IMF research staff have joined external critics in saying that capital account regulation should be more widespread and better coordinated across recipient countries, setting the stage for a contentious final debate on an IMF institutional view on capital account management at end October.
In early September, the IMF released a staff discussion note: Multilateral aspects of managing the capital account, written by research department staff Johnathan Ostry and Atish Ghosh with University of Maryland researcher Anton Korinek. The note does not represent the view of the Fund as an institution, but could be seen as the view of the research department. The paper argues for the need for some “rules of the road” on implementing regulations on the capital account. Building on welfare economics, it draws four implications for policy makers: “capital controls and related measures (including prudential, monetary and fiscal policies as relevant)… should not substitute for warranted external adjustment”; “countries should not seek to exploit market power”; “capital flows should be managed in both source and recipient countries”; and “coordination may be needed to avoid capital control wars across recipient countries”.
The first implication continues existing IMF positioning on the issue (see Update 81, 80, 79) but the third and fourth go beyond what the Fund has agreed in its previous string of policy discussions on the topic, which were supposed to lead into the final institutional view being discussed at the IMF board at end October. Regarding source country policy, the authors argue that source countries – principally the US, UK and the eurozone – could themselves gain from regulation. The previous policy discussion on this topic in late 2011 had exhorted source country policy makers only to “pay attention” to the effects of their policies on other countries (see Update 79).
For example, on the issue of how source country interest rates impact on capital flows, the staff note argues that “it would, in fact, be in the interests of the source country to take into account the cross-border spillovers since, otherwise, monetary policy would, from its own perspective, be excessively expansionary.” They also argue that it is more important to tackle source country policy than spillovers caused by capital flow measures in recipient countries.
Importantly, the paper supports coordination of inflow controls in recipient countries, arguing this will strengthen their effectiveness allowing the measures to be less intense. The paper’s inference is that the IMF could help in country coordination. This is likely to be the most controversial aspect of the IMF board discussion at end October, as governments from emerging powers, such as Brazil, explicitly rejected the idea that the IMF should have guidelines just last year partly because of fears of a liberalisation bias (see Update 76).
Regulations, not currency policy
A June working paper from the Initiative for Policy Dialogue at the University of Colombia, authored by Brittany Baumann and Kevin Gallagher, examined the effectiveness of capital flow regulations adopted in Brazil and Chile from 2009 through 2011. Brazil used capital flow measures while the Chilean central bank intervened in the foreign exchange markets directly by buying dollars. The authors found that Brazil’s “capital account regulations had a significant but small impact on exchange rate levels and volatility, asset appreciation, on monetary policy independence, and on the scale, composition, and spillover effects of capital flows.” In Brazil’s case they conclude the regulations “helped the nation ‘lean against the wind,’ but were not enough to tame the tsunami.”
Meanwhile, the Chilean approach “did not have a lasting impact on the Chilean exchange rate or on asset prices beyond the initial announcements of the policies.” Given the modest nature of the Brazilian success, the authors’ policy conclusions include that “capital controls alone will not be sufficient to address the concerns about capital flow volatility unless they are much stronger and better enforced.”
The early September release of the UN Conference on Trade and Development’s Trade and Development Report warned of capital flow volatility and underscored the usefulness of capital account regulations when compared to exchange rate policy or tackling imbalances from the trade side. “Capital movements have a much stronger influence on exchange rates than trade or current-account balances, and there is no reason to believe that they will reflect ‘economic fundamentals’. Public intervention is needed to manage these capital flows and guide real exchange rates to sustainable levels.” In June, Daniela Gabor, from the University of West England, argued that IMF advice – which emphasises that capital account regulations should be temporary, short-term and not a substitute for other policy – “should be used as a template of how not to manage capital accounts” because it may “perversely increas[e] exposure to hot money inflows.”
To IMF or not to IMF?
A July IMF report on the external sector (see Update 82) recognises that capital inflows can “require a wide range of policy tools” and that “push factors” in rich countries are often important in determining the volume of capital flows. However, it also states that “surges in capital flows often support balanced and healthy development” without any reference to evidence showing as much and argues for “carefully loosening capital account restrictions over time”. While inferring that capital account regulations are “distortions” throughout the document, the report claims that “careful reduction in [capital flow] barriers accompanied by appropriate supervision, regulation, and financial deepening should unambiguously improve the allocation of global savings and lower potential vulnerabilities.”
Columbia University’s José Antonio Ocampo, former UN undersecretary general for economic and social affairs, called this analysis “dead wrong. The evidence of emerging and developing country crises over the past four decades shows that capital account liberalisation has a high probability of leading into overvaluation, current account deficits, asset booms of different character and finally crises, which mix in variable ways balance of payments and domestic financial collapse.” He went on to argue that “You can even say that this is the story of Europe: the adoption of full capital account covertiblity in 1990 was soon reflected in the European monetary crisis of 1992, and the story of the European periphery is just very similar to that of emerging economies (introduction of the euro leads to a sharp reduction in risk premiums, leading to large capital inflows, current account deficits, asset bubbles and finally crisis).”
Former IMF assistant director Arvind Subramanian, currently at the US think tank the Peterson Institute, recognises that not all capital flows are welcome. Responding to the June moves by the Reserve Bank of India to liberalise some capital inflows in order to attract back some of the outflows India has seen in recent months, Subramanian wrote: “capital that returns is almost by definition going to be of the speculative sort, chasing high yields rather than long-term opportunities. This capital is, therefore, more susceptible to ‘sudden stops’ and will contribute to the boom-bust cycle that has been the bane of the international economy these last few years.” He also argues that “the opening today will lead to an unnecessary loss of policy options in the future” because liberalisation measures are hard to reverse.
Although countries such as Brazil are reticent to have the IMF set up and monitor any ‘rules of the road’ related to capital account regulations, they are willing to have discussion elsewhere. At an early August meeting in Quito, Ecuador, central bank leaders from South America agreed to meet in the first half of 2013 to discuss management of capital flows, the first such open regional discussion.