## Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework—Supplementary Information (_031111)

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### Role of supply-side factors
- Supply-side factors, including advanced economy monetary policies and global risk aversion, can have important consequences for capital flows to emerging market countries (EMs).
- Empirical finding cited: a 50 basis point fall in the yield on the 10-year US Treasury bond is estimated to be associated with a 13 percent increase in gross inflows in EMs.
- The estimated relationship explains only part of the observed variation in capital flows and the effect would depend on global economic conditions.
- The role of supply-side factors is highlighted in other recent Board papers, including Understanding Financial Interconnectedness and The Fund’s Role Regarding Cross-Border Capital Flows, as well as the April 2010 GFSR.
- Further discussion will be provided in the forthcoming WEO and GFSR.
- Ongoing and planned staff work related to sources of global capital flows and policy implications includes:
  - Chapter 4 of the forthcoming Spring WEO, which discusses the extent to which policies in advanced countries influence capital inflows to EMs;
  - Spillovers reports on the five most systemic economies, in particular the one on the United States, which will examine the impact of QE2 on capital flows to EMs;
  - Work on macroprudential policy frameworks (beyond the forthcoming Board paper on Macroprudential Policy: An Organizing Framework) and multilateral aspects of policies related to capital flows to support CFMs;
  - Work on global liquidity—how to measure it and assess its adequacy.
- Timing note: With the exception of the Spring WEO chapter (already issued), this work is expected to come on stream between the Spring Meetings and the Fall.

### Nature of the proposed framework for CFMs
- Purpose: to highlight circumstances under which it would be appropriate to deploy capital flow management measures (CFMs); not intended to prescribe a predetermined sequence of policy instruments.
- Core principle: so long as appropriate macroeconomic policies are in place, it is reasonable for recipient countries to deploy CFMs where inflows give rise to significant economic or financial stability concerns.
- Framework role: to identify a general preference among a menu of possible measures, with due regard to country-specific factors, rather than endorsing a particular sequence of measures.
- Residency-based CFMs:
  - The proposed framework recognizes a Fund preference against residency-based CFMs from a multilateral perspective because they directly discriminate against nonresidents and run counter to international cooperative spirit.
  - Residency-based CFMs are more likely to have multilateral effects or lead to proliferation of such measures.
  - Nonetheless, the framework acknowledges that residency-based CFMs may be appropriate under certain circumstances—for example, where CFMs that target a specific prudential risk may be less effective than those targeting residency, or where a narrowly-targeted residency-based CFM is less distortive than a broad prudential measure targeting all foreign currency transactions.

### Use of the framework in Fund policy advice
- The framework would provide a basis for policy advice to members facing capital inflows and was motivated by numerous members coping with large capital inflows.
- Application contexts:
  - Article IV consultation discussions where a clear analytical framework is needed to weigh alternative policies to manage inflows.
  - Public support for members appropriately using CFMs, while explaining the basis for such support.
- Institutional considerations:
  - Board endorsement of the framework would facilitate provision of policy advice to members managing large inflows, including in the context of Article IV surveillance.
  - It is not proposed or contemplated that the policy framework would provide guidance on the scope of members’ obligations under Article IV at this stage.
  - If there is broad support, consideration could be given to using the framework for such purposes at a later stage, for example when similar frameworks on other aspects of capital flows have been provided.
- Objective: to help achieve consistency and evenhandedness in Fund policy advice to countries in similar circumstances and to avoid ad hoc advice that would undermine the Fund’s credibility.
- Flexibility: the framework is intended to be sufficiently flexible to give due regard to country-specific considerations in its application.

*Prepared by the Strategy, Policy, and Review Department; Approved by Reza Moghadam; March 11, 2011.*

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