The International Monetary Fund on Tuesday reversed a decades old policy,
which opposed inter-country
capital flow controls, when it endorsed guidelines for countries to
use restrictions in some circumstances to protect their economies.
The Fund's executive board said on Tuesday that "capital flows have
returned with the ebbing of the global financial crisis, bringing investment and
growth benefits to recipient countries, but also important macroeconomic and
financial stability challenges. Improved fundamentals and growth prospects in
emerging markets and loose monetary policy in advanced economies are among the
main pull and push factors behind the recent wave of inflows to emerging
It reviewed a staff paper on the experience of selected countries in dealing
with capital inflows, which suggests a possible framework for Fund policy advice
on the spectrum of measures available to policymakers to manage inflows,
including macroeconomic policies, prudential measures, and capital controls. The
board said: "Illustrative applications of this framework suggest that it may
be appropriate for several countries, based on their current circumstances, to
consider prudential measures or capital controls in response to capital
A majority of directors supported the change.
IMF managing director Dominique Strauss-Kahn said the fund is taking a
"very pragmatic" view of capital controls, the use of taxes, interest rates
or other policy tools to curb flows of cash in and out of countries.
"It cannot be a substitute for the right economic policies, but when the
right economic policies are in place, then it can be necessary, on a temporary
basis, to use this kind of tool," he said.
Several countries including Brazil, South Korea and Turkey have placed limits
on capital flows in an effort to control inflation, limit the rise in their own
currencies or prevent bubbles in their stock and property markets.
The Fund released two studies this week:
Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes
and Possible Policy Framework, (pdf) which looks at country cases and
suggests a framework of measures available to manage inflows,
including macroeconomic policies, tax and prudential measures, and
capital controls. The second paper,
Managing Capital Inflows: What Tools to Use, (pdf), provides analytical
underpinning to the Fund’s research on the topic.
This work on
capital flows is part of a broader work agenda to enhance the
coverage, candour, and evenhandedness of IMF policy advice. In the
process, the Fund says it is looking at ways to strengthen how it
evaluates advanced economies, where the global crisis began.
The IMF is studying the originators of capital flows, known as
the “push” forces. Reports on the effects that policies in one
country or group of countries might have on others, known as
spillovers, are being prepared for the world’s five largest systemic
economies - - China, the Eurozone, Japan, the UK, and the
Net private capital flows to
developing countries rose 44% in 2010 to about $753bn,
according to the World Bank. The nine countries that attracted the most
capital flows were Brazil, China, India, Indonesia, Malaysia, Mexico, South
Africa, Thailand and Turkey, the bank said in January.
Brazil’s currency, the real, has jumped 42% against the dollar since the
beginning of 2009. The Indonesian rupiah has risen 25%, while the South Korean
won is up 14%.
Choices, choices, choices
While capital flows are generally beneficial for receiving
countries, surges in inflows carry risks for their economies and
financial systems. IMF research finds that policy responses to
inflows have varied considerably, in part because of the differences
between countries and the nature of the capital inflows in each
Surges in inflows can pose challenges such as rapid currency
appreciation and a buildup in financial sector fragilities, such as
those stemming from asset price bubbles or rapid credit growth, or
the risk of a sudden stop or reversal of inflows.
The management of capital inflows “covers a whole swath of
economic policies,” said
Strauss-Kahn in his
(pdf) to the executive board. These issues are central to
the role of the IMF.
IMF research: common ground and lessons
The following key principles form the foundation of an organizing
framework around which national authorities can formulate policies:
1. No “one-size-fits-all”. The right policy mix
will depend on each country’s circumstances, including the state of
the domestic economy and the nature and magnitude of the capital
2. Structural reforms are always encouraged.
Policies designed to increase the capacity of the economy to absorb
capital inflows for example, by creating deeper domestic capital
markets should be pursued under all circumstances.
3. There are no substitutes for the right macro policies.
Any response has to give primacy to macroeconomic policies. Measures
specifically designed to influence inflows cannot be a substitute
for the implementation of appropriate macroeconomic policies.
4. Capital controls are part of the policy toolkit.
As outlined recently by Strauss-Kahn, capital controls can be used on a
case-by-case basis, in appropriate circumstances.
5. Design the medicine to treat the ailment.
Capital flow management measures should match the specific
macroeconomic or financial stability concerns in question. In
general, these measures should maximize efficiency and minimize
distortions, and should be withdrawn when risks recede.
6. Think of others. Policies that might affect
the external stability of other countries and, by extension, global
financial stability or growth prospects, should be discouraged. In
this regard, the framework suggests giving preference to measures
that do not discriminate on a residency basis. This reflects the
Fund’s multilateral mandate to promote systemic stability and foster
global policy coordination.
The effectiveness of the policy framework will be analyzed and
adjusted over time, particularly in light of the impact that
policies in one country or group of countries might have on others.
Country experiences in managing capital flows will also be
covered in forthcoming IMF research and in the upcoming Regional
Economic Outlooks, to be issued in late April and May this year.