IMF Executive Board Discusses Liberalizing Capital Flows and Managing OutflowsPublic Information Notice (PIN) No. 12/42
May 4, 2012
On April 2, 2012 the Executive Board of the International Monetary Fund (IMF) discussed a staff paper on “Liberalizing Capital Flows and Managing Capital Outflows.”
The IMF staff paper is a further building block in formulating a comprehensive, flexible, and balanced approach for the management of capital flows, drawing on country experiences. The paper aims to develop an up-to-date and operational framework for policy advice on liberalizing capital flows and managing capital outflows. It argues that while the understanding of these issues has advanced over the past decade, it remains far from complete.
What is now known is consistent with the following conclusions. First, the appropriate degree of liberalization for a country depends on its specific circumstances, notably on whether it has reached certain thresholds with respect to financial development. The crisis has underscored the financial stability risks associated with capital flows. Managing these risks requires stronger policies and cooperation across countries. Capital flow management measures (CFMs) may need to be temporarily re-imposed in accordance with the relevant policy frameworks without compromising the overall process of liberalization. Second, in systemically important emerging market economies, further liberalization would be beneficial based on implementation of the authorities’ liberalization plans and more rapid progress on supporting reforms, particularly in the financial sector. Liberalization needs to be well planned and sequenced, as it could have potentially significant domestic and multilateral effects. Third, the re-imposition of CFMs on outflows can be useful mainly in crisis or near crisis conditions, but only as a supplement to more fundamental policy adjustment.
Executive Board Assessment
Executive Directors welcomed today’s discussion on liberalizing capital flows and managing outflows as part of the ongoing efforts to develop a comprehensive, balanced, and flexible approach to managing capital flows. They observed a modest trend over the past decade toward the liberalization of capital flows among member countries, including in systemically important emerging market economies. Recognizing both the benefits and costs of liberalization, Directors considered the role of capital flow management measures (CFMs) to help manage vulnerabilities that can arise from cross-border capital movements. They acknowledged that the proposals discussed today will need to be reviewed periodically as the understanding of the underlying issues advances.
Directors concurred that full liberalization is not an appropriate goal for all countries at all times, and that a country’s appropriate degree of liberalization depends on its specific circumstances, notably the stage of institutional and financial development. A number of Directors nevertheless considered that full capital account liberalization should be a worthy long-term goal. Some Directors remained unconvinced of the benefits of full liberalization, noting the empirical evidence that emerging market economies with greater restrictions on capital inflows had fared better during the recent global financial crisis. Directors underscored that liberalization should proceed in an orderly, well-sequenced manner, underpinned by sound macroeconomic and financial sector policies. Putting in place adequate preconditions for liberalization is key. This requires enhancing the ability of the economy and the financial sector to deal with larger and more volatile capital flows through structural policies.
Directors noted that there is no single best approach to capital flow liberalization. Most viewed as broadly appropriate the sequencing of capital flow liberalization with other policies recommended by the staff’s “integrated approach,” which has been modified in light of recent experience and research. Directors emphasized the need for a cautious approach to liberalization, paying attention to the institutional and market capacity to absorb capital flows and manage risks in an increasingly financially integrated world. Some Directors stressed the importance of greater exchange rate flexibility during the liberalization process.
Against this background, most Directors considered that the proposed approach for liberalizing capital flows, laid out in Box 2 and paragraphs 22-29 of SM/12/55, provides a broadly appropriate basis for developing a comprehensive institutional approach to inform policy discussions with member countries. A few of them stressed that the suggested approach should not be seen as a set of rigid or prescriptive policies. A number of Directors regarded it as premature to adopt any framework without more conclusive evidence from country experience, although a few of these Directors recognized the usefulness of the proposed principles and integrated approach in informing policy discussions with authorities while more experience is gained. Directors acknowledged that countries may need to re-impose CFMs temporarily, although reversing the liberalization process could undermine market confidence. This calls for a carefully sequenced, timed, and paced strategy that is coherent with other policies. A few Directors stressed that transparent, rules-based, and market-oriented controls or nondiscriminatory CFMs are usually preferable.
Most Directors stressed that close attention should be paid to the multilateral effects of capital flow liberalization. Liberalization by large, systemically important emerging market economies could have significant multilateral effects, including through higher gross capital flows, a diversion of capital flows to or from other countries, implications for financial stability, and greater exchange rate flexibility. Some Directors also called for further analysis of the multilateral impact of long-standing uses of CFMs, in particular by large, systemically important emerging market economies, and a few of them emphasized the importance of considering capital flow policies in a broader context, including exchange rate and reserve accumulation policies. Some others called for deepening the analysis of push factors generating capital flows, underscoring the need for an evenhanded approach to both source and recipient countries.
Directors saw merit in extending the definition of CFMs to include measures designed to affect capital outflows. Most Directors considered that the proposed approach on the use of CFMs to manage outflows, laid out in Box 7 and paragraphs 58-64 of SM/12/55, provides a broadly appropriate basis for developing a comprehensive institutional approach to inform policy discussions with member countries. They considered that the temporary re-imposition of CFMs on capital outflows can be useful in crisis or near-crisis conditions to prevent a depletion of international reserves and excessive currency depreciation, as well as to provide breathing space for adjusting macroeconomic policies and stabilizing the financial sector. A few saw room for improving the rigor and specificity of the approach, including on the conditions for such use to guard against an undesired proliferation of CFMs and delays in required policy adjustments. A number of others considered it premature to adopt any policy framework for managing capital outflows at this stage, absent a better understanding of capital flow issues. Many Directors stressed that appropriate macroeconomic, structural, and financial sector policies should be the first line of defense against excessive, volatile capital outflows. A number of others saw a broader role for CFMs as part of the permanent toolkit, which could be used effectively where macroeconomic or other policies are constrained. As CFMs on outflows, especially restrictions on repatriation of previous inflows, can give rise to significant distortions and externalities, their possible benefits should be weighed against their costs, and they should be lifted once the conditions for their removal have been met. More generally, CFMs could not substitute for more fundamental policy adjustments.
As requested by the IMFC, the subsequent paper will articulate a comprehensive, balanced, and flexible approach for the management of capital flows, drawing on country experiences. A number of Directors recommended that staff consider the G-20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences in taking forward work on this topic.