and the United States). The Pearson correlation is 0.271, significant at the 1% level. With the outliers included, the correlation is 0.267, still significant at the 1% level.

Source: WDI for export data.

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The CTC indicators have an even stronger association with FDI inflows per capita. This alternative measure of FDI captures the volume of foreign investment being made available per person across economies. Figure 12 shows the relation between the CTC indicators and average FDI inflows per capita, which has a very strong correlation of 0.427 and is highly significant. This association remains statistically significant even when controlling for the size of GDP across economies, as well as if outlier economies Ireland, Singapore, and Hong Kong SAR, China are included, reflecting a more robust relation between the CTC indicators and this measure of FDI.

As with the other correlations, this does not suggest that a more open foreign exchange regime would necessarily lead to more inflows of FDI per capita. This association could reflect instead that higher levels of FDI flows encourage increased openness to cross-border transactions, for example. More Figure 12: Five-year average of FDI inflows per capita have even stronger correlation with CTC indicators <!-- Start of picture text --> 2,500<br>2,000<br>1,500<br>1,000<br>500<br>0<br>0 20 40 60 80 100<br>CTC average indicator score per economy<br>2007-11 average (USD)<br>Inward FDI flows per capita,<br><!-- End of picture text --> Note: three economies are omitted as outliers with more than $3,000 in inflows per capita (Ireland, Singapore, and Hong Kong SAR, China). The Pearson correlation is 0.427 and is highly significant. With the outliers included, the correlation is 0.287, still significant at the 1% level.

Source: UNCTADstat for FDI data.

robust econometric analysis would consider additional factors considered to be determinants of FDI, such as GDP growth, availability of natural resources, and macroeconomic stability. But these associations do suggest that the CTC indicators are measuring relevant aspects of the foreign exchange regime across economies, and the new data will hopefully enable further research to better understand the relationship between foreign exchange regimes and global FDI.

# 7. Policy implications and regulatory reform considerations

The CTC indicators identify common types of foreign exchange restrictions across economies, including requiring government approval for cross-border transactions; restricting how or when certain payments abroad may be made; and limiting firms’ ability to hold foreign exchange earnings. The indicators also show that there is significant variation in the economies that impose such restrictions. High-income economies have generally unrestricted regimes, and 38% of low- and lower-middle income economies have moderate or heavy restrictions in place; but another 38% of lower-income economies have open foreign exchange regimes for FDI, suggesting that being at an earlier stage of economic development is not necessarily a barrier to removing restrictions. Existing research has found that foreign exchange openness can attract FDI, and correlations between CTC data and measures of economic performance suggest that the indicators measure relevant aspects of the foreign exchange regime for FDI.

This benchmarking and analysis suggests that removing restrictions on converting and transferring currency may be a viable regulatory reform option in many economies. It should be stressed that any relaxation of restrictions is a complex process, and has to be grounded in the specific macroeconomic, structural, and financial sector conditions in any given economy. As noted in Section 2, the removal of one control can undermine the effectiveness of other controls, and reforms to liberalize the regime for 14
FDI must be designed in a way that maintains the effectiveness of the overall foreign exchange regime. Specific country experiences may be useful illustrations of the nuances of the reform process, such as the case of Turkey presented below.

# Case study: Turkey’s foreign exchange liberalization

Turkey’s process of liberalizing its foreign exchange regime began in the 1980s, when encouraging foreign investment was established as a key policy component of broader economic reform and export promotion. A first reform was to decriminalize the possession of foreign exchange without official government authorization, as penalties for non-compliance were reduced to administrative fines. Broader use of foreign exchange was gradually allowed, culminating in the passage of Decree 32 in 1989, which fully liberalized exchange regulations by removing all restrictions on the purchase or possession of foreign exchange. Decree 32 also laid out reforms to the capital account, and in 1990 strict controls on capital movement were removed and residents were allowed to borrow in foreign exchange or Turkish lira from international financial markets. Throughout this process, Turkey created government institutions focused on enabling the private sector, in order to support the implementation of effective domestic policies and regulatory frameworks relevant for an open foreign exchange regime.

Further liberalizing reforms have continued in recent years, even as Turkey has focused on developing sound macroprudential policies to manage the impacts of the global financial crisis. In 2008, Turkey abolished the requirement to repatriate export proceeds back to Turkey. In 2009, Turkey removed a restriction that only allowed firms with foreign exchange earnings to borrow in foreign currency from within the Turkish financial sector; this decreased reliance on external borrowing, while enabling all Turkish firms to still access long-term foreign currency loans via domestic financing. These liberalizing reforms faced political opposition, but policymakers maintained the commitment to a liberal exchange policy and the free flow of capital, along with sound macroprudential policies. The Turkish financial sector ultimately emerged from the global crisis with relatively <u>good performance.</u> Considering the need for any foreign exchange liberalization to be grounded in the country-specific macroeconomic context, general options for regulatory reform are presented below. These options are based on the assessment in Section 5 of restrictions that are common on the transactions covered by the CTC indicators, suggesting that the restrictions are obstacles to FDI in many economies. Where macroeconomic justifications do not exist for such restrictions, economies can consider the examples of less-restrictive regimes as models for how to facilitate cross-border transactions and improve their investment climates for FDI. And where justifications do exist for some restrictions, countries may consider other policy options to achieve the same goals in ways that are less burdensome to firms. Specific options include:

- Reduce or remove approval or authorization requirements to receive long-term foreign loans for FDI. Government approvals could be replaced with rules-based automatic authorizations if loans conform to certain terms, such as having terms of five years or more. If the policy goal is to gather statistical information about the stock of private debt, authorization requirements could be replaced with post-facto registration requirements, to decrease the administrative burden on private firms.

- Remove approval requirements or timing restrictions on outflows of liquidated capital and dividend/loan payments. Dividends and repayments of loans in installments are considered current transactions, and there is macroeconomic policy consensus that such transactions should be allowed freely. Restricting the repatriation of liquidated FDI is inconsistent with a policy of allowing FDI inflows, and many countries have allowed these outflows early in their liberalization process (see subsequent text box). Given the importance of these flows for FDI, the maintenance of restrictions should be strongly justified by the macroeconomic and financial sector conditions in an economy.

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# Liberalizing liquidation

Removing restrictions on inward FDI is often a first step in capital account liberalization, with outflows of FDI and other types of capital being allowed at later stages. But the ability to repatriate liquidated direct investment is a key aspect of the regime for inward FDI. Ghana, Malaysia, and Thailand are three emerging markets that maintain numerous controls on their capital accounts,<sup>xv</sup> but that have liberalized their inward FDI regime, including for repatriation: none of the three imposes restrictions beyond documentation requirements on outflows of liquidated FDI or on dividend or loan payments.quidated FDI or on dividend or loan payments.uidated FDI or on dividend or loan payments.payments.ayments.yments.ments.

- Remove approval requirements, timing restrictions, or quantitative limits on current cross-border payments such as for imports of goods or services. As with dividend and loan payments, there is general macroeconomic policy consensus that such transactions should be allowed freely, and the monitoring of such payments could be achieved for example through the risk-based documentation requirements described below.

- Allow firms to keep and manage foreign exchange liquidated FDI or on dividend or loan payments.quidated FDI or on dividend or loan payments.uidated FDI or on dividend or loan payments.payments.ayments.yments.ments. earned from exports by removing repatriation and surrender requirements. Requirements to convert export proceeds into local currency are a particularly strong disincentive to the export of goods and services; they decrease the ability of firms to manage exchange risk, and their imposition should be based on established macroeconomic justifications considering the availability of foreign exchange in the economy. Repatriation requirements may be less of a disincentive if firms are able to hold foreign exchange accounts with local banks, but may still be perceived as an unnecessary burden by foreign investors.

- Remove or reduce approval requirements and other restrictions on holding bank accounts in foreign exchange. Domestic foreign exchange accounts are an important means for firms to hedge against exchange rate movements, as noted above. Offshore foreign exchange accounts are also important for foreign investors, but may need to be liberalized at a later stage given that offshore accounts can be used to circumvent capital controls on non-FDI transactions. Regarding specific restrictions, notification could be required instead of authorization to ensure governments’ awareness of foreign exchange accounts. Approvals could be replaced with rules-based authorization processes whereby any firm with cross-border business operations is allowed to hold such accounts.

- Improve the efficiency of government authorization processes. When an approval or authorization is required and justified, or documentation must be reviewed, the waiting time required for firms to receive the authorization could be reduced. Internal government processes could be reviewed to remove unnecessary steps or to identify bottlenecks in staff capacity to process requests from the private sector. As mentioned above regarding foreign loans and bank accounts, approval requirements could be replaced with rules-based automatic authorizations to increase transparency and reduce discretion in the authorization process.

- Review documentation and other administrative requirements to ensure these are useful and efficient. In some contexts, such requirements serve as efficient monitoring mechanisms; in others, they become undue bureaucratic hurdles for firms. Risk-based mechanisms implemented by private financial institutions to ensure the legality of cross-border transactions is one option to consider, instead of requiring that specific documentation be provided for every cross-border transaction.

Reforms to substantial restrictions such as approval requirements for various foreign exchange operations will be most relevant in the 24 economies that impose moderate to heavy restrictions, most of which are in Sub-Saharan Africa and South Asia. Reforms to more nuanced restrictions, such as decreasing procedural requirements, will also be relevant in these economies, as well as in the 21 economies that impose administrative requirements across transactions (and which range from lowincome to upper-middle income, across all regions of the world).

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