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Emerging markets rout stirs unease about capital curbs

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Moves by Nigeria and China to clamp down on currency and equity markets have raised fears other countries may also seek to curb capital movement as a way to stem the exodus of money from emerging markets.

Some governments are already restricting citizens' ability to move cash freely or tightening existing measures and some foreign investors worry they may be next in line.

As 2015 outflows from emerging stock and bond funds near $100 billion and currencies from Malaysia to Brazil plumb multi-year lows, memories are stirring of past controls that block unlucky investors' exits.

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At stake is the $7 trillion that the Institute of International Finance reckons has flowed into emerging markets since 2005, via direct investments, mergers and acquisitions, and stock and bond purchases. Some of those with EM exposure may considering moving before regulators do.

"Malaysia, Brazil, Indonesia all have a recent history of intervening and imposing capital controls ... this is very much contingent on how much more outflows there are to come, and how much more depreciation there is to come," said Aidan Yao, senior emerging Asia economist, Axa Investment Managers Asia.

Capital controls are often first levied on local bank deposits or exporting firms. But freezing exchange rates or interbank trading can leave foreign investors struggling to liquidate assets or withdraw cash from banks.

Having resolved not to devalue its naira, Nigeria has clamped down on firms' dollar purchases and squeezed interbank currency trading to the maximum -- market players report three to five deals a day instead of 80-100 previously.

China has increased checks on firms' currency buying and passed regulations to curb "malicious" trade in stock futures after months of equity turmoil and capital outflows.

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Those steps have halted the rout but daily turnover on the Shanghai and Shenzen exchanges has more than halved since July.

Neither is a typical emerging economy, however: China restricts free movement of capital anyway, while Nigeria, like much of Africa, has relatively undeveloped and illiquid markets.

Foreigners faced no trouble repatriating cash from Nigeria, one former debt holder said. Rather than blanket controls, subtler measures such as taxing short-term investments at point of exit or limiting residents' ability to send money abroad are seen as likely. But "soft" curbs too may eventually be counterproductive.

"Capital flight can become a self-fulfilling prophecy if investors get worried about ability to transact, and you could see more pressure on bonds," said Yacov Arnopolin, a portfolio manager at Goldman Sachs Asset Management.

The thinking on capital controls has undergone a shift in recent years, with the International Monetary Fund giving a tacit nod during the boom years to moves by countries such as Brazil to prevent currencies from rising too much.

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Far from being an anachronism, controls were deployed in recent years in Iceland, Cyprus and Greece, while small economies such as Argentina and Ukraine also have curbs. Some resorted to temporary measures during the 2008-2009 meltdown.

Such steps can aid crisis management by reducing panic, advocates say, noting that Malaysian controls in 1998 freed its central bank to loosen policy, helping its economy recover.

Some even see Nigeria's decision to freeze currency markets as justified while the new president tackles corruption.

"Occasionally flows do become very alarming and erratic, and potentially have negative repercussions for the economy. So (the IMF) have changed their stance, and maybe some countries should have capital measures against these kind of erratic flows," Yao said, though he warned countries must think carefully over the timing and severity of the controls.

Such fears may be overdone -- countries which benefited from foreign capital will probably want to keep investors sweet, many say, especially if they have balance of payments deficits.

Even the rouble's 58 percent peak-to-trough fall last year and the real's 35 percent slump in 2015 didn't prompt controls they note, and Malaysia has ruled them out this time.

Christian Keller, head of economics research at Barclays, said struggling governments will prefer to go to the IMF or wealthier countries for assistance, while soft curbs such as taxes are ineffective during a market meltdown.

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"If everything is going belly-up, you won't care about paying a tax to exit and save some of your investment," he added.

The clincher may be the extent of the selloff, because spiraling inflation and currency collapse are difficult for voters to stomach.

Malaysian stocks and the ringgit are down about 20 percent this year compared with an 80 percent plunge during the 1998 crisis, noted Bank of America Merrill Lynch analysts.

But central bank intervention has depleted reserves by $25 billion this year, while Malaysia is also deep in political crisis, meaning capital controls can't be ruled out, they said.