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To be totally effective, such requirements must apply in all jurisdictions in which foreign exchange transactions can be booked. Policy-makers might contemplate a variety of measures to limit the ability of hedge funds and other international investors to take positions in domestic financial markets. By taxing short-term capital inflows (as, for example, Chile has done), hedge funds and others could be discouraged from taking long positions that they might wish to close out suddenly.
Hedge fund managers, who emphasize the importance they attach to being able to put on and take off positions with a minimum of transaction costs, would be particularly sensitive to such measures. Along the same lines, by slowing the development of active and liquid bond markets, it might be possible to discourage trading in those assets by hedge funds and other investors that prefer to transact in markets where positions can be easily taken and liquidated. But the costs in terms of economic growth of suppressing the development of domestic financial markets are high. If measures are taken to discourage position taking by hedge funds and other investors, it is critically important that these do not encourage a relapse into inflexible financial markets that retard economic growth.
Concluded.
* Contributed by -
Swetha Narayanaswamy,
M.B.A. II year (Finance),
ICFAI Business School, Mumbai.
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