DP6347 Capital Controls and Foreign Investor Subsidies Implicit in South Africa's Dual Exchange Rate System

Author(s): Harry Huizinga , Eric Schaling , Peter C van der Windt

Publication Date: June 2007

Keyword(s): capital controls , Dual exchange rate systems , financial repression

JEL(s): H21

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6347.asp.asp

Both in theory and practice, capital controls and dual exchange rate systems can be part of a country's optimal tax policy. We first show how a dual exchange rate system can be interpreted as a tax (or subsidy) on international capital income. We show that a dual exchange rate system, with separate commercial and financial exchange rates, drives a wedge between the domestic and foreign returns on comparable assets. As a borrower, the government itself is a direct beneficiary. Secondly, based on data from South Africa, we present empirical evidence of this revenue implicit in a dual exchange rate system; a revenue that amounted to as much as 0.1 percent of GDP for the South African government. However, this paper also shows that both the capital controls and the dual exchange rate system in South Africa gave rise to many perverse unanticipated effects. The latter may render capital controls and dual exchange rate systems unattractive in the end and, thereby, provides a rationale for the recent trend in exchange rate liberalization and unification.