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We use changes in Brazil’s tax on foreign investors from 2006 to 2011 to test for any direct and multilateral effects of capital controls on portfolio flows. The analysis is structured based on information from a series of investor interviews. We find that increases in Brazil’s capital controls cause investors to decrease their portfolio allocations to Brazil. Investors simultaneously decrease portfolio allocations to other countries believed to be more likely to use controls, and increase allocations to other countries in Latin America, that constitute a large share of the benchmark index, and that have substantial exposure to China. The results suggest that much of the effect of capital controls on portfolio flows is through signalling rather than the direct cost of the controls. The results also suggest that any assessment of capital controls should consider their spillover effects on investment in other countries.

* Author contact information: Kristin Forbes at kjforbes@ mit. edu; Marcel Fratzscher at marcel. fratzscher@ ecb. int; Thomas Kostka at thomas. kostka@ ecb. int; and Roland Straub at roland. straub@ ecb. int The authors would like to thank Giovanni Dell’Ariccia, Iikka Korhonen, and seminar participants at the HKMA for helpful comments and suggestions. The views expressed in this paper are those of the authors and do not necessarily reflect those of the ECB or of the Eurosystem. Further thanks to Apolline Menut at MIT for research assistance.