How to Manage Foreign Capital Inflows? A Brief Technical Note (original) (raw)
Related papers
2009
Managing capital flows is one of the most difficult issues facing policy makers in emerging economies. This book documents the complexities of the issues surrounding capital flows and their control, and the range and depth of the debate concerning the most appropriate policy choices. In the early 1990s, these issues were thought to be largely resolved in favor of the elimination of capital controls in emerging market economies, a move that would naturally follow the removal of restrictions on current account transactions. By the 1990s most emerging markets had adopted the IMF's Article VIII which commits member Governments not to impose restrictions on trade and services payments. The benefits from the elimination of current account restrictions were by then also so obvious that the Interim Committee of the IMF in 1997 proposed that their Articles of Agreement be extended to include jurisdiction over the elimination of capital account restrictions. This was in line with the neoclassical growth view that freeing up capital movement would increase allocative efficiency and thereby promote economic growth. As Alfaro, Kalemi, Ozcan and Volosovych remind us in the first paper, capital flows to emerging economies are much smaller than theory would predict (the Lucas paradox). This is echoed by Goldberg's paper which uses a new dataset on US banks' international exposures which she shows to be heavily concentrated in Europe. But the required elimination of restrictions was not to be. The emerging market crises of the late 1990s intervened and the sudden stops of capital were held largely responsible. The capital controls that Chile had used and Malaysia subsequently adopted came to be seen in a more favorable light, as potentially having merit in protecting emerging economies from the starts and stops of international capital movements. By 1999 the IMF Executive Board recommended a "stronger emphasis than was previously placed on the adoption of prudential polices to manage the risks from international capital flows" (IMF, 1999). By the time of the NBER sponsored conference in 2004, which is the basis for the collection of papers in this book, capital inflows to emerging economies were again rising, making the issues increasingly pressing for policy makers. Do capital controls reduce the vulnerability to crisis or the cost of crisis, and at what cost? Measuring the degree of financial openness has been a major impediment to addressing such questions. As Edwards discusses in his paper, apart from complete openness and total closure, the measurement of financial openness has proved to be extremely difficult, plagued by a wide range of controls on both inflows and outflows, on the different types of capital flows (i.e. FDI, portfolio equity and debt flows), as well as exchange restrictions and prudential regulations. The measurement issue has amplified the wedge that varying degrees of enforcement and evasion drives between legal and de facto controls. Studies that have used more subtle graduations of capital controls tend to support the notion that countries with more open capital accounts have performed better. For his paper in this volume Edwards uses a combination of IMF data with country information and work of Mody and Murshid (2002) and Quinn (2003) that allows him to divide the countries into high, intermediate and low capital mobility. Looking at instances of sudden stops in capital inflows and current account reversals, Edwards concludes that there is no evidence that low mobility countries have significant lower incidence of sudden stops or current account reversals. Overall his results cast some doubt on the belief that increased capital mobility caused heightened macroeconomic vulnerabilities. However the results do suggest that once a crisis has occurred, countries with a high degree of capital mobility tend to face a higher cost in terms of growth decline. Another approach to getting around the bluntness of macro-measures of financial openness is to look at microeconomic effects. Forbes' paper provides a nice companion to the macro-studies by looking at the microeconomic effects of capital controls. In a review of the micro-literature, she finds that capital controls tend to reduce the supply of
International capital flows and emerging markets: amending the rules of the game?
1999
Recently, and partly as a result of the currency crises in emerging markets, a broad debate on reforming the international financial system has begun. Talk of a "new financial architecture" abounds, and academics, financiers, and politicians have offered blueprints for reforming existing institutions. Some have talked of creating a global lender of last resort, while others have argued that it is high time to abolish the International Monetary Fund (IMF). It is becoming increasingly apparent, however, that political considerations will stand in the way of true change, and it is highly likely that in the next few years we will see, at most, a modest reform of the IMF and of the other major multilateral institutions. However, we are also likely to see some important changes in exchange rate arrangements, as well as in country-specific rules governing capital mobility. Policy discussions have begun to concentrate on the following issues: (a) the conjecture that optimal exchange rate regimes are characterized by either a clean float or an institutionally rigid system, à la dollarization (Calvo 1999; Edwards 1999a); and (b) the role of capital controls as a way of reducing an emerging country's vulnerability to speculation and currency crises. Most proponents of controlling capital mobility have argued that a system aimed at limiting short-term-or speculative-capital movements would be beneficial to emerging countries. Almost invariably, the supporters of this policy refer to Chile's experience with controls on capital inflows as an illustration of the merits of this system. Joseph
Managing Capital Inflows: What Have We Learned?
2005
At the beginning of the 1990s, the development of a global capital market with a larger role for capital flows to developing countries was a major objective of international economic policy. In fact, consideration was being given to making an open capital account a condition of IMF membership. However, a decade of frequent and very costly financial crises throughout Latin America and Asia has led to a reconsideration of that advice. The experience also promoted an explosion of economic research to reexamine the tradeoff between the benefits and risks of international capital flows. The objective of this paper is to review that research and the policy advice that flows from it. The paper provides a brief review of the recent pattern of capital flows to developing countries before turning to three substantive issues: (1) the impact of capital inflows on growth, (2) the role of domestic financial structure, and (3) the interaction between open capital markets and the exchange rate regime. First, it is surprisingly difficult to produce robust evidence of a strong relationship between integration with the global financial system and large net benefits to the participating countries. The benefits accrue very gradually and can be wiped out for many years by the occurrence of a financial crisis. The link between financial liberalization and crises is the major reason for the finding of limited net gains. Second, there is much greater appreciation of the linkage between domestic and external financial liberalization. The two reforms need to be coordinated, but some analysts would go further in suggesting that external liberalization should be conditional on the achievement of certain minimal standards of liquidity and oversight in the domestic financial system. Third, the coordination of liberalization with changes in the exchange rate regime remains an area of significant dispute. There is agreement that a simple fixed rate system is too exposed to speculative pressures and leads to excessive levels of risk-taking in cross-border financing. However, there is no agreement that the adoption of a flexible rate is sufficient to resolve the problems. The level of foreign-currency debt is high even in flexible exchange rate regimes. The issue of currency risk is also not adequately addressed in the Basel accords on bank supervision. The liberalization of the capital account is an inevitable by-product of economic growth and involvement in the global trading system. The increasing complexity of international transactions will make controls ineffective, and their complexity will impose costs on other cross-border transactions. However, the historical experience does suggest that countries are right to proceed with caution, and as an integral part of an overall program of reform of the domestic financial system and the exchange rate regime.
Capital Flows in Emerging Economies: Policies, Practices, and Consequences (Chicago
2016
The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is not unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success ” and (iv) the empirical studies lack a common methodology – furthermore these are significantly “overweighted ” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize ” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control...
Why Should Emerging-Market Countries (Still) Concern Themselves With Capital Inflows?
2007
This paper develops a simple analytic framework to analyze the effects of capital surges and sudden stops in the financial account of the balance of payments in emerging economies. In this model, capital inflows are largely exogenous to the recipient economies, they are very large when scaled to the size of the domestic financial sectors of recipients, and have large real effects. They also sow the seeds for the ensuing sudden stops, or capital flow reversals, observed in recent financial crises in emerging markets. Sudden stops can have devastating effects on output, growth, and employment. The paper goes on to test the main hypothesis derived from the model with an econometric analysis of capital surges and sudden stops using a panel-probit framework with heterogeneous unobserved country effects. While capital surges can be triggered by a number of domestic or foreign signals, the main variables that account for sudden stops are preceding capital surges, the size of the current ac...
Capital Flows: Issues and Policies
Open Economies Review, 2013
This paper presents an analytical overview of recent contributions to the literature on the policy implications of capital flows in emerging and developing countries, focusing specifically on capital inflows as well as on the links between inflows and subsequent capital-flow reversals. The objective is to clarify the policy challenges that such inflows pose and to evaluate the policy alternatives available to the recipient countries to cope with those challenges. A large menu of possible policy responses to large capital inflows is considered, and experience with the use of such policies is reviewed. A policy "decision tree"-i.e., an algorithm for determining how to deploy policies in response to an exogenous inflow episodeis developed, and strategies to achieve resilience to both inflows and outflows in a world where exogenous events may frequently drive capital flows in both directions are discussed.