Despite concerns about the consequences of the credit market breakdown in rich countries spilling over into other countries, the IMF is nagging developing countries to open their capital accounts and planning to regulate sovereign wealth funds.
The October communiqué of the body of finance ministers that sets strategy for the IMF recognised the risks of the credit market breakdown. Given that the IMF’s first multilateral consultations failed to lead to concrete action to resolve global imbalances (see Update 54), there seems to be little appetite to make the IMF the locus of any new initiative on market volatility.
At the meetings the deputy governor of the People’s Bank of China, Wu Xiaoling, called for the Fund to do more surveillance over industrialised countries and spend less time telling developing countries what to do. “As the turbulence in the global financial markets caused by the US sub-prime mortgage market developments has adversely affected global growth prospects, it is all the more urgent a priority to strengthen surveillance of the systemically important advanced economies in order to safeguard global financial stability and economic prosperity.”
dismantling the floodgates at exactly the moment when a storm surge is arriving
Contentious capital controls
The situation in global markets has started pushing portfolio, equity and speculative capital towards developing countries, with India bearing the brunt of the influx. In the midst of the IMF and World Bank meetings in October, India was setting new records for the volume of capital inflows, even with some controls in place. Despite recognition of the dangers to financial stability of unfettered capital flows by nearly everyone, including the Fund’s former chief economist Kenneth Rogoff (see Update 39), the IMF seems intent on advising its members against using capital controls.
The IMF’s autumn editions of both the Global Financial Stability Report (GFSR) and World Economic Outlook (WEO) discussed how emerging-market countries can deal with capital inflows. The GFSR concluded that “capital controls should be used only as a last resort” and “may have uncertain effectiveness and unintended side effects.” The WEO advised central banks not to intervene and for governments to spend less money. Dominique Strauss-Kahn, the new IMF managing director, joined the debate shortly after taking office, warning India against imposing any capital controls: “It has been said or asked or it has been written that India should implement in one way or another some limits to the capital inflow. The problem of this kind of thing is it may undermine the confidence on the Indian economy. It will have an influence certainly on capital inflows but not always a good influence. I think the Indian authorities should think over several times before implementing this kind of an instrument”. The IMF is essentially arguing for dismantling the floodgates at exactly the moment when a storm surge is arriving.
This is the opposite conclusion of that reached across the road at the World Bank, which has warned against premature capital account liberalisation. In a seminar hosted by the South Asia department of the World Bank during the annual meetings in October, Thai finance minister Chalongphob Sussangkarn called for more support to countries that wanted to slow capital inflows. Former assistant director for research at the IMF Arvind Subramanian criticised market fundamentalists who opposed the use of controls. The Korean alternate executive director at the Bank, Choi Joong-Kyung, said that his own country’s capital account liberalisation occurred because policy-makers shifted from looking after national priorities to worrying solely about macroeconomic stability and that this invited the Asian financial crisis. The Bank’s chief economist for South Asia Shantayanan Devarajan summed up the session saying that it seemed clear that there was no justification for any rush to liberalisation and that capital controls can be useful in certain situations.
A timely IMF working paper on capital account liberalisation in India by Amadou Sy does clearly recognise the risks of introducing fuller capital account convertibility (FCAC), a euphemism for capital account liberalisation. Sy explains what prudential and regulatory measures must be put in place in order to safely further open up India’s economy to foreign money. However, the advice is unidirectional: the assumption is that liberalisation to foreign capital is always desirable.
Yilmaz Akyüz, former chief economist at UNCTAD, instead called for the IMF to be more proactive: “Guidelines for IMF surveillance should specify circumstances in which the Fund should actually recommend the imposition or strengthening of controls over inflows. It should also develop new techniques and mechanisms to separate capital account from current account transactions to distinguish among different types of capital flows from the point of view of their sustainability and economic impact, and to provide policy advice and technical assistance to countries at times when such measures are needed.”
Sovereign wealth fund regulation
The US and European proposals for more regulation of sovereign wealth funds, investment pools for countries’ foreign exchange reserves, have translated into Fund action despite the reservations expressed by the IMF’s chief economist (see Update 57). The communiqué of the Fund’s advisory body of finance ministers echoed the demands of the industrial countries, welcoming “the work by the IMF to analyse issues for investors and recipients of such flows, including a dialogue on identifying best practices.”
The Fund agreed to take up the task of drafting codes of conduct for the sovereign funds. IMF staff in the Middle East have claimed that the government investment institutions in that region have indicated that they are willing to abide by the new voluntary code. In mid-November the IMF hosted its first meeting of sovereign asset and reserve managers, which it plans to hold annually. Officials from 28 countries attended and Strauss-Kahn told the opening session that “a process is underway to define a role for the Fund on the issue of how sovereign wealth funds can be managed in ways that are consistent with global financial stability.”