## ppea2023055 ## Source details **Canonical URL:** [ppea2023055](https://www.imf.org/-/media/files/publications/pp/2023/english/ppea2023055.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2023/english/ppea2023055.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2023/english/ppea2023055.pdf.json) --- ### Executive summary — overview and purpose - Provides operational guidance to staff on the use of the Fund’s institutional view (IV) on the liberalization and management of capital flows. - IV establishes a framework for consistent policy advice and assessments of members’ capital flow policies when relevant for surveillance. - IV does not alter rights and obligations under the Fund’s Articles of Agreement or other international agreements; IV has no mandatory implications for the Fund’s financing role. - IV aims to help countries reap benefits of capital flows while managing associated risks in a way that: - preserves macroeconomic and financial stability, and - does not generate significant negative outward spillovers. - Guidance covers capital flow liberalization (including premature liberalization), management of inflow surges and preemptive measures, management of disruptive outflows, role of source countries, treatment of special categories of measures, and operational considerations. - Staff maintains a running roster of macro-critical policy measures assessed as CFMs or CFM/MPMs introduced or adjusted since adoption of the IV. ### Determining macro-criticality — principles and procedures - A CFM is macro-critical when it has a significant impact on present or prospective domestic or BOP stability. - Staff analytical sequence: - analyze economy-wide significance of the sector subject to the CFM; - analyze the flows targeted by the CFM within the specific sector; - assess expected impact of the measure on targeted flows; - analyze channels and economic variables through which domestic or BOP stability would be affected (examples: international reserves, exchange rates, financial system stability, fiscal sustainability, asset prices including house prices, economic efficiency and growth) and determine significance. - Key considerations: - Assess both current and prospective impact; use past levels of capital flows if reasonable expectations exist flows will return. - For measures with discretionary application, focus on macro-criticality of sector or targeted flows. - For packages of measures, assess the full package; if one measure is macro-critical, the package is macro-critical. - Characterize changes as tightening or loosening when possible. - Dynamic reassessment: macro-criticality may change as flows and sectoral importance evolve. - Engage with authorities; reflect differences in views in staff reports. ### Capital flows in multilateral surveillance and spillovers (ISD context) - Under the ISD, policies that may significantly influence the effective operation of the IMS need to be discussed in Article IV consultations. - Staff should: - assess whether policies give rise to outward spillovers transmitted through capital flows that could undermine global stability; - use multilateral surveillance products to assess push factors and structural changes in global capital flows; - discuss alternative policy actions with authorities to minimize spillovers. - Authorities are not obliged to act on staff recommendations when promoting their own domestic and BOP stability. ### Guidance on surveillance practice (policy note, mission, staff report) - Early engagement: inform the Fund’s interdepartmental group on capital flows (LEG, MCM, RES, SPR) of any policy measures that may be CFMs or CFM/MPMs as early as possible. - Policy note should highlight capital flow developments and policies raising concerns for domestic and BOP stability, preliminary views on inflow surges, FX mismatches on external debt, disruptive outflows, and capital flow and stock vulnerabilities. - During missions: discuss developments, staff assessments, appropriateness and effects of policy mix, and potential or actual outward spillovers using G-RAM, VE, and other multilateral products. - Staff reports should discuss capital flow–related policies when macro-critical or when generating spillovers that may significantly influence the IMS; label measures as CFMs or CFM/MPMs and provide clear policy recommendations. ### Institutional View, financing role, and Integrated Policy Framework (IPF) - IV has no mandatory implications for the Fund’s financing role; members’ rights under Article VI, Section 3 continue to preclude the Fund from requiring removal of capital controls as a condition for access to Fund resources. - CFMs maintained consistently with the IV would not be considered measures “requested” by the Fund pursuant to Article VI, Section 1. - IV and the IPF are fully consistent; the IPF jointly considers monetary, exchange rate, MPMs, CFMs, CFM/MPMs, and fiscal policies. - IPF insights: optimal policy mix depends on country characteristics, type of shocks, and initial conditions; optimal policies may include both ex ante and ex post measures. ### Terminology and implementation - Staff should use IV-consistent terminology; Annex 1 discusses terminology and examples, including residency-based and non-residency-based CFMs. - Assessment of whether a measure is designed to limit capital flows (especially when non-residency based) often requires country-specific context. --- ### Capital flow liberalization — assessment, integrated approach, premature liberalization - “Capital flow liberalization” = the removal of CFMs; includes underlying capital transaction and related payment/transfer; full liberalization = unrestricted convertibility of local currency in international financial transactions. - No presumption that full liberalization is appropriate for all countries at all times. - Staff should assess benefits (e.g., facilitating FDI, financing current account deficits for investment/smoothing consumption, fostering financial sector development, improving liquidity, lowering borrowing costs) and risks (e.g., heightened macro volatility, lower policy autonomy, buildup of systemic financial risks, vulnerability to reversals). - Integrated approach to liberalization: - removal of CFMs properly timed and sequenced with macroeconomic, structural, and prudential policies; - tailored path based on country circumstances and objectives. - Preconditions/thresholds to consider (Annex II): credible exchange rate arrangement and adequate reserves; low and stable inflation; financial market depth (money, FX, equity, bond markets); financial sector resilience; governance and disclosure; strong regulatory and supervisory frameworks; policy track record. - Sequencing principle: “long term before short term, FDI and other non-debt before debt, and inflows before outflows.” - Premature liberalization: - occurs when removal of CFMs outpaces capacity to safely handle flows; may justify re-imposition of CFMs temporarily. - Identification requires a wide range of macrofinancial indicators and analysis of flows after removal. - If re-imposed, prefer the least discriminatory effective measure; progress on policy actions addressing weaknesses is expected for reimposed CFMs to remain appropriate. ### Risks of removing CFMs and staff responsibilities - Staff should identify effective CFMs and assess risks their liberalization would pose to macroeconomic and financial stability. - Reforms should be designed to reduce identified risks and support safe liberalization. --- ### Managing capital inflows — surges, tools, design principles, and removal - Surges: increases in capital inflows exceeding historical average over a relevant timeframe; can be economy-wide or sectoral. - Identification uses quantitative indicators plus judgment; methodologies include Threshold Analysis, Trend Analysis (HP filter, Hamilton filter), Rolling Window, and Cluster Analysis. - Toolkit for staff: identify gross/net inflow surges across approaches, cross-country comparisons, analyze macrofinancial indicators; delineates 14 categories of cross-border capital flows and sector/asset classes. - Policy mix assessment: - appropriate macroeconomic policies: lowering interest rates (if no overheating), allowing exchange rate appreciation if not overvalued, building foreign reserves via sterilized intervention (if not more than adequate). - MPMs when inflow surges raise financial stability risks. - When CFMs and CFM/MPMs may be appropriate during surges: - limited room for macro policy adjustment (e.g., overheating, asset bubbles, overvalued exchange rate, reserves more than adequate); - inflow surge raises financial system instability risks; - rapidly changing conditions where policy assessment/implementation is slow — CFMs can be temporary to buy time. - Design principles for inflow CFMs: - transparent, targeted, temporary, preferably non-discriminatory; - target flows causing instability as directly as possible; - least discriminatory effective measure preferred; residency-based measures justified if necessary for effectiveness; - continuous review due to efficacy erosion and circumvention risks. - CFMs should not substitute for warranted macroeconomic adjustments or be used to influence exchange rates to gain unfair competitive advantage. - Removal of inflow CFMs after a surge: - phase out as surge abates or scale back to pre-surge settings when appropriate; - some CFM/MPMs may remain to manage systemic risks; ongoing evaluation required. - If liberalization has outpaced capacity, additional reforms may be needed before lifting CFMs. --- ### Preemptive CFM/MPMs on inflows — criteria and two-step risk assessment - Preemptive CFM/MPMs may be appropriate to address systemic risks from: - (i) FX mismatches due to external FX debt; and - (ii) local currency–denominated external debt. - Three main considerations when assessing preemptive measures: - Are systemic financial risks elevated? - Is the preemptive CFM/MPM needed (i.e., MPMs insufficient and not a substitute for warranted macro/structural policies)? - Would the measure maintain or exacerbate a stronger-than-warranted external position caused mostly by domestic policy gaps? - FX mismatches: two-step approach - Step 1: assess level of FX mismatches at relevant maturities using stock of FX liabilities, denomination of assets and availability of hedges, and maturity structure; use multiple indicators; move to Step 2 if mismatches judged high or intermediate-range. - Step 2: assess whether systemic financial risks are elevated using stress tests, authorities’ analysis, or existing bilateral surveillance risk assessments; consider consequences of reversal and amplifying/mitigating factors (e.g., FX debt service as percent of export revenues). - Local currency external debt: preemptive CFM/MPMs appropriate only in narrow and exceptional circumstances; four joint conditions required: - (i) local currency debt and FX markets are sufficiently shallow; - (ii) large depreciation is costly due to FX mismatches or other reasons; - (iii) domestic monetary policy is constrained and FX reserves are low; - (iv) ex post policy instruments (local currency LOLR and liquidity facilities) are substantially impeded or unavailable. - For local currency leverage, follow a two-step approach: Step 1 identify elevated local currency leverage and maturity mismatches; Step 2 assess systemic risks via granular stress tests and existing risk assessments. - Conditions for a preemptive CFM/MPM: - (i) the policy measure should be a CFM/MPM; - (ii) MPMs alone are insufficient; - (iii) well-targeted and calibrated to minimize costs/distortions; - (iv) must not substitute for warranted macroeconomic adjustments; - (v) must not substitute for or undermine market development or structural policies. - Staff should review preemptive measures periodically and recommend removal if conditions for appropriateness no longer hold. --- ### Managing disruptive capital outflows — no-imminent-crisis vs imminent/crisis circumstances - No-imminent-crisis: - handle outflows through macroeconomic, financial, and structural policy adjustments rather than CFMs. - Policy options: allow exchange rate to adjust; increase interest rates consistent with inflation outlook; intervene in FX markets if reserves adequate; fiscal policy adjustments to rebuild credibility; liquidity provision and prudential measures in the financial sector; relax inflow CFMs if safe to do so. - In fixed exchange rate regimes, intervention is integral and typically unsterilized; realignment may be needed if shock requires significant real exchange rate adjustment. - Imminent crisis or crisis circumstances: - CFMs on outflows may be appropriate temporarily to restore macroeconomic and financial stability, prevent reserve depletion, and avoid a full-blown crisis. - Outflow CFMs should be part of a broader policy package and not substitute for warranted policy adjustments. - Design principles: transparent, temporary, seek non-discriminatory application where possible; outflow CFMs often need to be comprehensive; plan exit strategy at or soon after implementation. - Risks of poor design: exacerbate crises, delay legitimate transactions, encourage circumvention, and impose high costs. - Phasing out outflow CFMs: lift when macroeconomic stability, market access, and reserves are restored; sequencing and communication are critical. --- ### Role of source countries and multilateral coordination - Source-country policies influence global capital flows via push factors; staff should: - discuss outward spillovers from source-country policies when significant in Fund surveillance; - encourage source-country policymakers to internalize spillovers where possible (without expecting them to adopt less effective domestic policies). - Examples of source-country influences: exit from unconventional monetary policies in AEs, CFMs by large economies, prudential policies in jurisdictions with G-SIBs. - Staff encouraged to promote multilateral coordination and collaborate with BIS, FSB, OECD and other institutions to exchange data and foster consistent approaches. --- ### Special categories of measures — security, prudential, AML/CFT, tax cooperation - Security-based CFMs: - Determination of whether a measure is a CFM is made regardless of stated security intent. - If measures are introduced solely for national or international security, they should not be assessed for appropriateness under the IV; staff should note authorities’ representation that the measure is security-based (good practice: written communication). - Measures not so represented will be assessed under general IV criteria. - Measures implemented in line with internationally agreed prudential standards (Basel framework): - Will be labelled as CFM/MPMs but not assessed under the IV for appropriateness if implemented in accordance with the Basel framework; staff reports should note special treatment. - Examples: reciprocation of CCyB, capital surcharges on D-SIBs/G-SIBs, LCR and NSFR designed with residency-based discrimination allowed under Basel framework. - Interdepartmental group checks applicability of carve-out and consults MCM experts as needed. - AML/CFT measures: - Some AML/CFT measures that delay or prevent transactions to mitigate ML/TF risks may discriminate on residency or nationality. - CFMs implemented in accordance with international AML/CFT standards will not be assessed under the IV; if not implemented in accordance, they should be assessed under IV criteria. - Staff should consult LEG-FIG on compliance with AML/CFT standards. - Measures arising from international cooperation on tax avoidance/evasion: - Residency-based CFMs consistent with international tax cooperation standards will not be assessed under the IV, but if macro-critical should be noted as CFMs in staff reports and not assessed. - Special treatment limited to measures based on and implemented in accordance with agreed international standards (typically peer reviewed); bilateral/regional agreements beyond those standards are not covered. - Country teams should inform the interdepartmental group and consult LEG if in doubt. --- ### Interaction with Article VIII, exchange restrictions, and MCPs - Article VIII obligations (Section 2(a) and Section 3) on exchange restrictions and multiple currency practices (MCPs) remain unchanged by the IV. - If a policy measure constitutes both a CFM and an exchange restriction and/or MCP, the Article VIII framework generally takes precedence. - Operational rules: - Measures that are CFMs and also exchange restrictions/MCPs subject to Fund approval under Article VIII will not be assessed under the IV for appropriateness; they will be assessed only under Article VIII approval criteria. - Measures affecting both capital and Article-defined current transactions: staff assess capital-transaction part under the IV only if not an MCP/exchange restriction requiring Article VIII assessment; otherwise follow Box 5 cross-classification rules. - CFMs that are MCPs applicable solely to capital transactions: assessed under the IV (Executive Board decision No. 8648-(87/104) precedent). - Contingency measures, zero-parameter measures, or unenforced CFMs: - Safeguard/contingency measures not activated are not labeled CFMs until activated. - Measures with parameters set at zero are not labeled CFMs until parameters become non-zero. - Adopted but not enforced CFMs should be assessed if/when enforcement tightens. ### Taxes, residency distinctions, and treatment under the IV (Annex VI) - Tax residency definitions commonly used: domicile, physical presence, or 183-day presence test; these definitions conforming to international standards generally do not produce a “residency-based” discrimination finding. - Distinction: - General tax measures using a complying tax residency definition: typically not “residency-based” discrimination. - Non-general tax measures (e.g., stamp duties) that distinguish based on citizenship/nationality or adopt non-compliant residency concepts may be residency-based CFMs. - No automatic carve-out for tax measures: even measures not residency-based can be CFMs if, on totality of circumstances, designed to limit capital flows. - Staff should consult LEG and FAD as needed when assessing tax-related measures. --- ### Annexes and analytical tools referenced - Annex I: terminology and classification of CFMs, MPMs, CFM/MPMs; Box AI.1 summary points. - Annex II: liberalization thresholds, preconditions, sequencing, operational considerations. - Annex III: data sources and operational considerations for preemptive CFM/MPMs, FX mismatch assessment, stress-testing principles. - Annex IV: assessment of housing measures under the IV. - Annex V: examples of capital flows in staff reports. - Annex VI: aligning assessment of tax measures under the IV. - Toolkit and quantitative methods referenced: Threshold Analysis (Reinhart and Reinhart 2008 cut-off 20th percentile; Ghosh et al. 2014 top 30th percentile criteria), Trend Analysis (HP filter with lambda = 1600 for quarterly gross inflows; IMF 2011a surge definition > one standard deviation and > 1.5 percent of annual GDP), Hamilton (2018) regression-based filter, Rolling Window (Forbes and Warnock 2012), Cluster Analysis (k-means as in Ghosh et al. 2014). *Source: GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS (excerpts).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview and purpose - Provides operational guidance to staff on the use of the Fund’s institutional view (IV) on the liberalization and management of capital flows. - IV establishes a framework for consistent policy advice and assessments of members’ capital flow policies when relevant for surveillance. - IV does not alter the rights and obligations of members under the Fund’s Articles of Agreement or other international agreements. - IV has no mandatory implications for the Fund’s financing role. ### Premise and objectives of the IV - Premise: capital flows are desirable because they can bring substantial benefits, but they may also generate risks. - CFMs or measures that are both CFMs and macroprudential measures (CFM/MPMs) can be useful in certain circumstances but should not substitute for warranted macroeconomic adjustment. - IV aims to help countries reap benefits of capital flows while managing associated risks in a way that: - preserves macroeconomic and financial stability, and - does not generate significant negative outward spillovers. ### Guidance for Fund staff and surveillance - Staff should discuss capital flows and related policies in surveillance when these are macro-critical or when spillovers from those policies significantly influence the effective operation of the international monetary system. - Staff reports should: - characterize measures designed to limit capital flows as CFMs or CFM/MPMs, and - assess their appropriateness under the IV, except for CFMs subject to special treatment. - Use of the IV should reflect both country circumstances and evenhandedness. - Staff maintains a running roster of macro-critical policy measures assessed as CFMs or CFM/MPMs and referred to in published IMF staff reports as they have been introduced or adjusted since adoption of the IV. ### Circumstances and applications covered - The Guidance Note discusses application of the IV across a range of circumstances: - capital flow liberalization (including premature liberalization); - management of capital inflows in the context of inflow surges and preemptively (i.e., outside of surges); - management of disruptive outflows; - the role of source countries; - treatment of certain categories of measures; and - other operational considerations. - Typical circumstances when the IV applies include: - Capital flow liberalization: when authorities contemplate further liberalization, cases of premature liberalization, or when staff has a view on the usefulness of liberalization considering benefits versus costs and risks. - Managing capital flows: cases of capital inflow surges, situations where financial sector vulnerabilities have built over time as a result of capital inflows, instances of disruptive outflows, and circumstances when capital flows generate actual or potential significant outward spillovers. ### Relation to prior guidance and reviews - Combines, elaborates, and clarifies all previous IV guidance, replacing: - the 2013 Guidance Note for the Liberalization and Management of Capital Flows, and - the 2015 note on Managing Capital Outflows—Further Operational Considerations. - Provides guidance on new elements introduced in the 2022 review of the IV. ### New elements introduced in the 2022 review (as reflected in this note) - Policy changes, including the use of preemptive CFM/MPMs on inflows and special treatment of certain categories of measures. - Elaboration of concepts, including macro-criticality, capital inflow surges, imminent crises, and premature liberalization. - Guidance on implementation issues that have arisen, including treatment of CFMs that are also exchange restrictions and/or multiple currency practices (MCPs), and other operational issues. ### Organization of the Guidance Note (section highlights) - Section II: operational guidance for Fund staff on use of the IV, including procedural guidance for considering capital flows in surveillance. - Section III: considerations for capital flow liberalization and when liberalization may be premature. - Section IV: considerations for managing capital flows, covering: - management of capital inflow surges; - management of capital inflows preemptively (i.e., outside of inflow surges); - management of disruptive capital outflows; and - the role of source countries. - Section V: guidance on special categories of measures (e.g., national or international security, internationally agreed prudential standards, AML/CFT, international cooperation standards against avoidance or evasion of taxes). - Section VI: guidance on other operational issues. ### Implementation and terminology - Staff should use terminology consistent with the IV; Annex 1 provides discussion of terminology and examples, including residency-based and non-residency-based CFMs. - Assessment of whether a measure is designed to limit capital flows, when non-residency based, often needs to take into account country-specific circumstances and the overall context in which the measure was introduced or adjusted. November 17, 2023 *Guidance Note on the Liberalization and Management of Capital Flows — Executive Summary* ### 7. This Guidance Note elaborates on the principles for determining macro-criticality of ### 7. This Guidance Note elaborates on the principles for determining macro-criticality of ### Determining macro-criticality: overall approach - A CFM is assessed as macro-critical when staff determine it has a significant impact on present or prospective domestic or BOP stability (referred to as a macro-critical impact). - Staff should first analyze: - the economy-wide significance of the sector subject to the CFM; - the flows targeted by the CFM within the specific sector; and - the expected impact of the measure on the targeted flows. - Staff should then analyze the channels and economic variables through which domestic or BOP stability would be affected (examples given: international reserves, exchange rates, financial system stability, fiscal sustainability, asset prices including house prices, or economic efficiency and growth) and determine whether the impact would be significant. - A CFM on a macro-critical sector is not necessarily macro-critical if expected impact on targeted flows or relevant economic variables is small. ### Key considerations in assessing macro-criticality - Current and prospective impact: - Staff should assess both current and prospective impact on domestic or BOP stability. - A CFM with small present effects may be macro-critical prospectively if future capital flows are expected to be significant. - When prospective impact is relevant, staff should consider: - staff’s view on future capital flows which may be affected by the measure, including using past levels of capital flows if reasonable expectations exist that flows will return; and - important reforms or other measures underway or expected with high degree of certainty to affect capital flows (e.g., planned financial sector reforms or planned removal of CFMs). - Comparator countries may be used when expecting increases in targeted-sector flows due to factors like financial sector development. - Measures with discretionary application: - If a measure (for example, approval requirements) involves wide discretion making ex ante impact hard to establish, staff should focus on the macro-criticality of the sector or targeted flows. - Packages of measures: - A set of measures constitutes a package if at least one criterion is satisfied: (i) similar objectives; or (ii) similar sector and/or geographical impact. Proximity in time may also indicate a package. Final determination requires staff judgment. - Principles when measures are a package: - Macro-criticality assessment should focus on the full package. If one measure is macro-critical, the package is macro-critical. - If none are individually macro-critical, staff assess the overall impact of the package. - If some measures tightened and others loosened, staff assess overall impact. - Staff reports should discuss changes to a measure or package previously assessed as macro-critical even if marginal changes alone would not be macro-critical. - Incremental changes to previously non-macro-critical measures may render the resulting measure or package macro-critical. - Removal of a measure that was part of a macro-critical package may render the package non-macro-critical. - Characterization of changes: - When discussing a change, staff should characterize it as either a tightening or loosening of the measure or package; where not feasible, staff need not characterize the overall change. - Dynamic reassessment: - The macro-criticality assessment may change over time as capital flows and sectoral importance evolve. Staff may reassess macro-criticality and revise appropriateness under the IV when clear long-term changes in capital flows have occurred. - Engagement with authorities: - Staff should discuss actual and expected impacts with authorities and consider their views; differences in views should be reflected in the staff report. ### Capital flows in multilateral surveillance and spillovers (ISD context) - Under the ISD, if a member’s policies may significantly influence the effective operation of the IMS (for example by undermining global economic and financial stability), those policies need to be discussed during the Article IV consultation. - Staff actions: - Assess whether policies and developments may give rise to outward spillovers transmitted through capital flows that could undermine global economic and financial stability or significantly influence the effective operation of the IMS. - Use the Fund’s multilateral surveillance products to assess push factors and structural changes in global capital flows. - Discuss possible spillovers with authorities and examine viable alternative policy actions that achieve authorities’ objectives while minimizing spillovers. - Authorities are not obliged to act on staff recommendations if they are promoting their own domestic and BOP stability. ### Box 1 — Guidance on Considering Capital Flows in Surveillance (policy note, mission, staff report) - Early engagement: - Staff should inform the Fund’s interdepartmental group on capital flows (LEG, MCM, RES, SPR) as early as possible of any policy measures that may potentially be a CFM or CFM/MPM, or changes to existing CFMs or CFM/MPMs for assessment under the IV. - Staff would conduct periodic evaluations, as appropriate, of existing measures. - Policy Note should highlight: - Capital flow developments and policies raising concerns for domestic and BOP stability (see paragraph 22 of the ISD for specific indicators), including preliminary views on inflow surges, FX mismatches on external debt, disruptive outflows, and challenges from capital flow and stock vulnerabilities (including external debt in local currency). For source countries, highlight potential and actual outward spillovers (drawing on the G-RAM, vulnerability exercises, and multilateral surveillance products). - How macroeconomic and other policies have been adjusted regarding capital flows and related risks, including announcements or implementation of new CFMs and CFM/MPMs, changes, and liberalization measures. - For new, recently changed, or reevaluated CFMs and CFM/MPMs, discuss the measures, the assessment, the circumstances of assessment, and any relevant policy advice. - Existing CFMs and CFM/MPMs previously assessed under the IV should be mentioned when relevant to issues in the staff report. - During the mission: - Discuss developments in capital flows, size and sustainability, and impact on macroeconomic and financial stability and staff’s assessment. - If capital flows and related policies are macro-critical or may affect the IMS, discuss: - appropriateness and effects of the policy mix (including whether warranted macroeconomic adjustments are being made), types of policies in use (monetary, fiscal, CFMs, MPMs, CFM/MPMs), and financial system stability; - staff’s assessment of any new/changed/reevaluated CFM or CFM/MPM when assessed under the IV by the interdepartmental group, including policy recommendations; and - potential or actual outward spillovers with significant implications for global stability, using G-RAM, VE, and other multilateral products as useful framing. - Staff Report content: - Staff reports should discuss capital flow–related policies when they significantly influence member’s present or prospective domestic or BOP stability (i.e., are macro-critical), and when they generate spillovers that may significantly influence the IMS (other spillovers may be discussed if requested or agreed with authorities). - Assessments should be based on the IV and cover the aspects noted above from policy note and mission discussions. - Reports should ensure relevant policy challenges are adequately covered, label measures as CFMs or CFM/MPMs as appropriate, and provide clear policy recommendations. Differences with authorities’ views should be reflected. - In assessing data adequacy for surveillance, staff should keep in mind data related to capital flows. ### Institutional View (IV), financing role, and the Integrated Policy Framework (IPF) - Financing role and Article VI: - The IV has no mandatory implications for the Fund’s financing role. - Members’ rights under Article VI, Section 3 continue to be interpreted as generally precluding the Fund from requiring removal of capital controls as a condition for access to Fund resources. - CFMs maintained consistently with the IV would not be considered measures “requested” by the Fund pursuant to Article VI, Section 1. - CFMs maintained inconsistently with the IV would not be considered measures the Fund could require members to eliminate as a condition for use of Fund resources. - An analysis under the IV could be taken into account as input for a UFR assessment of whether a member’s policies are appropriate to help resolve balance of payments difficulties and regain external viability. - IV and IPF consistency: - The IV and the Integrated Policy Framework (IPF) are fully consistent with each other. - The 2022 review of the IV was informed by staff work on the IPF; the IPF aims to provide a systematic analytical approach to consider appropriate policy mixes for macroeconomic and financial stability in countries experiencing shocks. - The IPF jointly considers monetary, exchange rate, MPMs, CFMs, CFM/MPMs, and fiscal policies, and their interactions. - Key IPF insights: optimal policy mix depends on country characteristics, type of shocks, and initial conditions; optimal policies may include both ex ante and ex post measures. - Key country characteristics considered in the IPF include balance sheet mismatches, depth of FX markets, monetary policy credibility, currency of trade invoicing, and other relevant factors. *Source: GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS (excerpts).* ### Box 2. Integrated Surveillance Decision: Aspects Related to Capital Flows ### Box 2. Integrated Surveillance Decision: Aspects Related to Capital Flows ### ISD framework and capital flows (overview) - The ISD establishes the policy framework for Fund’s surveillance and explicitly addresses capital flows. - The ISD lays out the scope and modalities of surveillance and defines PGMs that provide guidance on members’ exchange rate and domestic economic and financial policies. - The PGMs call on members to: - avoid manipulation of exchange rates to prevent adjustment or to gain unfair competitive advantage; - intervene in the exchange market if necessary for countering disorderly market conditions; - take into account in their intervention policies the interests of other members; - avoid exchange rate policies that result in BOP instability; and - seek to avoid domestic economic and financial policies that give rise to domestic instability. - The ISD provides that, in assessing a member’s policies, the Fund will always evaluate developments in the member’s BOP, including the size and sustainability of capital flows. - Capital flow management policies shall be covered when they significantly influence the member’s present or prospective domestic or BOP stability, i.e., when they are macro-critical. - Developments directly related to capital flows that may trigger a thorough review include: - The introduction or substantial modification for BOP purposes of restrictions on, or incentives for, the inflow or outflow of capital. - The pursuit, for BOP purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows. - Large external sector vulnerabilities, including liquidity risks, arising from private capital flows. - When a member’s capital flow policies, while not undermining the member’s own domestic and BOP stability, lead to spillovers that may have a significant impact on global stability, staff should encourage the authorities to consider alternative policy options that minimize spillovers while continuing to promote the member’s own stability. - The ISD allows a more balanced treatment of capital flows in both recipient and source countries, even though source country authorities are not obligated to alter their policies as long as they are promoting their stability. - Volatile capital flows, the excessive build-up or depletion of reserves, and imbalances arising from excessive or insufficient global liquidity are among developments that could affect the effective operation of the IMS. *See Modernizing the Legal Framework for Surveillance – An Integrated Surveillance Decision; See Guidance Note for Surveillance under Article IV Consultations.* ### Multilateral coordination - Staff are encouraged to promote multilateral coordination on treatment of policies related to capital flows. - The IV does not alter members’ rights and obligations under other international agreements. Staff could use the IV in dialogue with members and international organizations to promote a more consistent approach towards treatment of policies related to capital flows across other international agreements. - In cases where a country’s introduction of CFMs or CFM/MPMs may be appropriate under the IV but conflicts with obligations under other international agreements, the IV-guided economic analysis cannot be construed to advise violating international agreements of which the country is a party. - Staff are encouraged to develop collaboration with relevant international institutions (examples noted in the source text): - exchange data and information with due regard to different mandates, purposes, and memberships of the IMF and other institutions. Box (examples of multilateral collaboration) notes: - Collaboration with the BIS: special treatment for some prudential measures in the 2022 review of the IV where measures conform with the Basel Framework; staff participation in technical working groups in BIS. - Collaboration with the FSB: staff participation in technical working groups at the FSB and SSB on issues related to NBFIs and market-based intermediation of capital flows. - Collaboration with the OECD: staff participation in the OECD’s Advisory Task Force on the Code of Capital Movements (ATFC); joint workshops to facilitate policy discussions based on new analytical and empirical work. ### Capital flow liberalization — considerations to assess - The IV provides principles when staff advice covers capital flow liberalization. - Capital flow liberalization should be covered in surveillance when: - the authorities are undertaking or considering liberalization steps or strategies; - liberalization appears to have outpaced the economy’s capacity to safely handle capital flows (premature liberalization); - staff judges that benefits of further liberalization relative to costs have risen. - Working definition: “Capital flow liberalization” refers to the removal of CFMs. The concept includes the underlying capital transaction as well as the related payment or transfer, and full liberalization includes unrestricted convertibility of local currency in international financial transactions. - Liberalization does not rule out temporary re-imposition of CFMs or the imposition and maintenance of certain measures that are subject to special treatment under the IV (see Section V). - Staff’s advice should be guided by the principle that liberalization is more beneficial and less risky if countries have reached certain levels or thresholds of financial and institutional development. - There is no presumption that full liberalization is an appropriate goal for all countries at all times. - Staff should assess benefits and costs when advising on liberalization. Benefits listed include: - facilitating transfer of technology and management practices (particularly through foreign direct investment (FDI)); - financing of current account deficits for productive investment or smoothing consumption; - fostering financial sector development, macroeconomic policy discipline, and economic efficiency; - support for country economic objectives such as boosting growth-enhancing investment, lowering borrowing costs, providing funding to credit-constrained sectors, bringing in new technology, lengthening debt maturities, improving liquidity in securities markets, or enhancing macroeconomic policy discipline. - Risks to consider include: - heightened macroeconomic volatility; - lower level of macroeconomic policy autonomy; - a buildup of systemic financial risks; - vulnerability to capital flow reversals; - magnified risks when countries have yet to achieve sufficient financial and institutional development. - Staff should consider adequacy of macroeconomic policies, macroeconomic and financial stability, structural policies, institutional quality, financial regulation and supervision, and macroprudential policy to manage risks associated with capital flows. ### Integrated approach to liberalization (process, thresholds, direction, spillovers) - Staff’s advice should provide a systematic process and pace of liberalization consistent with each country’s institutional and financial development; the “integrated approach” includes: - (i) removal of CFMs in a manner that is properly timed and sequenced, taking into account other policies and conditions, notably macroeconomic, structural, and financial sector prudential policies; and - (ii) the path toward and extent of liberalization needs to be tailored to countries’ particular circumstances and objectives. - Issues to consider when assessing liberalization: - Thresholds: benefits of liberalization are largest when countries have achieved certain levels (“thresholds”) of financial and institutional development (Figure 1). Literature and country experiences do not provide a uniform guide as to adequate levels; staff assessments require judgment based on country-specific circumstances. - Liberalization direction: no presumption for full liberalization; degree depends on country circumstances and objectives. Discussion could cover strength of macroeconomic fundamentals (growth, price stability, foreign reserves); financial sector (balance sheets and financial markets); composition of external flows (such as share of equity and FDI; long-term vs. short-term debt flows); and trends in financial development, trade openness, and institutional quality. - Liberalization process: emphasize systematic process, pace, and sequencing consistent with institutional and financial development; emphasize progressively deeper and broader supporting reforms to financial and non-financial frameworks; rely on Financial Sector Assessment Programs (FSAPs), Reports on Observance of Standards and Codes (ROSCs), and cross-country examples; draw on expertise from MCM where detailed recommendations are warranted. - Spillovers: assess potential outward spillovers of liberalization measures, especially for large, systemically important countries. ### Premature liberalization and re-imposition of CFMs - The IV can support the re-imposition of CFMs due to premature liberalization. A temporary re-imposition of CFMs can be consistent with an overall strategy of capital flow liberalization under certain circumstances. - Identifying premature liberalization requires assessment of whether removal of CFMs has outpaced the capacity of the economy or financial system to safely handle resulting flows. - The integrated approach in the IV sets out conditions or thresholds (see Figure 1 and Annex 2) which should generally allow for safe liberalization of different types of flows. - Premature liberalization occurs when those conditions are not met even if they may have appeared to do so at the time of liberalization and a country’s capacity to handle the liberalized flows is seriously challenged. - Identification of premature liberalization needs to consider a wide range of macrofinancial indicators and explore whether large changes have taken place in capital inflows or outflows following liberalization and whether, as a result, a severe deterioration in indicators of macrofinancial stability has emerged. - Analysis should look at the period shortly after CFMs were removed and, if needed, at subsequent periods when the newly open financial account (or specific segments of it) has become exposed to sizable flows or changes in the global financial cycle for the first time. - Examples of premature liberalization include: - Liberalization of short-term flows without having necessary prudential, supervisory, and monitoring frameworks to manage associated risks. - Relaxation of outflow CFMs in response to a temporary increase in inflows that leads to sustained or accelerating outflows as inflows subside, creating unstable macroeconomic and financial conditions without supporting reforms. - Figure 2 (Potential Indicators of Premature Liberalization) provides an overview of indicators; a country experiencing premature liberalization would usually have a number of these features leading to lack of capacity to handle capital flow volatility. - If liberalization is assessed as premature, it may be appropriate to re-impose CFMs until conditions for safe liberalization are in place. Re-imposition may be implemented alongside liberalization of other types of flows if conditions for those are met. - When CFMs are re-introduced, the least discriminatory measure that is effective should be preferred. - Subsequent assessment after re-imposition should identify necessary improvements in policy framework and financial and institutional development to remove reimposed CFMs over time while safely managing achieved financial account openness; staff’s advice on policy actions would be based on this assessment. *Guidance Note on the Liberalization and Management of Capital Flows (excerpts).* ### 22. Progress in implementing policy actions to address the weaknesses that led to the ### 22. Progress in implementing policy actions to address the weaknesses that led to the reimposition of CFMs would be expected for the reimposed CFMs to remain appropriate ### Progress in implementing policy actions to address weaknesses - If a country has reimposed CFMs, staff will analyze the actions taken following the reimposition to guide the assessment of appropriateness of such reimposition, e.g., enhancing the effectiveness of financial supervision or increasing exchange rate flexibility. - Lack of or insufficient/inadequate policy action to address weaknesses may suggest that the re-imposition of CFMs is no longer consistent with a safe liberalization strategy. - In such cases, staff’s advice should focus on the policy actions to address the weaknesses. ### Distinction between premature liberalization and temporary overwhelm - Premature liberalization does not include cases where capital flow episodes or systemic stock vulnerabilities temporarily overwhelm countries with generally adequate capacity to manage their openness. - Countries that have appropriately sequenced liberalization and generally have adequate capacity may still experience exceptionally large inflow surges, disruptive outflows, or accumulated stock vulnerabilities (e.g., FX mismatches) that may warrant temporary use of CFMs and/or CFM/MPMs. - In the case of premature liberalization: - The lack of capacity to safely handle capital flows is likely to be more sustained, arising from underlying weaknesses in institutional or financial development. - It would not be appropriate for the reimposed CFMs to be loosened and re-tightened to manage capital flows; the removal of the reimposed CFMs should be part of a safe liberalization strategy. ### Managing capital flows — staff guidance - The note provides operational guidance to staff on the IV’s policy advice for managing capital flows. - Managing large and volatile capital flows, or vulnerabilities built up over time, will often pose policy challenges and have implications for domestic and BOP stability; staff reports should cover and assess these comprehensively and evenhandedly. - Staff should use the IV to ensure consistent advice while taking due account of country-specific circumstances. - When discussing policy responses with authorities, staff should ascertain the objectives of specific measures (e.g., targeted at macroeconomic risks, financial stability risks, or other objectives). ### Risks from capital inflows and policy roles - Under certain circumstances, capital inflows can give rise to macroeconomic and/or financial risks, including: - rapid currency appreciation, - overheating, - asset bubbles, - credit booms, - incremental buildup of financial vulnerabilities. - Some risks may materialize during subsequent reversals of inflows or outflow episodes. - Macroeconomic and financial policies are a key part of the appropriate combination of policies for addressing these risks. - Improving structural policies, strengthening financial stability by financial supervision and regulation, and enhancing institutional capacity improve a country’s ability to absorb and safely handle capital flows. - CFMs and CFM/MPMs may be appropriate but should not substitute for warranted adjustments in macroeconomic policies. ### A. Managing Capital Inflow Surges — guidance overview - Surges in capital inflows often pose policy challenges; they can lead to macroeconomic and financial volatility and may be followed by “sudden stops” or reversals. - Surges need not be large economy-wide to pose risks if they are sizeable in a particular sector with systemic linkages. - Guidance covers: - (i) identifying capital inflow surges; - (ii) appropriate macroeconomic and financial sector policies to deal with inflow surges; - (iii) circumstances in which CFMs and/or CFM/MPMs may be helpful. ### Working definition and identification of inflow surges - A surge can be understood as an increase in capital inflows exceeding their historical average over a specific time frame relevant for the episode; includes economy-wide and sectoral surges with systemic linkages. - Identifying a surge can be guided by quantitative indicators but involves judgment. - Staff may use a stepwise procedure and a variety of quantitative methods (as outlined in the 2022 Review of the IV) to inform the assessment; quantitative metrics are tools to assist staff, not substitutes for judgment. ### Analytical tools and indicators to assess surges and risks - Staff can rely on various methodologies to signal surges and assess macrofinancial variables and absorption capacity. - Quantitative methodologies useful to gauge capital inflow surges include: - Threshold Analysis: - Identifies surges as flows exceeding historical patterns by looking at past distributions. - Reinhart and Reinhart (2008) selected a cut-off of 20th percentile for net capital flows (in percent of GDP). - Ghosh et. al (2014) define a surge if it lies both in the top 30th percentile of the country's own distribution of net capital flows (expressed in percent of GDP) and in the top 30th percentile of the cross-country distribution of net capital flows (in percent of GDP). - Trend Analysis: - Derives historical patterns by looking at deviations from a long-term trend using a Hodrick-Prescott (HP) filter. - IMF (2011a) defines a surge when inflows in a given period significantly exceed their long run trend (by one standard deviation or more) and are large in absolute magnitude (exceeding 1.5 percent of annual GDP). - The country-specific trend is calculated by applying a Hodrick-Prescott filter with a smoothing parameter (lambda) of 1600 for quarterly gross capital inflows data. - Hamilton (2018) proposed a regression-based filter that produces a stationary cycle and suffers less from end-of-sample bias than the HP filter. - Rolling window: - Considers a recent period as benchmark via use of a rolling window. - Forbes and Warnock (2012) defined a surge as an annual increase in gross inflows that is more than one standard deviation above the five-year rolling average, and at least two standard deviations above the average in at least one quarter. - Cluster Analysis: - Partitions inflows into k clusters with the nearest mean (minimizing within-cluster sum of squared differences). - Ghosh et al. (2014) applied k-means clustering on each country's standardized net flow to GDP observations, grouping them into three clusters: (i) surges, (ii) normal flows, and (iii) outflows. - Note: "This is not an exhaustive list of methodologies that can used by staff." ### Toolkit and further assessment steps - Staff may use a specially designed toolkit based on the methodologies in this guidance and the IV Review to: - (i) identify gross and net inflow surges across a variety of quantitative approaches, - (ii) conduct cross-country comparisons, - (iii) analyze a range of macrofinancial indicators to assess whether surges can pose macroeconomic and/or financial stability challenges. - The toolkit allows identification of episodes in fourteen categories of cross border capital flows and delineation into sectors or asset classes to inform on sectoral financial stability risks (see Annex 7 for details). - The toolkit is intended to assist staff but not replace staff judgment. ### Assessing risks and determining policy mix - Once a surge is identified, staff should assess macroeconomic and/or financial stability risks and clearly lay out key risks already playing out or likely due to the surge, such as: - rapid currency appreciation leading to overvaluation; - higher inflation due to overheating; - excessive credit growth and asset price bubbles increasing systemic financial risks. - Staff should assess the appropriate policy mix, considering country-specific circumstances. - Appropriate macroeconomic policies to address risks associated with a capital inflow surge could include: - Lowering interest rates in the absence of overheating or asset price pressures, through monetary easing and/or fiscal tightening; - Allowing exchange rate appreciation if the currency is not overvalued; - Building foreign reserves, if these are not more than adequate, through sterilized intervention. - When inflow surges contribute to financial stability risks, MPMs may be appropriate as well. ### When CFMs and CFM/MPMs may be appropriate during inflow surges - CFMs and CFM/MPMs may be appropriate to support macroeconomic policy adjustment and safeguard financial system stability in circumstances such as: - Limited room for adjusting macroeconomic policies (e.g., signs of overheating or asset bubbles, overvalued exchange rate, and reserves more than adequate). - When an inflow surge raises risks of financial system instability: MPMs (also CFM/MPMs) may be useful provided they accompany needed macroeconomic policy adjustment and financial regulations. - When rapidly changing underlying conditions make the macroeconomic stance difficult to assess quickly, or warranted policy adjustments take long to implement: CFMs can be temporarily useful to gain time while assessments are made or policies are implemented (for example, during fiscal consolidation until consolidation affects the real economy and interest rates). - These circumstances require judgment by country teams; staff need to substantiate them clearly and show whether necessary policy adjustments are being undertaken. ### Additional considerations in assessing CFMs during inflow surges - CFMs should not substitute for macroeconomic policies warranted for macroeconomic adjustment, domestic stability, and the effective operation of the IMS. - Using CFMs to influence exchange rates to gain unfair competitive advantage would not be appropriate and could be inconsistent with countries’ obligations not to manipulate exchange rates under Article IV. - Effectiveness of CFMs is country-specific; in larger economies with more developed financial markets, controls may be less effective. - CFMs may be precluded by international commitments (e.g., within the EU, full capital mobility is generally required). - For countries with well-established reputations for openness, the reputational costs of CFMs may be relatively high and need to be offset by commensurately higher benefits. ### Design principles for CFMs - CFMs on inflows during a surge should be: - transparent, - targeted, - temporary, - preferably non-discriminatory. - CFMs that target the flows resulting in instability as directly as possible may be most effective and least costly for specific risks or sectoral surges; broader measures may suit overall macroeconomic concerns. - When adopted, CFMs should generally be temporary and phased out when capital inflow pressures abate (assessment of abatement draws on surge analysis and judgment). - CFMs should preferably be non-discriminatory between residents and non-residents; the least discriminatory effective measure is preferred. - If non-discrimination would render the policy ineffective, residency-based measures may be justified. - The design of measures needs continuous review as efficacy can erode over time due to incentives for circumvention. ### CFMs as MPMs and consistency with macroprudential framework - When an inflow surge gives rise to financial stability risks, measures that are both CFMs and MPMs may be appropriate to safeguard financial stability. - In such cases, staff should draw on both the IV and the macroprudential policy framework developed by Fund staff. - Key shared principles: - avoid using CFM/MPMs as substitutes for necessary macroeconomic adjustment; - use instruments that are most effective, efficient, direct, and least distortive in addressing the objective; - seek to treat residents and nonresidents in an evenhanded manner. *Guidance Note on the Liberalization and Management of Capital Flows — International Monetary Fund* ### 38. Staff should be guided by the following considerations on the removal of inflow CFMs ### 38. Staff should be guided by the following considerations on the removal of inflow CFMs ### Removal of inflow CFMs after a surge - When an inflow surge has abated, CFMs on those inflows could impose unnecessary costs or at best be ineffective. - Staff should assess continued appropriateness and generally recommend: - phasing out CFMs as the surge abates, or - scaling back to pre-surge settings in cases when a long-standing inflow CFM was tightened.41 - Some inflow CFM/MPMs imposed during surges may nonetheless continue to be necessary to manage systemic financial risks even after the surge subsides; their usefulness relative to costs must be evaluated on an ongoing basis.42 ### Ongoing evaluation and alternatives - Evaluations should consider whether alternative ways exist to address the prudential concern that are not designed to limit capital flows. - MPMs can increase financial sector resilience and contain vulnerabilities that may have built up in the context of a surge, even when they are not designed to limit capital flows.42 - Evaluations are particularly appropriate when circumstances relevant to the measure’s continued need change (for example, when prudential regulations are revised). - If liberalization has outpaced the economy’s capacity to safely handle flows, further reforms to improve institutional and financial development may need to be implemented before CFMs can safely be lifted (see paragraph 20 on premature liberalization). ### Clarification on discriminatory vs non-discriminatory measures - Example: a limit on the net open FX position for commercial banks would be a non-discriminatory measure, while a limit on their FX borrowing from non-residents abroad would be considered discriminatory.39 ### Box 4 — Assessment of Housing Measures Under the IV (summary) - Context: housing demand from non-resident buyers prompted measures (stamp duties, transaction taxes, purchase restrictions) in several countries (examples listed: Australia, Canada, Hong Kong SAR, Macao SAR, New Zealand, and Singapore). - Core assessment steps (apply usual CFM assessment steps): - Determine whether the measure is a CFM, or CFM/MPM; whether it is macro-critical (including package considerations); and whether it is introduced during surges. - Specific considerations for housing measures: - When housing measures discriminate between residents and non-residents, they are identified as CFMs (discrimination may be based on tax residency; Annex 6 provides guidance). - Housing measures may constitute CFM/MPMs because of the financial sector’s exposure to housing and use of housing as loan collateral; measures introduced for financial stability purposes may be CFM/MPMs while measures aimed at ensuring affordability are usually “pure” CFMs. - In most cases, housing measures are macro-critical given the sector’s economic significance, though macro-criticality must be assessed (see paragraph 7). Housing measures may form part of a package when targeting flows in the same sectors or when similar measures are introduced across regions. - Staff may refer to Annex IV for additional guidance, examples, and data sources. ### B. Managing Capital Inflows Preemptively — overview - Stock vulnerabilities (even absent a surge) can be a source of systemic financial risks, e.g., external debt denominated in foreign currency may build up or remain high after a surge and, if large and unhedged, increases the probability that reversals and depreciations generate costly balance sheet effects and systemic financial risks.39 - Preemptive CFM/MPMs on inflows to reduce these risks may be appropriate in some circumstances (Figure 4). - The IV identified two potential systemic risk sources where preemptive CFM/MPMs may be appropriate: - (i) FX mismatches due to external FX debt; and - (ii) local currency-denominated external debt. ### Criteria when assessing preemptive CFM/MPMs (three main considerations) - Are systemic financial risks elevated? (Assess risks from (i) FX mismatches and (ii) local currency-denominated external debt.) - Is the preemptive CFM/MPM needed to address these risks? (Do not use if MPMs suffice; do not substitute for warranted macroeconomic policy adjustments or market development and structural policies.) - Would the preemptive CFM/MPM help maintain or exacerbate a stronger-than-warranted external position caused mostly by domestic policy gaps? (The measure should not add to domestic policies causing an over-strong external position.) ### Assessment of systemic financial risks arising from FX mismatches — two-step approach - Preemptive CFM/MPMs on FX debt inflows are appropriate only if systemic financial risks are elevated due to FX mismatches.41 - Step 1 — Assess level of FX mismatches at relevant remaining maturities using available datasets: - Required components: (i) the stock of FX liabilities; (ii) the denomination of assets and availability of hedges; and (iii) the maturity structure of the balance sheet (including FX liabilities, assets, and hedges). - Use multiple indicators where possible; data gaps are likely. - Annex 3 lists publicly available data sources and illustrates use for a hypothetical country. - Step 1 guidance when data are unavailable: - Use other country-specific information (e.g., unpublished data, characteristics such as FDI parent guarantees) to assess FX mismatches.43 - If FX mismatches at relevant maturities are judged high in Step 1 for at least one macro-critical sector, proceed to Step 2. For intermediate-range mismatches, err on the side of caution and move to Step 2.44 - Step 2 — Assess whether systemic financial risks arising from those FX mismatches are elevated: - Risks depend on financial structure, macrofinancial linkages, and mitigating/amplifying factors. - Use multiple sources and tools to understand shock transmission. - Possible approaches: - Stress test: granular stress tests of relevant sectors covering liquidity and solvency risks; can draw on past FSAPs or be done in Article IV surveillance if data allow. Annex 3 illustrates solvency and liquidity stress-test principles and a system-wide FX liquidity stress-test example. - Country authorities’ analysis and data: discuss with authorities for additional data, unpublished stress tests, credit registries, legal guidelines, and other relevant information that can inform stress test design and analysis.45 - The systemic risk assessment can build on existing bilateral surveillance risk assessments when stress tests are not feasible.46 - Elements to analyze in FX-related systemic risk assessment: - Consequences of capital inflow reversal — could reversal lead to elevated systemic financial stress (disruption of financial services with negative real economy effects)? - Amplifying and mitigating factors — analyze whether these operate via transmission mechanisms closely connected to FX mismatches identified in Step 1. Examples: FX debt service as a percentage of export revenues; elevated housing or stock valuations linked to high leverage; resilience of FX borrowers’ balance sheets; large FX contingent liabilities; functioning of FX hedging markets; access to FX buffers by central bank or government. ### Assessment of systemic financial risks arising from local currency external debt - Preemptive CFM/MPMs on local currency debt inflows may be appropriate only in narrow and exceptional circumstances.47 - A wider set of policy tools generally exists to manage abrupt reversals in local currency-denominated debt inflows (monetary and exchange rate policy, open market operations, asset purchases, local currency lender of last resort, and other liquidity facilities). - For reversals in local currency-denominated debt inflows to generate systemic financial risks, such policies and other risk mitigants would need to be substantially impeded or unavailable. - Four conditions should be jointly satisfied for preemptive CFM/MPMs on local currency external debt to be considered: - (i) local currency debt and FX markets are sufficiently shallow so that an outflow by some foreign investors would be unlikely to be offset by other (domestic or foreign) investors; - (ii) a large depreciation is costly due to FX mismatches or other reasons (e.g., if it de-anchors inflation expectations), and these costs outweigh the benefits of depreciation, such as from the improvement of net exports; - (iii) domestic monetary policy is constrained, and FX reserves are low; and - (iv) other relevant ex post policy instruments to address capital flow reversals, particularly local currency lender-of-last-resort and liquidity facilities, are substantially impeded or unavailable. - If conditions (i)–(iv) are jointly satisfied, staff should proceed to the risk assessment process using a two-step approach analogous to that for FX mismatches; if not jointly satisfied, preemptive CFM/MPMs are not appropriate under the IV. *GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS, INTERNATIONAL MONETARY FUND (paragraphs 38–47).* ### 48. In Step 1 of the risk assessment, staff should establish whether local currency leverage ### 48–61. In Step 1 of the risk assessment, staff should establish whether local currency leverage ### Step 1 — Identifying elevated local currency leverage and maturity mismatches - Staff should establish whether local currency leverage and maturity mismatches are elevated owing to local currency-denominated debt inflows. - Use data on local currency-denominated external debt stocks, assets, and maturity structure to determine whether leverage and maturity mismatches are high enough in at least one macro-critical sector (potentially including recipients and providers of cross-border funding) to proceed to Step 2. - Judgment is necessary; when mismatches are neither clearly elevated nor clearly safe, staff should err on the side of caution and move to Step 2. ### Step 2 — Assessing systemic risks from local currency leverage and maturity mismatches - Stress tests. - Ideally and subject to data availability, staff’s approach should involve granular stress tests of the relevant sectors to assess both solvency and liquidity risks (such as those conducted in FSSAs) related to a rise in local currency yields and fall in local currency asset prices. - Stress tests should build in the impairment of policy instruments during crises considered applicable for the specific country and which justified the beginning of the assessment process (such as the need for sharp increases in policy rates, or the inability of the central bank to provide liquidity support). - Building on existing risk assessments. - The risk assessment can build as appropriate on existing risk assessments in Article IV reports. - Staff should assess whether systemic vulnerabilities arise from local currency debt inflows, and whether crisis risks would be accentuated in the event of a reversal in these flows owing to FX mismatches or to other factors. - Example: whether elevated housing or stock price valuations are associated with high leverage due to local currency—denominated debt inflows and which, when unwound during a reversal with subsequent effects on local currency interest rates and asset prices, would lead to stress that could not be alleviated by central bank local currency liquidity support. ### Conditions that justify a preemptive CFM/MPM - The following conditions should be satisfied for a preemptive CFM/MPM to be a needed measure to address systemic financial risks: - (i) the policy measure should be a CFM/MPM; - (ii) MPMs alone are insufficient to address the risks; - (iii) the measure should be well-targeted and calibrated effectively to minimize costs and distortions; - (iv) the measure should not be used to substitute for warranted adjustments in macroeconomic policies; - (v) should not substitute for market development or structural policies that could reduce the underlying frictions, nor undermine such policies. - In general, all these conditions would need to be met. ### Requirement that the measure be both an MPM and a CFM - The policy measure—both in the case of FX mismatches and local currency external debt vulnerabilities—should be primarily oriented to address the systemic financial risks stemming from capital inflows. - For systemic risks from FX mismatches: - Staff should determine whether the measure reduces risks arising from unhedged FX debt by reducing existing FX mismatches, preventing capital inflows from causing a further increase in FX mismatches from already-elevated levels, or increasing resilience to FX mismatches by requiring additional capital or liquidity for external borrowing in FX. - For systemic risks from local currency–denominated external debt stocks: - The measure should lower vulnerabilities by reducing such inflows. - If the measure does not pursue a financial stability objective, it would not be an appropriate preemptive measure. ### When MPMs alone are insufficient (and a preemptive CFM/MPM may be justified) - MPMs typically contribute substantially to managing risks from FX borrowing, but they may be unavailable or insufficient to address specific sources of systemic risk. - Under such circumstances, staff may determine that using a preemptive CFM/MPM—either alone, or to reinforce other MPMs—may be needed as the least distortive way to address the risks effectively. - It is useful for staff to determine the sources of FX lending resulting in FX mismatches: - Example: when FX mismatches occur primarily due to local banks lending in FX to local firms and households, MPMs (which are not designed to limit capital flows) are typically able to manage risks from FX borrowing. - However, if there is significant cross-border borrowing in FX, a CFM/MPM that adds constraints on direct cross-border borrowing in FX can be necessary to address risks effectively (IMF 2014a). 49 ### Targeting systemic risks at source and calibration - The preemptive CFM/MPM should be designed to address systemic risks by targeting them at source. - For FX mismatches, staff should determine the magnitude and source of FX mismatches across relevant sectors (financial sector, non-financial corporate sector, and household sector) and the underlying financial transactions (e.g., type and maturity of financial instruments) that give rise to the risks. - The measure should: - Target debt inflows in the specific sector that give rise to the risk as closely as possible. - Be calibrated to address risks effectively while minimizing costs and side effects (on capital flows, domestic credit, output, or market functioning). - Avoid coverage or calibration beyond what is necessary; prefer the most efficient preemptive CFM/MPMs that minimize distortions and costs while being effective. ### Do not substitute for warranted macroeconomic adjustments - The preemptive inflow CFM/MPM should not be used to substitute for warranted adjustments in monetary policy, exchange rates, or fiscal policy. - Two-step assessment: - First, determine whether macroeconomic policies are significantly away from desirable levels and whether an adjustment is warranted, relying on Article IV consultations. - Second, assess whether a warranted adjustment in macroeconomic policies will significantly reduce or eliminate the specific systemic risk. - If warranted macro adjustments would significantly reduce the systemic risks but immediate adjustment is unduly costly or slow, CFM/MPMs may be temporarily appropriate to maintain financial stability while adjustments take place. - Such temporary measures should be accompanied by a commitment to undertake and progress in delivering the warranted policy adjustments recommended in Article IV consultations. ### Do not substitute for or undermine market development or structural policies - The preemptive CFM/MPM should not undermine market development that could reduce the underlying friction (e.g., development of local currency money, bond, equity, and hedging markets). - Structural policies (such as local currency market development) can address frictions and may not produce adverse side-effects; because they take time, preemptive CFM/MPMs may be appropriate in the interim unless they undermine such efforts. - If preemptive CFM/MPMs are used, staff should discuss ways to combine them with reforms to address underlying frictions (examples: developing and deepening local currency bond markets, boosting credibility of the macroeconomic policy framework, developing sound financial supervision and regulation). 50 - When warranted, preemptive CFM/MPMs can be used to accelerate development of necessary structural reforms (market development, institutional and regulatory reforms). ### Assessing effects on a stronger-than-warranted external position - The preemptive CFM/MPM should not help maintain or exacerbate a stronger-than-warranted external position driven by domestic policy gaps. - Staff should form a view on three areas: - The strength of the external position and the contribution of domestic policies. - Staff needs to establish whether the country’s external position is stronger than warranted relative to the level implied by medium-term fundamentals and desirable policies according to the External Sector Assessment (ESA). 52 - Staff should establish whether policy gaps underpinning the external imbalance are mostly domestic rather than foreign. - The expected effect of the preemptive CFM/MPM on the external position. - In general, relative to the counterfactual of no CFM/MPM use, the inflow CFM/MPM would be expected to depreciate the currency and strengthen the external position, unless a case can be made that its impact on the currency would not be economically significant. - To assess this, staff should focus on whether the measure is narrowly targeted, its overall impact on capital inflows, and the ease of substitution of the assets targeted by the measure into other assets. - Example: a narrowly targeted measure to reduce FX mismatches in the banking sector may lead to flows into local currency debt. 53 - Policy actions to address a stronger-than-warranted external position. - If the country has a stronger-than-warranted external position caused by domestic policy gaps, staff should consider whether it is undertaking corrective policy actions or is committed to undertake them; absence of such actions raises concerns that the CFM/MPM could exacerbate the external imbalance. ### Overall assessment of appropriateness - Staff’s overall assessment requires: - Identifying elevated systemic financial risks. - Determining that the preemptive CFM/MPM is a needed policy instrument to address these risks. - Assessing whether the preemptive CFM/MPM would help maintain or exacerbate a stronger-than-warranted external position. - The preemptive CFM/MPM is inappropriate if: - The country is not taking policy actions to address the domestic policy gaps leading to the stronger-than-warranted external position. - The country is undertaking policy actions (or committed to them), but the extent and duration of the strength of the external position are large relative to the severity of the systemic financial risks and the expected effectiveness of the policy actions. ### Other issues and context - Countries with fixed exchange rate regimes 54 may face tighter policy constraints that may strengthen the case for preemptive CFM/MPMs. - During capital flow reversals, such countries face tighter constraints in the use of monetary policy and/or in allowing nominal exchange rate flexibility than those with more flexible regimes. - Their ability to provide local currency liquidity support may be limited. - These constraints may strengthen the case for preemptive CFM/MPMs, while bearing in mind these measures should not substitute for warranted macroeconomic and structural adjustments or help maintain unsustainable currency pegs. - Spillovers. - Policy advice on preemptive CFM/MPMs should take spillovers into account (effects on exchange rate, external position, or international financial flows, e.g., contagion effects). - Effects on the external position enter the determination of appropriateness under the IV. - If use of the CFM/MPM is assessed as appropriate, treatment of spillovers should follow ISD guidance, which mandates staff to discuss outward spillovers from members’ policies if they significantly influence the effective operation of the IMS. 56 - Staff should examine whether alternative policy actions could achieve domestic objectives while minimizing negative spillovers. - Consistent with the ISD, if policies promote domestic and BOP stability, authorities are not obliged to act on staff recommendations; staff may discuss outward spillovers on a voluntary basis. 57 - There should be no presumption that a preemptive CFM/MPM would have negative spillovers; it may have positive spillovers by supporting domestic and global financial stability. 55 ### Review, phasing, and removal - Staff should review preemptive CFM/MPMs periodically to assess continued appropriateness. - Periodic evaluations in Article IV consultations should ensure that conditions satisfied at introduction continue to hold. - Evaluations should follow up on new information regarding economic and policy developments since introduction, including: - Whether (new) MPMs have become available to address the risk; - Whether the measure has become a substitute for warranted macroeconomic adjustments; - Whether there has been progress on reforms to diminish the need for the CFM/MPM; - Whether the measure has caused the exchange rate to depreciate significantly (beyond originally envisaged); - Whether the external position has become stronger than warranted following the measure’s introduction; - Whether authorities have taken measures to address domestic policy gaps underpinning strength of the external position. - If any required conditions are no longer met, staff should recommend removal—immediately if feasible without jeopardizing macroeconomic or financial stability, or in a phased manner with phasing speed depending on the feasible time path for needed policy adjustments. ### Managing disruptive capital outflows (introductory guidance) - Capital outflows that are large, sudden, or sustained can be disruptive and pose significant policy challenges. - Staff advice should be tailored to circumstances: - (i) when there is no immediate threat of a crisis; - (ii) imminent crisis circumstances; - (iii) crisis circumstances. - When there is no immediate threat of a crisis, disruptive outflows can be handled through macroeconomic, financial, and structural policies. - In imminent crisis or crisis circumstances, CFMs may be appropriate to help restore macroeconomic and financial sector stability. - Staff’s assessment of whether there are imminent crisis or crisis circumstances is important for policy advice. *Guidance Note on the Liberalization and Management of Capital Flows, paragraphs 48–61.* ### 62. In the absence of imminent crisis risks, capital outflows should be handled through ### 62. In the absence of imminent crisis risks, capital outflows should be handled through ### Handling capital outflows when there is no imminent crisis - Core finding: In the absence of imminent crisis risks, capital outflows should be handled through macroeconomic, financial sector, and structural policy adjustments rather than capital flow measures (CFMs). - Rationale: - Some capital outflows are a natural consequence of openness, but large, sudden, or sustained outflows can affect exchange rates, external financing, and interest rates. - Macroeconomic, exchange rate, financial, and structural policies can facilitate external adjustment and reduce outflow pressures when no immediate crisis is present. - Policy selection should be based on macroeconomic conditions and take into account financial stability risks, including balance sheet foreign exchange exposures, and any need to adjust policies that contributed to outflows. ### Possible macroeconomic and financial sector policy responses to outflows (summary of options) - Allow the exchange rate to be a shock absorber: - Flexible exchange rates serve as an equilibrating mechanism. - If the currency is not undervalued, some depreciation would be appropriate. - A certain degree of exchange rate volatility is normal and may not be disorderly. - Increase interest rates: - Higher interest rates could compensate market participants for expected currency depreciation and discourage outflows or encourage inflows. - Consider consistency with inflation developments and targets. - Increasing rates is appropriate if the monetary stance is too loose vis-à-vis the inflation outlook. - Intervene in the foreign exchange market: - Intervention is appropriate provided reserves do not fall to inadequate levels as determined by appropriate metrics. - Use intervention to address disorderly market conditions or other inefficiencies (e.g., excessive movements that lead to balance-sheet effects, heightened counterparty risk, domestic spillovers). - Weigh costs to credibility against benefits of dampening shocks. - Sterilized intervention can avoid unwarranted tightening of monetary policy; unsterilized intervention can be appropriate if initial monetary conditions are too loose or under a fixed exchange rate regime. - Clear communication can emphasize purpose or temporariness of intervention. - Role for fiscal policy: - Fiscal policy may need adjustment based on macroeconomic stability, financing constraints, or policy credibility. - A broadly neutral fiscal stance that allows automatic stabilizers to work is generally appropriate if fiscal sustainability and financing constraints are not binding. - If policy space or credibility is eroded or financing constraints bind, rebuilding fiscal buffers may be needed; fiscal tightening that reduces imbalances can enhance credibility and lower risk premia, helping address outflow pressures and supporting financial sector policies. - Financial sector policies: - Liquidity provision may be required to support orderly financial conditions. - Prudential measures may be appropriate to prevent de-capitalization of banks and avoid confidence problems or deposit runs. - Policy action must be commensurate with risks—whether institution-specific or system-wide. - A ‘stop-loss’ approach—determining ex ante conditions that would trigger policy intensification—can aid coordination among supervisors. - Relaxing inflow CFMs: - Relaxing inflow CFMs (including those that are also macroprudential, i.e., CFM/MPMs) may be useful if conditions for safe removal are in place; response should safeguard systemic financial stability. ### Fixed exchange rate regimes - In fixed exchange rate countries, macroeconomic policies must ensure consistency with the peg; intervention is integral to the arrangement. - Foreign exchange intervention to deal with outflows under a peg should typically be unsterilized. - If a shock requires a significant real exchange rate adjustment, a realignment of the peg or crawling arrangement may be needed, with consideration for effects on peg credibility. - Intervention and realignment should not substitute for necessary macroeconomic adjustment. ### Imminent crisis or crisis circumstances and the role of outflow CFMs - Core finding: In imminent crisis or crisis circumstances, CFMs on outflows may be appropriate temporarily to restore macroeconomic and financial stability. - Crisis emergence: - Disruptive outflows can lead to crisis when FX reserves are inadequate, the exchange rate is undervalued or balance sheet FX exposure is high, and the economy is stagnating. - Imminent crisis circumstances can disrupt financial market functioning, cause financial system stress, and constrain central bank LOLR or ELA in FX. - Outflows may trigger reserve depletion, currency collapse, severe financial stress, and output losses—limiting policy flexibility (as represented by point (c) in the Venn diagram in Figure 5). - Use of outflow CFMs: - Temporary CFMs on outflows can prevent a free fall of the exchange rate and reserve depletion while fundamental policy adjustments are implemented. - In imminent crisis circumstances, CFMs may be desirable if they help prevent a full-blown crisis. - Historical examples: outflow CFMs were introduced in Iceland during its crisis in 2008, and in Cyprus and Greece during the European debt crisis (in 2013 and 2015, respectively). ### Design, implementation, and limitations of outflow CFMs - CFMs on outflows should not substitute for warranted policy adjustment; they must form part of a broader policy package (e.g., fiscal and exchange rate adjustment in a classic BOP crisis). - Design principles: - Transparent, temporary, and seek to be non-discriminatory when possible (acknowledging residency-based measures may be unavoidable in crisis situations). - Outflow CFMs generally need to be comprehensive to be effective; selective measures may trigger additional outflows and worsen pressures. - Support by sound institutional and regulatory systems; measures should be adjusted on an ongoing basis. - Consider the challenges of a smooth and timely exit from CFMs when designing them. - Avoid, whenever possible, measures that lead to external payment arrears or sovereign default, which can damage relations with creditors and the international payments system. - Risks of poor design: - Poorly designed or implemented CFMs can exacerbate crises and impose high economic costs by delaying legitimate transactions and encouraging circumvention through loopholes and lax enforcement. - If used in imminent crisis circumstances, CFMs should be introduced swiftly after announcement to prevent front running. ### Assessing imminent crisis circumstances - Determination of imminent crisis is important and requires judgment informed by quantitative indicators and country-specific conditions and authorities’ views. - Common crisis features: currency collapse, debt sustainability pressures, corporate and financial stress, sharp interest rate increases, and severe output contractions. - Guidance for assessing imminent crisis: - Assess underlying vulnerabilities using Fund tools: vulnerability exercise (VE), debt sustainability analysis (DSA), and external sector assessment (ESA). - Identify possible crisis triggers (domestic or global) and their probability, using tools such as the global risk assessment matrix (G-RAM). - Monitor high-frequency data for signs of mounting financial sector and economic distress and shifting market sentiment. Useful high-frequency indicators include: - Exchange rate data (rapid depreciations often precede and occur in early crisis phases). - Official FX reserves data on daily or weekly frequency. - Asset price data: yields on local currency bonds, spreads on foreign currency bonds, and stock market indices; sovereign bond pressures can signal fiscal sustainability risks or sovereign-banking nexus concerns; corporate bond yields/spreads and stock market data can be useful where non-financial corporate sector is a concern. - High frequency portfolio flow data to gauge magnitude of outflow pressures and investor sentiment; some 20+ countries now release monthly, weekly, or daily data on non-resident transactions of portfolio securities. If available, data on deposit outflows and deposit dollarization may also be useful. - Staff should monitor these indicators even when the initial assessment indicates no immediate crisis, because conditions can evolve rapidly (e.g., digitalization can accelerate bank runs). ### Phasing out outflow CFMs - Outflow CFMs introduced in crisis or imminent crisis circumstances can have significant costs over time once crisis conditions abate. - Phasing out measures helps mitigate adverse effects and supports macroeconomic growth and financial development. - Exit strategy considerations: - Plan the exit strategy at or soon after implementation to ensure a smooth exit; premature withdrawal may trigger renewed outflows and instability. - Timing to lift outflow CFMs depends on country-specific conditions rather than calendar dates. - In general, outflow CFMs should be lifted when: - Macroeconomic stability—especially exchange rate, debt sustainability, and financial stability—is restored; - Market access is reestablished; - Reserves climb above critical levels. - The exit roadmap must address design and incentives, communication, and sequencing to handle country-specific challenges. - Examples of countries that used exit strategies: Cyprus, Greece, and Iceland. ### The role of source countries (policies of capital origin countries) - Policies in source countries influence global capital flow developments via push factors (global) and pull factors (domestic in recipient countries). - Staff engagement with source countries: - Discuss outward spillovers from country policies when significant; Fund surveillance reports should include assessments of outward spillovers when they significantly influence the effective operation of the IMS, per the 2012 ISD. - Encourage source country policymakers to internalize spillovers from their monetary, capital flow management, and prudential policies. - Examples of relevant source-country influences: - Use of and exit from unconventional monetary policies (UMPs) in advanced economies (AEs) can generate significant spillovers, posing challenges for EMDEs. - Use of CFMs by large economies can amplify macroeconomic and financial stability risks abroad. - Prudential policies in jurisdictions with global systemically important financial institutions can generate spillovers. - Mitigating multilateral risks: - While countries are not expected to adopt less effective domestic policies, staff should examine options to reduce outward spillovers while maintaining policy effectiveness—e.g., careful communication, sequencing of policy changes, or alternative combinations of monetary, fiscal, capital flow management, prudential, and structural policies. - Progress in global financial sector reforms and improvements in supervision and regulation, including for non-bank financial institutions, can reduce capital flow riskiness by increasing resilience and improving intermediation infrastructure. *GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — Extracted content from the provided unit* ### 74. Countries may adopt CFMs for reasons of national or international security. In some ### ppea2023055 - 74. Countries may adopt CFMs for reasons of national or international security. In some ### Security-based CFMs: treatment and guidance - Determination of whether a measure is a CFM will be made regardless of the stated intent or motivation behind the adoption of the measure. Where staff finds that the measure is designed to limit capital flows, it will be considered a CFM. The security motivation of the measure will not be relevant for the determination of whether the measure is a CFM. - Security-based CFMs that are macro-critical or generate significant spillovers need to be discussed in surveillance and will be covered in Article IV consultations in line with the ISD if: - (i) they significantly influence a member’s present or prospective balance of payments or domestic stability (i.e., are “macro-critical”), or - (ii) they generate outward policy spillovers that may significantly influence the effective operation of the international monetary system, for example by undermining global economic and financial stability. - Where staff assesses that security-based CFMs should be covered in surveillance as specified above, the Article IV staff report will discuss the macroeconomic implications of security-based measures that are CFMs, covering economic significance and (potential) macro-economic impact. - If measures are introduced solely for reasons of national or international security: - They should not be assessed for appropriateness under the IV. - The staff report should note that the measure has been introduced solely for reasons of national or international security and thus should not be assessed under the IV. - Staff will not advise on removing or substituting such measures. - Staff will rely on a member’s representation as to whether the CFM is introduced solely for reasons of national or international security; such representation should be communicated to staff, and good practice would be for such communication to be in writing. - Measures not explicitly represented by authorities as introduced solely for national or international security will be assessed under the general IV criteria, even if similar measures elsewhere have been so represented. - If Executive Directors raise concerns about the member’s justification, these may be included in the Summing Up and/or Chairman’s Statement; the Compendium of Executive Board Work Procedures rules on Summing Up content apply. ### Measures based on internationally agreed prudential standards (Basel framework) - Certain prudential measures implemented in line with internationally agreed prudential standards may constitute CFM/MPMs but are accorded special treatment in the 2022 Review of the IV. - Such prudential measures will be labelled as CFM/MPMs but will not be assessed under the IV for appropriateness if implemented in accordance with the Basel framework. - Examples of measures that will be labelled CFM/MPMs but not assessed under the IV if implemented in accordance with the Basel framework: - A reciprocation of the countercyclical capital buffer (CCyB) (a residency-based outflow CFM/MPM). - Capital surcharges on domestically or globally systemically important banks (D-SIBs or G-SIBs). - The liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) where their design relies on residency-based discrimination allowed under the Basel framework, including differentiated LCRs and NSFRs by currency. - Such measures, when meeting criteria for coverage in surveillance for CFMs, will be discussed as CFMs in staff reports. - Mutually agreed reciprocity arrangements that constitute outflow CFM/MPMs (e.g., regional mechanisms by the European Systemic Risk Board to expand reciprocity to all outward exposure-based measures) will be labelled as outflow CFM/MPMs and, if covered by surveillance, discussed in staff reports but not assessed for appropriateness under the IV. - Steps to determine applicability of special treatment: - Country teams should flag the measure to the interdepartmental group on capital flows, including authorities’ views/representations, collect information, and note team concerns. - The interdepartmental group must determine the measure is both a CFM and an MPM. Only measures whose main objective is to ensure financial stability will be considered for special treatment; measures taken for other reasons will be assessed under the IV. - The interdepartmental group should not perform an in-depth analysis of compliance with the Basel framework; instead, it will check if the specific measure and parameters are provided for under the Basel framework or the relevant reciprocity agreement. - Staff should draw on RCAP or BCP/FSAP assessments where available. - If the interdepartmental group has no concerns that the measure falls under paragraphs 31–35 of the Review of the IV on internationally agreed prudential measures, it should not be assessed under the IV and the reason should be noted in the staff report. Standard staff report language may be used: “Staff has not assessed this measure for appropriateness under the IV, consistent with the special treatment under the IV for measures implemented in line with internationally agreed prudential standards.” - If the interdepartmental group has concerns regarding design, calibration, or other aspects, it should consult relevant experts in MCM before concluding that the prudential measure is covered by the carve-out. - If the measure is considered not to fall under the special treatment (or is not a CFM/MPM), it should be assessed for appropriateness under the IV as any other CFM or CFM/MPM. ### AML/CFT measures as CFMs - International AML/CFT standards require countries to adopt AML/CFT measures to prevent and stop illicit flows, including illicit cross-border capital flows. AML/CFT measures are required to be applied on an ongoing, risk-sensitive basis. - Some AML/CFT measures may delay transactions (e.g., enhanced due diligence) or prevent them altogether (e.g., prohibition to deal with banks from a certain country) with the principal objective to manage ML/TF risks of illicit capital flows. - AML/CFT CFMs may discriminate based on residency or nationality, which are among risk factors for illicit flows. - Differences between AML/CFT measures and typical CFMs: - AML/CFT measures are generally required on an ongoing basis, while CFMs are generally justified by temporary capital flow episodes. - The IV appropriateness criteria are not well-suited for assessing AML/CFT measures given their special purpose. - Treatment rules: - CFMs implemented in accordance with international AML/CFT standards will not be assessed under the IV for appropriateness. They are considered implemented in accordance with the AML/CFT standards if aimed to mitigate ML/TF risks in a commensurate fashion. - Staff should consider whether measures are targeted at ML/TF risks and based on an ML/TF risk assessment or whether measures are called upon by the Financial Action Task Force (FATF). - Such CFMs will be discussed in surveillance and covered in Article IV reports on a mandatory basis if macro-critical or generating significant outward spillovers; the staff report should note that the measure was introduced in accordance with international AML/CFT standards and thus should not be assessed under the IV. - If staff determines the CFM is not implemented in accordance with international AML/CFT standards, it should be treated like any other CFM and assessed under the IV criteria for appropriateness. - Examples where assessment under the IV would be expected: - Measures purportedly based on ML/TF concerns but unsupported by a risk assessment or compliance with international AML/CFT standards (e.g., limiting capital transactions by foreign nationals in real estate or capital markets without supporting risk assessment). - Measures limiting capital transactions in education or charitable sectors by some foreign nationals or governments on terrorist financing grounds, absent assessment or evidence of misuse risk. - Operational consultations: - Staff should consult with LEG-FIG to determine compliance with AML/CFT standards. - Staff should consult with experts from LEG when providing recommendations regarding measures intended to address ML/TF risks or implement AML/CFT requirements. ### Measures arising from international cooperation standards against tax avoidance or evasion - A “residency-based” CFM that is consistent with international cooperation standards against tax avoidance and evasion will not be assessed under the IV. However, if macro-critical, staff should note the measure as a CFM, discuss it in the staff report, and note that it is not assessed under the IV. - Special treatment applies only to tax measures based on and implemented in accordance with international cooperation standards against tax avoidance and evasion (e.g., certain minimum standards of the Inclusive Framework on BEPS and established tax transparency standards on exchange of information). - The special treatment exclusions: - Other recommended actions not agreed by consensus in international tax standard-setting bodies (e.g., other BEPS Actions that were not “minimum standards”) are not covered. - The special treatment is limited to avoid misclassification. Tax measures qualify only when: - (i) based on and implemented in accordance with the agreed international cooperation standards (typically peer reviewed); and - (ii) designed to prevent avoidance or evasion of taxes. - Eligible measures must arise from and be consistent with relevant international standards and, if defensive, be based on identification of countries that fail established peer review processes. - Example covered by the carve-out: adoption of defensive tax measures against non-cooperative tax jurisdictions in the form of a “residency-based” CFM that applies a higher withholding tax rate on payments to a specifically listed non-cooperative tax jurisdiction which has failed, based on peer review, to implement agreed standards. - The special treatment will not apply to bilateral or regional agreements to limit capital flows that go beyond the relevant standards. - Operational guidance: - Country teams should inform the interdepartmental group of such measures and raise any concerns if in doubt about implementation consistency with relevant standards; consult with LEG if necessary. *Source: GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — excerpt (paras. 74–81) — INTERNATIONAL MONETARY FUND* ### 82. Under the IMF’s Articles of Agreement, members are free to exercise controls over ### ppea2023055 - 82. Under the IMF’s Articles of Agreement, members are free to exercise controls over ### Interaction with Article VIII and scope of obligations - Under Article VIII, Section 2(a) and Section 3, all Fund members have an obligation not to introduce exchange restrictions or multiple currency practices (MCPs) unless approved by the Fund or subject to transitional arrangements under Article XIV. - The IV does not alter members’ obligations under Article VIII. If a policy measure constitutes both a CFM and an exchange restriction and/or an MCP, the respective Article VIII framework generally takes precedence. - Staff advising members on CFMs should design CFMs so they do not give rise to exchange restrictions or MCPs for current transactions. - Measures that are both CFMs and exchange restrictions and/or MCPs will: - always be mentioned as exchange restrictions and/or MCPs in relevant staff reports in line with surveillance coverage requirements, and - be identified in the report as being a CFM if the criteria for coverage of CFMs in surveillance are met. ### Definition overlap: current transactions, capital transactions, CFMs, exchange restrictions, and MCPs - Article XXX(d) definition of “current transactions” captures some transactions that, economically, are capital in nature and are registered in the capital and financial accounts of the balance of payments, namely: - (i) payments of moderate amounts for amortization of loans or for depreciation of direct investments; - (ii) normal short-term banking and credit facilities; and - (iii) moderate remittances for family living expenses. - Consequences of the Article XXX(d) overlap: - Measures impacting transactions in the three categories above may be classified simultaneously as CFMs and exchange restrictions and/or MCPs. - Some measures may affect solely capital transactions (per Article XXX(d)) and be both MCPs and CFMs. - A broad measure may affect both capital transactions and transactions defined as “current”, and therefore be classified as: - a CFM and MCP with respect to capital transactions, and - an exchange restriction and/or MCP with respect to payments and transfers for current transactions. - Treatment principle: measures that are CFMs and also exchange restrictions and/or MCPs because of the Articles’ definition of current transactions and are subject to Fund approval under Article VIII will not be assessed under the IV for appropriateness; they will be assessed only under the relevant Article VIII approval criteria. ### Box 5: Operational treatment of measures that are both CFMs and exchange restrictions/MCPs - Exchange restrictions and MCPs (including those that are also CFMs) are subject to Board approval, except for MCPs applicable solely to capital transactions. - Executive Board decisions set out criteria for temporary approval of exchange restrictions maintained for balance of payments reasons and for temporary approval of MCPs maintained for either balance of payments or primarily for non-balance of payments reasons. - Rules for overlapping classifications: - Measures that are CFMs and also exchange restrictions and/or MCPs due to the Articles’ definition of current transactions and subject to Fund approval under Article VIII: assessed only under Article VIII approval criteria (not under IV). - A measure affecting both capital and Article-defined current transactions: - If it is an exchange restriction and also a CFM (but not an MCP): assessed under the IV only for the part designed to limit capital flows, and under Article VIII approval policy for the part affecting current payments and transfers. Example: a ban on access to FX for certain current and capital transactions. - If it is an MCP affecting both current and capital transactions and also a CFM: assessed only under the MCP approval policy; its appropriateness will not be assessed under the IV. Example: a tax that gives rise to an MCP and applies to both current and capital transactions. - CFMs that are also MCPs and applicable solely to capital transactions: assessed only under the IV. Rationale: Executive Board repeatedly decided not to assert jurisdiction under Article VIII over MCPs relating solely to capital transactions (Decision No. 8648-(87/104)). - Cross-references cited in Box 5 include the Guidance Note for the Fund’s Policy on Multiple Currency Practices (2023) and the Review of the Fund's Policy on Multiple Currency Practices–Proposals for Reform, 2022. ### Illustrative examples (Table 1 summary) - Measures that are both CFMs and exchange restrictions because they relate to transactions capital in nature but considered current under the Articles: - Assessment under Article VIII policy: Yes - Assessment under IV for appropriateness: No - Examples: - Prohibition for payments of moderate amounts for amortization of external loans - Limiting the amount of short-term trade credits to nonresidents that previously were freely allowed - Discretional central bank approval requirement for payments of moderate amounts for family living expenses - Measures that are both CFMs and MCPs because they relate to transactions capital in nature but considered current under the Articles: - Assessment under Article VIII policy: Yes - Assessment under IV for appropriateness: No - Examples: - A tax that applies to the exchange rate used to sell FX for making payments of moderate amounts for amortization of external loans while other FX sales are free of such tax - Requiring use of a more depreciated exchange rate for short-term trade credits to nonresidents - CFMs that are also MCPs applicable solely to capital transactions: - Assessment under Article VIII policy: No - Assessment under IV for appropriateness: Yes - Example: - A tax on FX conversions for certain capital transactions relative to the exchange rate prevailing for other capital transactions - Measures designed to limit capital transactions (CFMs) and affecting transactions defined as current under the Articles (exchange restrictions, but not MCPs): - Assessment under Article VIII policy: Yes (only for current transactions) - Assessment under IV for appropriateness: Yes (only for capital transactions) - Examples: - A tax on outward transfers abroad related to both current and capital transactions - Absolute limits on transfers abroad for both current and capital transactions - Measures designed to limit capital transactions (CFMs) and affecting transactions defined as current under the Articles (MCPs): - Assessment under Article VIII policy: Yes - Assessment under IV for appropriateness: No - Example: - A special exchange rate imposed for transactions of certain market participants covering both capital and current transactions ### Other operational issues (Section B) - In some cases, CFMs may be part of a country’s regulatory framework but: - not activated (safeguard/contingency measures whose introduction is conditional on exceptional circumstances), - have quantitative parameters set to zero, or - are adopted but not enforced. - Treatment under the IV: - (i) Measures that are part of regulations but never activated (safeguard/contingency measures) will not be labeled as CFMs and will not be assessed for macro-criticality under the IV until activated. Examples of legal provisions on temporary safeguard measures include: Croatia (Chapter V: Safety Provisions, articles 47–48, Foreign Exchange Act, 2003), Iceland (Chapter 3: Protective measures under extraordinary circumstances, Foreign Exchange Act, No. 70/2021), Kazakhstan (Chapter 6, Article 24: Special currency control regime, Currency regulation and currency control, Law of the Republic of Kazakhstan, 2018), Moldova (Chapter VII, Article 56. Safeguard measures, Law on foreign exchange regulation, 2008), North Macedonia (Chapter 7. Special Measures, articles 37–38, Law on Foreign Exchange Operations), Serbia (Chapter VII. Safeguard measures, articles 42–43, Law on foreign exchange operations), Ukraine (Article 12. Remedies, Law of Ukraine on Currency and Currency Operations, 2018), and EU treaty provisions (Articles 66 and 144, Consolidated version of the treaty on the functioning of the European Union, 2012). - (ii) Measures that could be CFMs but currently have quantitative parameters set at zero (including measures that were active in the past with non-zero parameters but have parameters set at zero now) will not be labeled as CFMs until parameters become non-zero. Example: Iceland (Chapter II Special Macroprudential measures, article 4, Special reserve requirement on foreign currency inflows, Foreign Exchange Act, No. 70/2021). - (iii) CFMs adopted but not enforced: staff should assess them if/when they become enforced or enforcement is tightened. - Procedural points: - If a contingency measure is activated or a measure’s quantitative parameters are set at non-zero, staff should assess whether it is a CFM and macro-critical under the IV and, if so, discuss appropriateness in staff reports. - Pre-IV measures (introduced before November 2012) will be assessed if settings have been changed after 2012; unenforced pre-IV measures will be assessed if enforcement begins or is tightened after 2012. ### CFMs among residents, taxes, and residency-based distinctions - Measures on FX purchases and transactions between residents may be considered CFMs in certain circumstances, notably when used to arrest depreciation pressures in the context of capital outflows or a sudden stop. Examples: bans or limits on cash withdrawals and conversion into FX in Cyprus (2013), Greece (2015), and Ukraine (2015). - Assessing tax measures under the IV must consider internationally established legal principles of taxation: - Internationally accepted standards permit treating tax residents and non-residents differently. - General tax measures that discriminate based on tax residency (income tax, withholding tax, capital gains tax) are typically considered non-discriminatory if they seek equivalent treatment between persons in “like circumstances.” - International legal frameworks referenced include tax treaties, WTO rules, and OECD Codes of Liberalization of Capital Movements and Current Invisible Operations. - Practical guidance on tax-residency issues: - Staff will review the legal definition of tax residency used by the tax measure and determine whether it conforms to international standards by avoiding discrimination and treating persons in “like circumstances” the same way (see Annex 6). - General and non-general tax measures that solely discriminate based on tax residency conforming to international standards should not be automatically considered residency-based CFMs under the IV; further analysis of the circumstances of introduction or tightening is required. - If analysis shows the tax measure was designed to limit capital flows, it will be assessed as “other CFMs.” - Annex 6 provides guidance on when residency-based discrimination arises in tax measures and how to determine conformity with international standards; staff may consult LEG and FAD for determinations. - Note: The continued existence of tax rate discrimination in a non-general tax measure that need not differentiate on policy grounds tends toward a finding it was designed to limit capital flows and therefore is a CFM. ### Topics outside current IV coverage - Some topics are not covered under the IV because additional analytical and operational guidance is needed, including: - use of CFMs for social or political objectives, - distributional effects of capital flow liberalization, - use of outflow CFMs outside of (imminent) crisis circumstances, - effects of digitalization and climate change on capital flows and related CFMs. - Cross-reference: See para 7 in the 2022 Review of the IV. *GUIDANCE NOTE ON THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS, INTERNATIONAL MONETARY FUND* ### Annex I. Terminology: The Institutional View on the Liberalization ### Annex I. Terminology: The Institutional View on the Liberalization and Management of Capital Flows ### Capital Flow Management Measures (CFMs) - CFMs are defined as measures that are designed to limit capital flows. - CFMs comprise: - Residency-based CFMs, which encompass a variety of measures (including taxes and regulations) affecting cross-border financial activity that discriminate on the basis of residency. These measures are also generally referred to as capital controls. - Other CFMs, which do not discriminate on the basis of residency, but are nonetheless designed to limit capital flows. These other CFMs typically include measures, such as some prudential measures, that differentiate transactions on the basis of currency as well as other measures (for example, minimum holding periods) that typically are applied to the non-financial sector. - Measures not designed to limit capital flows do not fall under the CFM nomenclature. Examples of non-CFMs: - Prudential measures such as capital-adequacy requirements, loan-to-value ratios, and limits on net open foreign exchange positions when not designed to limit capital flows but to ensure resilience and soundness of the financial system. - Macroeconomic policies and structural or other policies that may directly or indirectly inhibit capital flows but are not designed to limit capital flows. ### Assessing whether a measure is a CFM - Key considerations to determine if a measure is designed to limit capital flows: - Whether the measure treats international capital transactions (and/or associated payments or transfers) less favorably than domestic capital transactions (and/or associated payments or transfers). - Whether the measure applies only to international capital transactions (and/or associated payments or transfers) and either imposes or intensifies a limitation on such transactions (and/or associated payments or transfers). - Contextual judgment may reclassify measures as CFMs even if not CFM by design; relevant contextual factors include adoption during periods of surges in inflows or disruptive outflows. - The determination should be guided by the above considerations regardless of stated intent or motivation behind the adoption of the measure. ### Illustrative indicators that a measure is designed to limit capital flows - The measure explicitly discriminates on the basis of residency (example: restrictions on non-resident investments or residents’ access to FX for portfolio investments abroad). - The measure directly targets a cross-border capital flow (example: a blanket tightening of domestic financial institutions’ net open foreign exchange position when the on-shore foreign exchange interbank market is small relative to external sources of finance). - Measures designed to deal with financial sector risks of increased liquidity arising from capital flows, but not to limit the flows themselves, are not CFMs. ### Use of terminology in Fund work - CFMs and MPMs should be identified as such in staff reports and other papers for transparency and even-handedness. - If classification is unclear or staff and authorities differ, reports can note the lack of clarity or difference in interpretation. - Terminology is intended only for the context of the Institutional View (IV) and Fund advice and assessments; it does not supplant terms used in other international frameworks. - In the IV, “capital flow liberalization” is understood as the removal of CFMs. - OECD concept of liberalization applies only to elimination of measures that discriminate between residents and nonresidents. - Treaty on the Functioning of the European Union obligations generally prohibit all restrictions on capital flows even if they do not discriminate based on residency. - Staff do not assess consistency of CFMs/MPMs with these other frameworks. ### MPMs and CFMs: distinctions and overlap - Primary objectives: - CFMs aim to contain the scale or influence the composition of capital flows. - MPMs are prudential tools primarily designed to limit systemic financial risk and maintain financial system stability irrespective of the source of risk. - Overlap: - When capital flows are the source of systemic financial sector risks, tools can be both CFMs and MPMs (CFM/MPMs). Example: restrictions on financial institutions’ foreign borrowing via a levy on foreign exchange inflows or required reserves on external foreign exchange liabilities to limit inflows, slow domestic credit and asset price increases, and reduce liquidity and exchange rate risks. - Classification practices: - Staff maintains a running roster of macro-critical policy measures assessed as CFMs or CFM/MPMs introduced or adjusted since adoption of the IV. - The IMF Taxonomy of CFMs, updated annually, provides details on CFMs and CFM/MPMs discussed in published IMF staff reports, including type, description, dates of introduction/adjustments, latest status as of cutoff date, and direct quotations from relevant IMF staff reports reflecting policy advice provided under the IV. ### Box AI.1 — Definition of CFMs, MPMs, and CFM/MPMs (summary points) - CFMs: measures designed to limit capital flows. - MPMs: prudential tools designed to limit systemic financial risks. - CFM/MPMs: measures designed to limit systemic financial risks stemming from capital flows. - Determination whether a CFM is also an MPM requires three conditions: - (i) primary objective is to safeguard financial stability; - (ii) a source of systemic financial risks can be identified; - (iii) the CFM can reasonably be expected to mitigate such risks. - Currency-based measures may be MPMs, but can be CFMs if designed to limit capital flows. - CFMs that mainly operate through the exchange rate are given extra scrutiny and may not qualify as MPMs. ### Source and recipient countries - Definitions are based on gross flows: - Source countries: countries from which significant gross flows originate. - Recipient countries: countries that receive gross flows on a scale that is substantial relative to the domestic economy. - Push and pull factors originate from source and recipient countries, respectively. ### Selected examples of CFMs (as described at introduction) - Measures designed to limit inflows: - Brazil 2009: Introduction of a 2 percent tax on portfolio equity and debt inflows. — Tax directly on inflows. - Indonesia 2011: Imposition of (1) a six-month holding period on central bank bonds and (2) a limit on short-term foreign borrowing by banks to 30 percent of capital. — Directly targets a capital flow and will reduce demand for foreign capital. - Korea 2011: Restoration of a 14 percent withholding tax on interest income on nonresident purchases of treasury and monetary stabilization bonds (in addition to a 20 percent capital gains tax), leading to equal treatment of both foreign and domestic investors. Nonresident investors based in countries with double taxation treaties with Korea are subject to reduced rates based on these treaties and official investors are exempt. — Increased the tax rate for foreign investors with the stated intention of reducing capital inflows (even though it led to equal treatment). - Peru 2010: Increase of fee on nonresident purchases of central bank paper to 400 basis points (from 10 basis points). — Discriminates on the basis of residency and is intended to limit capital flows. - Measures designed to limit outflows: - Argentina 2001: Establishment of Corralito, which limited bank withdrawals and imposed restrictions on transfers and loans in foreign currency. — Direct restrictions on capital flows. - Iceland 2008: Stop of convertibility of domestic currency accounts for capital transactions. — Direct restrictions on capital flows. - Malaysia 1998: Imposition of 12-month waiting period for nonresidents to convert proceeds from the sale of Malaysian securities. — Discriminates on the basis of residency to limit outflows. - Ukraine 2008: Introduction of a 5-day waiting period for nonresidents to convert local currency proceeds from investment transaction to foreign currency. — Discriminates on the basis of residency to limit outflows. - Thailand 1997: Imposition of limits on forward transactions and introduction of export surrender requirements. — Restricts foreign exchange transactions to limit capital outflows. ### Annex II — Liberalization: Thresholds, Pre-Conditions, Sequencing, Other Operational Considerations - Staff should analyze consistency of liberalization plans with safe liberalization that allows reaping benefits of greater openness while managing risks. - Aspects to consider when assessing readiness for liberalization: Preconditions for safe liberalization - Stable macroeconomic and financial conditions supported by a strong macroeconomic policy framework. Key elements: - A credible exchange rate arrangement supported by adequate reserves can reduce risks related to increased capital flow volatility. - A flexible exchange rate arrangement facilitates absorbing external shocks, as could a credible peg combined with fiscal and labor market flexibility. - Low and stable inflation reduces the risk of capital inflow surges that can stem from carry trade and capital flight caused by depreciation expectations. - Building and maintaining macroeconomic and financial sector buffers can serve to reduce risks. - A sustainable fiscal position and manageable public sector and external debt reduce the likelihood of adverse macroeconomic effects of capital flow retrenchment, while providing room for private sector outflows. - The absence of potential credit and asset price bubbles reduces financial stability risks. - Financial sector capacity to absorb inflows: - Active and deep domestic money and foreign exchange markets facilitate absorption of capital flow volatility and implementation of effective monetary policy. - Development of equity and bond markets helps reduce residents’ reliance on foreign assets and corporate sector’s resort to foreign funding by providing alternative investment and funding opportunities. - Development of an adequate yield curve is necessary to ensure availability of hedging instruments. - Ability of financial sector to deal with increased capital flow volatility: - Evaluate resilience of banks’ balance sheets with attention to: - (i) relatively high reliance on deposits, in particular from institutional investors who may rebalance portfolios when outward capital transactions are liberalized; - (ii) adequacy of net open foreign exchange position limits or exchange rate risk management practices; - (iii) credit risk associated with exchange rate depreciation, due to a large share of foreign exchange-denominated loans or inflation-linked loans (especially in high exchange rate pass-through countries); - (iv) high levels of NPLs. - High standards of governance and disclosure: - Adherence to international accounting, transparency and shareholder protection standards facilitates liberalization of FDI and portfolio flows and allows proper pricing of stocks and securities. - Adequate governance standards reduce vulnerability of financial and nonfinancial corporate sectors to risks related to greater openness. - Strong financial sector regulatory standards and effective supervisory framework: - Adequate micro and macroprudential regulations contribute to containing risks of greater openness. - Cooperation agreements with supervisory authorities of other countries, particularly important source/destination countries, facilitate detection and management of financial stability risks. - An adequate deposit guarantee framework can help local banks retain residents’ deposits. - Proper crisis preparedness and resolution frameworks are important in context of increased capital flow volatility and potential contagion. - Adequate prudential regulations need to be in place on institutional investors’ foreign investments before liberalizing capital outflows. - Reforms need to address risk that operations through the informal financial sector can undermine effectiveness of the prudential framework in the formal sector. - Strong policy track record: - A track record of implementing sound policies provides a credible basis for necessary reforms underpinning liberalization and facilitates managing its risks. - Data and analysis sources: - Rely on a range of available sources of relevant information. The macroeconomic assessment should be based on analysis for bilateral and multilateral surveillance and draw on examples of other similarly situated countries that have liberalized successfully. *Annex I. Terminology: The Institutional View on the Liberalization and Management of Capital Flows (extracted content).* ### 3. Assess the risks that removal of the CFMs would pose to macroeconomic and financial ### 3. Assess the risks that removal of the CFMs would pose to macroeconomic and financial stability ### Risks of removing CFMs and staff responsibilities - Staff should identify CFMs that are effective and assess the risks their liberalization would pose to the economy and the financial sector. - Reforms can be designed to support liberalization by eliminating or reducing identified risks. ### Sequencing of liberalizing reforms (general approach) - Plan sequencing to match achievement of preconditions and thresholds to reduce risks. - Broad sequencing principle summarized as: “long term before short term, FDI and other non-debt before debt, and inflows before outflows.” - The currency composition of financial assets can have implications for stability and may warrant caution. - Sequence must be calibrated to country-specific circumstances and entail flexibility and judgment, taking into account dialogue between authorities and staff and expertise from MCM and others. - Reference sequencing approach (to be adapted to each country): - Liberalize FDI inflows and certain short-term bank-related flows needed to facilitate trade and financial transactions for clients of financial institutions (for example, trade finance and allowing banks to open accounts with correspondent banks abroad). - Liberalize FDI outflows and inflows into traded securities (for example, listed bonds and equities). Notes: - Liberalizing inflows into equities may present fewer complications than bonds, given equities’ potential for both greater risk-sharing and market-deepening. - Development of bond markets could also benefit from foreign participation enlarging the investor base. - Some countries have initially allowed inflows only for long maturities to lengthen maturities. - Prudential controls on banks’ open positions need to continue, especially to limit large-scale use of short-term foreign currency borrowing to fund domestic currency lending, along with prudential rules on domestic lending in foreign exchange. - Progressively lift controls on outflows and allow greater participation of foreign investors in other assets. ### Evaluating current stage of liberalization and potential re-imposition of CFMs - Staff should evaluate whether the current stage of liberalization is appropriate, given benefits and risks and the existing preconditions. - If liberalization has outpaced the economy’s capacity to safely handle flows, re-imposition of CFMs may be warranted until sufficient progress is made on macroeconomic, financial, and governance policies and market development recommended by the integrated approach. - If CFMs are re-introduced, the least discriminatory measure that is effective should be preferred. - Examples of liberalizing capital flows discussed in staff consultations: - China (2011 Article IV Consultation): staged approach; initial focus on removing restrictions on more stable, long-term sources such as FDI; full liberalization—including short-term flows—wait until bulk of financial sector reforms implemented; risk that liberalizing interest rates could raise rates and lead to potentially destabilizing capital inflows; allowing exchange rate appreciation would help reduce these pressures. - Korea (2006 Article IV Consultation): role of financial development for handling capital flows; priority areas include development of an active money market to price forward FX transactions. ### Annex III — Preemptive CFM/MPMs: Data sources and operational considerations - Purpose: guidance on data sources and operational considerations for assessing appropriateness of preemptive CFM/MPMs. Data inputs and approaches for assessing FX mismatches and systemic risk - Private sector FX debt stocks: - Analyze stock of private sector FX debt economy-wide and at sectoral level. - Breakdown across households, non-financial corporations (NFCs), banks, and non-bank financial institutions (NBFIs) is particularly useful. - Possible data sources: - Public databases: BIS, LBS, IDS, and IFS. - Authorities’ data: may cover certain sectors and may require requests to several government institutions; central bank may have data for banks and possibly NBFIs but not for NFCs or households; NFC data may come from supervisory agencies; household data may come from surveys. Authorities’ data may be provided confidentially. - Private sector FX assets and hedges: - Hedging forms: (I) natural; (ii) via holdings of liquid FX assets; or (iii) through financial contracts in deep hedging markets. - Natural hedges: approximate using export revenues net of FX expenses for corporates, or remittances for households—may cover only export sector or remittance-supported households. - Liquid FX assets: portfolio assets and other investment assets in the IMF’s BOP/IIP database; Balance Sheet Approach (BSA) data (including currency and deposits subcomponent) with short- and long-term maturities. In general, assume maturities have significant liquid components. - Hedging via non-deliverable instruments (e.g., NDFs): protects buyer from exchange rate losses but does not provide FX liquidity at maturity or hedge maturity mismatch. BIS’s Triennial Central Bank Survey provides comprehensive data but only on a triennial basis and for a limited number of currencies. - Maturity structure: - Breakdown of FX debt stocks and assets by maturity identifies mismatches between short-term FX obligations and liquid FX assets. - Timing of FX income and maturity of hedges informs rollover risk and FX maturity risks. - Data gaps can be proxied using reasonable assumptions; proxies include debt categories likely to be short-term FX debt (e.g., external interbank debt) and using ratios of FX to local currency debt from short-term external debt series in the IIP database. Stress testing principles for solvency and liquidity - Solvency stress test: - Assess how an adverse macroeconomic scenario, including a calibrated depreciation, may increase defaults of private sector agents (banks, corporates, households) due to FX balance sheet mismatches, and the resulting effects on bank solvency. - Liquidity stress test: - Assess how withdrawal of FX funding or drop in FX revenue interacts with FX maturity mismatches to create systemic shortfalls and amplification across domestic sectors. - Calibrate depreciation and withdrawal of FX funding to private sector; model liquidation of each sector’s FX assets and operation of FX hedging markets under stress. - Identify spillovers of FX shortfalls to the rest of the economy using information on financial system structure, elevated asset valuations, and availability of policy support. - Objective of both tests: - Assess sectoral resilience, quantify domestic contagion, and judge the degree of FX policy support that may be needed. - Compare required policy support to FX buffers held by central bank or government, including access to other FX liquidity sources (sovereign wealth funds, FX reserves, FX swap lines, and/or Fund arrangements). ### Annex IV — Assessment of housing measures under the IV - A housing measure designed to limit capital flows is a CFM. A measure that discriminates between residents and non-residents constitutes a CFM under the IV. - A housing measure may be classified as a CFM/MPM if: - (i) the authorities’ primary objective is to limit systemic risk; - (ii) a potential source of systemic risk can be identified; and - (iii) a transmission path exists by which the measure can be expected to reduce systemic risk. - Measures primarily aimed at housing affordability alone do not qualify as MPMs in addition to CFMs (e.g., measures in Australia and Canada). - Macro-criticality: - Housing CFMs or CFM/MPMs must be evaluated under the IV when they are macro-critical. - Housing market measures often have important implications for financial sector functioning and consumption. - A measure may be non-macro-critical if its effect on current and prospective domestic or BOP stability is very small. - If prior measures have already reduced nonresident inflows, a new measure’s prospective impact may render it macro-critical. - If measure is part of a package of prior measures, the overall package’s macro-criticality matters. - Appropriateness under the IV: - CFMs and CFM/MPMs may be appropriate if introduced or tightened during a capital inflow surge; CFM/MPMs may also be appropriate if introduced preemptively in certain circumstances. - A surge need not be large economy-wide; a sectoral surge with systemic linkages can pose stability risks. - Access to data on nonresident demand is necessary: number and value of housing transactions separated by resident and nonresident buyers are useful because nonresident investors may not use domestic banks for financing. - Assess whether demand is concentrated in a segment or broad-based; nonresidents may be “marginal investors” affecting overall prices even if their share of transactions is small. - When measures have already been introduced, analyze the pre-implementation period when assessing surges. - CFMs/CFM-MPMs should not substitute for warranted macroeconomic adjustment. - Many housing measures (e.g., stamp duties) may have limited impact on overall capital flows and external position and thus do not substitute for warranted macro adjustment. - Cases exist where measures could substitute for warranted adjustment (e.g., inappropriate monetary policy, structural housing supply issues, taxes). - 2022 Review of the IV: - Did not alter evaluation of housing measures introduced during surges; past practice is a useful guide. - Recent years: a number of housing CFMs and CFM/MPMs assessed appropriate under the IV where a surge and systemic risk were identified (e.g., Hong Kong SAR and Macao SAR). - In some cases, imposition or tightening was found inappropriate due to lack of an inflow surge. - Removal/continuation rules: - IV requires inflow CFMs be removed once the surge abates. - CFM/MPMs introduced during surges may continue until financial risks subside, but ongoing evaluation of usefulness relative to costs is required. - Some housing CFM/MPMs have remained in place for extended periods (e.g., Hong Kong SAR stamp duties) due to continuing systemic risk. - Staff have recommended phasing out measures where replacement by less discriminatory measures is feasible (examples: nondiscriminatory tax on vacant housing (Canada), broader land tax (Australia), broader non-discriminatory housing agenda (New Zealand)). - Specific past staff recommendation example: Canada Article IV (2020), para 56. ### Annex V — Capital flows in staff reports: examples - Managing capital inflows during surges (selected staff reports): - Australia (2017 Article IV): appropriate policy mix including CFMs; drivers of housing demand; supply-side housing measures; prudential measures for financial risk; appropriateness of CFMs when macro policy adjustment not warranted and prudential tools insufficient; desirability of replacing CFMs with non-discriminatory measures and removal as surge abates. - Brazil (2012 and 2013 Article IV): drivers of inflows/outflows and pressures from inflows on an already-overvalued real; fiscal tightness as part of reducing net capital inflows; usefulness of CFMs (IOF tax on portfolio inflows); costs of CFMs and need to address structurally high interest rates as pull factor; importance of increasing financial sector’s absorptive capacity; discussion of easing IOF as conditions improve. - Liberia (2016–2019): surrender requirement on remittance flows, with most surrendered proceeds auctioned back to markets; assessed as an appropriate temporary measure and discontinued as conditions allowed. - South Africa (2011 Article IV): reliance on macroeconomic policies; authorities’ responses including exchange rate appreciation while building reserves, accommodative monetary policy, liberalizing capital outflows; medium-term scope to build reserves further and tighten fiscal policy to create room for monetary policy; CFMs case in near-term given little short-term policy space and overvalued rand, but concluded use was not warranted owing to potential costs and low effectiveness. - Managing disruptive capital outflows (selected staff reports): - Iceland (2008 SBA Request, 2012 Second Post-Program Monitoring Report): need for tighter monetary policy and maintenance of exchange controls to prevent exit of large non-resident krona holdings after banking collapse left private sector debt at over 450 percent of GDP by end-2008; need for appropriately sequenced and paced liberalization strategy to avoid disorderly outflows. - Kazakhstan (2022 Article IV): need for tighter monetary policy to curb inflation, fiscal consolidation, and role of financial sector policy. *Source: Guidance Note on the Liberalization and Management of Capital Flows (excerpts).* ### Annex VI. Aligning the Assessment of Tax Measures Under the IV ### Annex VI. Aligning the Assessment of Tax Measures Under the IV ### Purpose and scope - Provides guidance on assessing tax measures under the IV because internationally accepted standards on taxation generally permit treating tax residents and non-residents differently. - Clarifies when residency-based discrimination arises and how to determine whether differentiation based on tax residency conforms to international standards. - Country teams are encouraged to bring potential tax-related CFMs to the attention of the Legal Department at an early stage. ### Definition of tax residency - Tax residency is commonly defined under domestic tax law and determines liability by reason of domicile, physical presence, or any other criterion of a similar nature. - Typical standard formulation for an individual: - An individual is resident in the local jurisdiction for a year of tax assessment if the individual: (i) resides in the local jurisdiction; (ii) is domiciled in the local jurisdiction unless the individual has a permanent place of abode outside that jurisdiction; or (iii) is present in the local jurisdiction for a period of, or periods amounting in aggregate to, 183 days in any 12-month period. - Tax residency tests are also typically adopted for other non-individual taxpayers (e.g., such as corporations, trusts and partnerships) and are designed and drafted to similarly avoid discrimination and reflect the specific circumstances of those entities. ### Residency-based discrimination: principal findings - A finding of “residency-based” discrimination will not arise with respect to tax measures based solely on tax residency conforming to international standards (i.e., physical residence, legal domicile, or the 183-day presence test). - A finding of “residency-based” discrimination will apply to domestic tax law measures designed based on citizenship, nationality, or immigration status (example: applying different tax treatment to foreign nationals). - Staff will review the relevant tax residency definition used by the particular tax measure under assessment and will not consider whether other aspects of the general tax law framework comply with international standards. ### General tax measures vs non-general tax measures - General tax measures (e.g., income tax, withholding tax, and capital gains tax): - Determination that these do not contain “residency-based” discrimination should follow when enacted within a complying general tax law framework that has an existing tax residency definition meeting international standards. - Otherwise, the country’s whole general income tax system that hinges on that definition would be susceptible to breaching applicable public international law frameworks. - Non-general tax measures (e.g., stamp duty or property tax measures): - A conclusion that these do contain “residency-based” discrimination should follow when distinction between residents and non-residents is based on citizenship, nationality, or immigration status. - Stamp duty measures do not typically use an international standard definition of tax residency because of their different design, policy, collection, and enforcement objectives. - If a non-general tax measure adopts a tax residency concept that meets international standards, it will be treated similarly to general tax measures. ### When tax measures are assessed as CFMs - There is no automatic carve-out for tax measures in CFM assessment. - Tax measures not characterized as “residency-based” can still be CFMs if, on the totality of country-specific circumstances, they are found to be designed to limit capital flows. - This applies to: - General tax measures that, despite complying residency definitions, are designed to limit capital flows. - Non-general tax measures that impose a higher tax rate on non-residents compared to residents, where such tax rate discrimination could point to deliberate design to limit capital flows. - A comprehensive evaluation of the totality of country-specific circumstances surrounding the introduction (or adjustment) of a tax measure is required to determine whether it constitutes a CFM, regardless of stated intent. ### Hybrid and cross-cutting measures: assessment complexities - Hybrid measures (e.g., some property taxes levied at subnational levels) may adopt the complying tax residence concept used in the general tax law. - A tax measure goes beyond international standards where it does not adopt the existing tax residency definition in the general tax law: - In form (e.g., by failing to make a specific cross-reference to the complying general law tax residency definition); or - In substance (e.g., by adopting its own standalone definition that is not reproduced from—or equivalent to—the general tax law definition meeting international standards). - Practical assessment question proposed: “If the particular non-general tax measure being assessed under the IV was within the scope of tax treaties, would it breach the Non-Discrimination Article?” If the answer is “no”, then there is unlikely to be “residency-based” discrimination under international standards of taxation. ### Illustrative example - The Canadian provincial speculation and vacancy tax (SVT) in British Columbia: - Introduced the specific concept of “untaxed worldwide earner” (based on tax residency for general tax purposes) to ensure the tax residency feature overrode any pure immigration-based discrimination. - It was assessed as “other” CFM because, based on the totality of circumstances, it was considered to be designed to limit capital flows, but it was not assessed to be a “residency-based” CFM. ### International treaty reference - Article 24 of both the OECD and UN Model Tax Conventions prohibits discrimination based on nationality but does not apply where a different tax treatment results from acceptable tax residency concepts. _Annex VI. 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