Capital Flows, Real Exchange Rates, and Capital Controls: What Is the Scope of Liberalization for Tunisia?

This paper deals with an important aspect of Tunisian economic and political decisions related to the opportunity for currency convertibility. Tunisia has established its current currency convertibility and has taken steps to achieve full convertibility of the dinar by gradually removing capital flow obstacles. Theoretical and empirical literature suggests that capital account liberalization generally leads to capital inflow in developing countries, generating an appreciation in the real exchange rate (RER) and thus a loss in competitiveness. However, preserving competitiveness is a key challenge for monetary authorities, who have to conciliate these two apparently conflicting purposes. To guide their decisions with respect to the prescribed procedure for capital liberalization, we need to evaluate the impact of each capital component flow on the RER. The question is addressed by analysing impulse response functions (IRF) resulting from a VAR model, covering 1970 to 2010 and gathering the RER, its fundamental determinants, monetary variables and an estimated capital control (CC) variable. Results show that a relaxation of CC over-appreciates the RER to its long-term level, and liberalizing portfolio investment is the most compromising for competitiveness.