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Capital Controls in the Eurozone: Restricting International Trade to Preserve It

By Frances Coppola

International businesses consider capital controls incompatible with free movement of goods and services, since impeding the free flow of money across borders inevitably makes international trade more difficult. But “difficult” is better than nothing, and sometimes capital controls can prove to be the lesser of alternative “evils.”

As we have explained before, controls on inflows limit inward investment, which can restrict the availability of financing for international business’ expansion; while controls on outflows can make it difficult for international businesses to pay suppliers and repatriate funds. Capital controls also restrict free movement of people, since people will not visit a country if they cannot bring with them the means to pay for accommodation, food and entertainment while they are there.


Thus, it is hard to see how capital controls could operate within a trade bloc whose founding principles enshrine the freedom of movement of goods, services, people and capital. Yet, since 2008, capital controls have been imposed by two members of the European Union. How does this work, and what are the implications for international trade with these countries?


The EU’s “Four Freedoms” Should Eliminate International Trade Barriers – But There is a Caveat


The heart of the Treaty on the Functioning of the European Union (TFEU) includes “four freedoms”:


  • Freedom of movement of goods and services
  • Freedom of movement of people
  • Freedom of movement of information
  • Freedom of movement of capital and payments1

Article 63 of the TFEU prohibits restrictions on movement of capital and payments not only between EU member states, but between EU member states and third countries.2 In theory, therefore, EU members should be unable to use capital controls.


But Article 65 provides a caveat. It allows member states “to take measures which are justified on grounds of public policy or public security.” This clause has twice been used to justify imposing capital controls.3


Capital Controls in Cyprus


In 2012, Greece restructured its sovereign debt, imposing losses on private sector bondholders. Among those bondholders were Cyprus’ oversized and undercapitalized banks, already weakened after the financial crisis of 2008. The Greek “Private Sector Involvement” (PSI), restructuring effectively rendered the two largest banks, the Popular Bank of Cyprus (“Laiki”) and the Bank of Cyprus, insolvent.4


In March 2013, in an all-night negotiation with the European Commission, European Central Bank (ECB) and the International Monetary Fund (IMF), the Cypriot government agreed to close down Laiki Bank and restructure the Bank of Cyprus. The deeply indebted Cypriot public sector was unable to bear the cost of the restructuring, so the government agreed to impose losses on bank depositors. The original proposal was for all depositors in the Bank of Cyprus to take a small loss, including those subject to the EU’s deposit guarantee scheme.5 But the Cypriot parliament refused to allow the deposit guarantee scheme to be compromised.6 A second version of the bank bailout plan therefore restricted losses to depositors which were not subject to the guarantee scheme – households with large deposits, businesses, and institutions such as universities.7 This meant much larger losses for those depositors: they eventually lost nearly half of their holdings.8


To prevent a run on Cypriot banks, the Cypriot authorities imposed capital controls before reopening banks after a week-long enforced “bank holiday.” The Eurogroup, representing the European Union, declared that these “administrative measures” were “appropriate in view of the present unique and exceptional situation of Cyprus' financial sector and to allow for a swift reopening of the banks.”9


This sparked a debate about the legality of capital controls.10 Additionally, as Cyprus is a member of the single currency, there was considerable concern about what capital controls would mean for the euro. Restricting movements of money within the single currency area can create implied exchange rate differences between euros from different countries.11


The effect on the Cypriot economy was devastating, as businesses whose money was seized to make good on bank losses went out of business, cross-border trade diminished and international investors fled.12 Cyprus experienced a deep recession and unemployment rose to 16.1 percent. Four years on, unemployment remains in double digits and the trade balance is deeply in the red.13


But the euro remained intact. Indeed, Cyprus’ capital controls may even have helped to protect it. Since euro area countries do not issue their own currencies, cross-border bank runs can result in a country literally running out of money. In Cyprus, capital controls prevented devastating capital flight and a crippling shortage of money, which could have forced a “disorderly exit” from the euro area. In its 2014 Article IV review of Cyprus’ economy, the IMF said although controls on outflows were hampering international trade, removing them was unwise while Cyprus’ banks remained fragile.14


The Cypriot authorities started to relax capital controls one year after their imposition, and removed them completely in April 2015.15


Capital Controls in Greece


The possibility that Greece might need capital controls was widely discussed from the time of its first bailout, in 2010.16 But Greece managed to avoid capital controls – until the renewed crisis in 2015.


Like Cyprus, Greece is a member of the euro, and therefore cannot produce its own currency. In the first half of 2015, as bailout negotiations became more difficult, depositors started to move money out of Greek banks into safer homes such as German and Swiss banks, forcing Greek banks to ask the ECB to provide them with euros.17 For some months, the ECB accommodated their requests.


But in June 2015, negotiations failed and Greek Prime Minister Alexis Tsipras called a referendum on the conditions the EU wished to impose on Greece’s latest bailout. As deposit flight from Greek banks intensified due to the uncertainty created by the referendum, the ECB imposed a limit on the quantity of euros it would provide.18 Faced with the real possibility of Greek banks literally running out of euros, and unable to provide them with any money, the Greek government closed the banks and imposed capital controls that impacted international trade.19


Although capital controls were effective at slowing deposit flight,20 there were reports that Greek and international businesses were suffering: businesses could not pay suppliers and consumer spending slumped.21 Many businesses froze investment.22 But although capital controls still remain in place,23 data from the OECD shows little evidence that capital controls have been as bad as many expected. The country dropped briefly into recession but has since recovered;24 investment is gradually returning25; and unemployment is slowly falling.26



How much of Cyprus’ economic collapse was due to capital controls impeding international trade, and how much arose from the combination of a major bank bailout and an IMF program, remains unclear. But for Greece, there is little doubt. Although Greece’s strict capital controls have hampered international trade to some degree, capital controls were the “lesser of two evils.” Without them, Greece would have been forced into a disorderly exit from the euro, with devastating impact on international businesses and international trade. In a financial crisis, using capital controls within the single currency area, far from breaking the euro, may be necessary to preserve it.

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.


1. “Treaty of Rome (EEC),” European Commission;
2. “Consolidated versions of the Treaty on European Union and the Treaty on the Functioning of the European Union,” European Commission;
3. Ibid.
4. “Beware of German gifts near their elections: How Cyprus got here and why it is currently more out than in the Eurozone,” Alexander Apostolides, European University of Cyprus;
5. “Sowing the wind,” Coppola Comment;
6. “Cypriot parliament rejects levy on bank deposits,” China Daily;
7. “Cyprus agrees €10bn bail-out deal with eurozone,” Telegraph;
8. “Bank of Cyprus deposit haircut is 47.5 percent, says central bank,” Reuters;
9. “Eurogroup Statement on Cyprus,” Eurogroup;
10. “Legal debate over Cyprus capital controls,” Financial Times;
11. “The broken Euro,” Coppola Comment;
12. “As Cyprus recovers from banking crisis, deep scars remain,” NY Times;
13. “Cyprus: Solid growth accompanied by fiscal loosening ahead,” European Commission;
14. “Cyprus : Staff Report for the 2014 Article IV Consultation, International Monetary Fund;
15. “Capital punishment,” The Economist;
16. “Effects of capital controls on Greece,” Financial Times;
17. “Greek deposit flight forces banks to apply for emergency support,” Telegraph;
18. “ELA to Greek banks maintained at its current level,” European Central Bank;
19. “The Day The Euro Died,” Forbes;
20. “Greek bank deposit flight slowed in July amid capital controls,” Reuters;
21. “Effect of Greece’s capital controls one year on,” Anadolu Agency;
22. “Capital controls still hurting the Greek economy,”;
23. “Capital controls to stay in effect until end of 2018 at least,” Greek Reporter;
24. “Greece real GDP growth,” Organization for Economic Co-operation and Development;
25. “Greece investment (GFCF),” Organization for Economic Co-operation and Development;
26. “Unemployment statistics” (accessed May 2017), Eurostat;

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