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

P.C. van der Windt, E. Schaling, H.P. Huizinga

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Abstract

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 e¤ects. 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.
Original languageEnglish
Place of PublicationTilburg
PublisherMacroeconomics
Number of pages31
Volume2007-91
Publication statusPublished - 2007

Publication series

NameCentER Discussion Paper
Volume2007-91

Keywords

  • Dual exchange rate systems
  • capital controls
  • emerging markets
  • financial repression
  • optimal tax policy

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