## _111412 ## Source details **Canonical URL:** [_111412](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_111412.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_111412.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_111412.pdf.json) --- ### Executive summary — main findings and framing - Capital flows have increased significantly in recent years and are a key aspect of the global monetary system. - Capital flows offer potential benefits, including enhancing efficiency, promoting financial sector competitiveness, and facilitating greater productive investment and consumption smoothing. - Capital flows carry risks that can be magnified by gaps in countries‘ financial and institutional infrastructure. - Liberalization is generally more beneficial and less risky if countries have reached certain levels or “thresholds” of financial and institutional development; liberalization can also spur development. - Liberalization needs to be well planned, timed, and sequenced; there is no presumption that full liberalization is appropriate for all countries at all times. - Rapid capital inflow surges or disruptive outflows can create policy challenges. ### Appropriate policy responses to capital flow volatility - Policy toolkit and principles: - Macroeconomic policies (monetary, fiscal, exchange rate) and sound financial supervision and regulation play a key role in managing inflow surges and disruptive outflows. - CFMs can be useful in certain circumstances but should not substitute for warranted macroeconomic adjustment. - Policymakers in source and recipient countries should take into account cross-border spillovers; cross-border coordination would help mitigate risks. - Design principles for CFMs: - Transparency, targeting, temporariness, and, where possible, non-discrimination; prefer the least discriminatory effective measure. - CFMs should be scaled back when inflow pressures abate to minimize distortions and moral hazard. - CFMs are more effective when part of a broader policy package and when enforcement minimizes circumvention. ### The Fund’s proposed institutional view and role - Purpose and scope: - Provide clear and consistent advice on capital flows and related policies; draw on earlier Fund policy papers, analytical work, and Board discussions. - Clarifies trade-offs among policy options, harnesses benefits of capital mobility, and addresses multilateral implications of capital flow management. - Will guide Fund advice to members and, where relevant, Fund assessments in surveillance. - Legal and operational limits: - The proposed view does not alter members‘ rights and obligations under the Articles of Agreement or other international agreements. - The institutional view is a basis for policy advice when requested; it is legally distinct from surveillance and does not impose obligations. - CFMs consistent with the institutional view would not be considered measures “requested” by the Fund under Article VI, Section 1; the view does not alter Fund jurisdiction under Article VIII, Sections 2(a) and 3. - Implementation next steps: - The view is intended to be flexible and updated with new experience and evidence. - In coming months, Fund staff would prepare a guidance note on the liberalization and management of capital flows on the basis of the proposed institutional view. - Use in surveillance and financing: - Bilateral surveillance: the institutional view would not be systematically used to assess compliance with Article IV, Section 1; the ISD requires capital flows be included in analysis where relevant. - Multilateral surveillance: spillovers that significantly influence the IMS would be discussed; the Fund may recommend alternatives informed by the institutional view but members are not obligated to follow recommendations. - Financing role: the institutional view would have no mandatory implications for the Fund’s financing role. ### Global trend, measurement, and preconditions for benefits - Global trend and measurement: - Recent decades show a gradual trend toward liberalization of inward and outward capital flows; trend pronounced in emerging Europe and among some systemically important emerging economies. - De jure index: staff estimates of restricted transaction categories ratio (AREAER); index ranges 0 to 1, a decrease indicates greater openness. - De facto index: staff-updated Milesi-Ferretti index; sum of gross stocks of foreign assets and liabilities as a ratio of group GDP; an increase indicates greater openness. - Data for 2005 onward are affected by methodological changes implemented in 2005 harmonizing AREAER and OECD entries. - Preconditions and when benefits are largest: - Benefits largest when countries have achieved certain financial and institutional thresholds. - Necessary capacities include financial systems that mediate flows safely and institutions that bolster balance-sheet resilience. - Supporting policies: sound fiscal, monetary, and exchange rate policies; exchange rate flexibility; greater trade openness. ### Benefits and risks of liberalization - Benefits: - Microeconomic: enhance resource allocation efficiency; promote competitiveness of domestic financial sector; transfer technology and management practices via FDI. - Macroeconomic: fund welfare-enhancing current account imbalances for productive investment or consumption smoothing; enable portfolio diversification. - Empirical evidence: relationship with growth is well documented for FDI and other non-debt flows, including for low-income countries; relationship less clear for debt-creating flows. - Risks: - Magnified when financial and institutional development is insufficient: macroeconomic volatility, crisis vulnerability, incentives for excessive risk-taking, historical association of liberalization with financial crises. - Even advanced, financially open economies faced large risks during the recent global financial crisis due to supervisory and regulatory failures. - Presence of CFMs does not fully eliminate contagion risk. ### Integrated approach and sequencing of liberalization - Integrated approach purpose: harness benefits and manage risks via systematic process consistent with country development. - Stylized phasing (successive and often overlapping): - First: liberalization of FDI inflows. - Second: liberalization of FDI outflows and long-term portfolio flows. - Finally: liberalization of short-term portfolio flows. - Supporting reforms required progressively: strengthen prudential regulation and supervision, restructure financial and corporate sectors, revise financial legal framework, improve accounting and statistics, strengthen systemic liquidity arrangements, develop capital markets and pension funds. - Sequencing mnemonic: "long term before short term, FDI (and non-debt) before debt, and inflows before outflows." ### Managing inflow surges — definitions, risks, and policy options - Surge definitions (examples cited): - Net capital inflows exceed the 30th percentile of the historical trend in the country as well as in a cross-country sample (Ghosh et al., 2012). - Net inflows exceed the historical trend by one standard deviation and are larger than 1½ percent of GDP (IMF, 2011d). - Risks from surges: - Overwhelm domestic markets, asset price volatility and bubbles, rapid exchange rate appreciation, credit booms, distorted money markets, balance-sheet vulnerabilities, potential sudden stops or reversals. - Policy options and examples: - Macroeconomic policies: lowering interest rates if no overheating (Turkey example); foreign exchange intervention (Japan, Switzerland); currency appreciation (South Africa). - Combined approaches with CFMs and prudential measures: Brazil’s tax on certain inflows; Indonesia’s holding period on central bank bond purchases; Korea’s leverage caps on banks’ derivatives positions. - When CFMs can be useful: - Limited room for macro policy adjustment, time lags for policy effects, or when inflows raise systemic financial risks. - CFMs should accompany macroeconomic adjustment and financial regulation; avoid diverting flows in ways that exacerbate vulnerabilities. - Limits and cautions: - CFMs should not substitute for necessary macroeconomic adjustment or be used to influence exchange rates for unfair competitive advantage. - Effectiveness may be limited without adequate macro policy adjustment; efficacy can erode over time due to circumvention. ### CFMs and MPMs: overlap, exit, and examples - Overlap: - A measure can function as both an MPM and a CFM when it limits inflows and addresses systemic financial risks. - Key principles: do not substitute for macroeconomic adjustment; use instruments that are effective and least distortive; seek even-handed treatment of residents and nonresidents. - Exit considerations: - Lift CFMs/MPMs when inflows are no longer unduly large or volatile; assess usefulness relative to costs; some prudential measures may remain for systemic-risk management. - If liberalization outpaced capacity, further reforms may be needed before lifting measures. - Examples: - Brazil adjusted the IOF tax rate after inflows slowed in 2011. - Korea kept measures introduced in response to the 2010 surge for macro-prudential reasons after inflows abated. ### Managing disruptive outflows - Risks and drivers: - Large, sustained, or sudden outflows can lead to reserve depletion, currency collapse, financial stress, and output losses. - Drivers include domestic imbalances and international factors (global risk appetite, liquidity, interest rates), and contagion. - Typical policy approach: - Handle outflows primarily with macroeconomic, structural, and financial policies; CFMs on outflows have a temporary crisis role when a crisis is imminent or when other policies cannot respond effectively. - Design and implementation principles: - CFMs should form part of a broader policy package, be temporary, avoid causing external payment arrears or default, and prefer non-discriminatory measures where feasible. - Historical experience and effectiveness: - Few countries tightened outflow CFMs as crisis responses over the past decade (examples: Argentina, Iceland, Ukraine); Iceland’s controls appear to have been effective in its context. - Outflow CFMs are more likely effective if accompanied by sound macro policy, comprehensive design and enforcement, and ongoing adjustment to prevent circumvention. - General criteria for lifting outflow CFMs: - Restoration of macroeconomic stability, regained confidence in domestic assets, resumed access to international capital markets, and foreign reserves climbing above critical levels. ### Push factors, source-country responsibilities, and global liquidity - Push factors: - Advanced-economy monetary and prudential policies, and global risk appetite, materially influence both the volume and riskiness of flows. - Increased role of large cross-border financial intermediaries and liquidity-creating instruments changed monetary policy and market liquidity relationships. - Since the crisis, advanced-country central banks injected substantial official liquidity as market-generated liquidity declined. - Official flows and reserves: - Reserve accumulation and foreign asset purchases have become increasingly important; reserve accumulation can limit adjustment to global imbalances and unduly influence government securities markets. - Policy recommendations for source countries: - Consider measures to address macroeconomic and financial stability risks associated with cross-border activities of institutions in their jurisdictions. - Continue progress on capital, liquidity, supervisory standards; monitor systemic nonbank financial institutions; advance recovery and resolution planning for large institutions. - Progress note: - As of end-May 2012, 20 of 27 Basel Committee members had implemented Basel rules related to strengthening capital charges and issued drafts or final Basel III regulations. ### Multilateral aspects, coordination, and data initiatives - Coordination: - Cross-border policy coordination between source and recipient countries can mitigate spillovers and achieve more efficient global outcomes; recipient countries should moderate CFMs that produce costly spillovers. - Cross-border cooperation on resolution planning and treatment of global systemically important institutions remains at an early stage. - The European “Vienna Initiative” provides lessons on cross-border collaboration. - Macroprudential frameworks: - Macroprudential perspective and coordination help assess and address cross-border systemic risks; collaboration can narrow data gaps and improve multilateral awareness. - Stronger global and regional financial safety nets could reduce the need for CFMs by providing temporary liquidity and reducing contagion concerns. - Data initiatives: - Joint IMF–FSB work identified data gaps that masked vulnerabilities before the crisis. - New standards including BPM6 expand reporting (cross-border nonbank activities, currency composition, remaining maturity of debt); remaining gaps include timeliness, gross balance sheet positions, and country coverage. - G-20 Data Gaps Initiative underpins surveillance enhancements, including CPIS frequency, timeliness, scope, and quarterly international investment position data based on BPM6. ### Institutional View — Box 3: key elements (summary) - Capital flow liberalization: - CFMs are measures specifically designed to limit capital flows; liberalization is removal of CFMs. - Countries better benefit from liberalization after achieving financial and institutional thresholds; no presumption that full liberalization is appropriate for all countries at all times. - Liberalization must be planned, timed, and sequenced consistent with institutional and financial development (integrated approach). - Managing capital flows: - Sound macroeconomic policies, financial market deepening, stronger regulation and supervision, and institutional capacity are essential. - CFMs should not substitute for macroeconomic adjustment; when used, they should avoid residency discrimination when possible and be the least discriminatory effective measure. - Policy advice on CFMs mainly applies to CFMs introduced to previously open portions of the capital account. - Source countries should internalize spillovers; members hosting global systemically important institutions play an important role. - Cross-border coordination would help harness benefits and mitigate risks. ### G20 coherent conclusions and terminology (Annex I & II highlights) - G20 conclusions emphasize that: - CFMs overlap with MPMs; CFMs can complement but not substitute for macroeconomic, exchange rate, reserve management, and prudential policies. - No one-size-fits-all approach; country-specific circumstances matter. - CFMs should be countercyclical, transparent, targeted, regularly reviewed, and reversible as pressures abate. - Strengthening domestic financial sectors and macroprudential frameworks is important. - Push and pull factors both matter; reserve currency issuers bear special responsibility given their impact on global liquidity. - There is no obligation to capital account liberalization under the IMF’s legal framework. - Terminology (Annex II): - CFMs comprise residency-based CFMs (capital controls) and other CFMs that do not discriminate by residency but are designed to limit flows (including some prudential measures differentiating by currency and measures such as minimum holding periods). - Measures not designed to limit capital flows (e.g., standard prudential requirements, macroeconomic policies) are not CFMs; classification requires judgment based on whether a measure was introduced or intensified in response to inflow surges or disruptive outflows. ### Interactions with other international agreements (Annex III) - Many members have obligations under bilateral and regional agreements that may differ from the Fund’s institutional view in scope or timing. - Possible divergences: - Some agreements may impose broader or accelerated liberalization obligations or unqualified prohibitions on CFMs, limiting policy space recommended under the integrated approach. - Maintenance of residency-based CFMs recognized in the Fund view could conflict with national treatment provisions in other agreements. - Legal status: - The Fund’s institutional view would not and legally could not alter members’ rights and obligations under other international agreements; conformity is determined by those agreements. - Practical implication: CFMs consistent with the Fund’s institutional view could still violate obligations under other international agreements if those agreements lack compatible temporary safeguard provisions. *Source: _111412 — Excerpt from "The Liberalization and Management of Capital Flows" (INTERNATIONAL MONETARY FUND).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Main findings and framing - Capital flows have increased significantly in recent years and are a key aspect of the global monetary system. - Capital flows offer potential benefits to countries, including by enhancing efficiency, promoting financial sector competitiveness, and facilitating greater productive investment and consumption smoothing. - Capital flows also carry risks, which can be magnified by gaps in countries‘ financial and institutional infrastructure. - Capital flow liberalization is generally more beneficial and less risky if countries have reached certain levels or ―thresholds‖ of financial and institutional development. In turn, liberalization can spur financial and institutional development. - Liberalization needs to be well planned, timed, and sequenced to ensure that its benefits outweigh the costs, as it could have significant domestic and multilateral effects. - There is no presumption that full liberalization is an appropriate goal for all countries at all times. - Rapid capital inflow surges or disruptive outflows can create policy challenges. ### Appropriate policy responses to capital flow volatility - Appropriate policy responses comprise a range of measures and involve both recipient countries and source countries. - For countries managing macroeconomic and financial stability risks associated with inflow surges or disruptive outflows, a key role needs to be played by macroeconomic policies, including monetary, fiscal, and exchange rate management, as well as by sound financial supervision and regulation and strong institutions. - In certain circumstances, capital flow management measures (CFMs) can be useful. They should not, however, substitute for warranted macroeconomic adjustment. - Policymakers in all countries, including countries that generate large capital flows, should take into account how their policies may affect global economic and financial stability. - Cross-border coordination of policies would help to mitigate the riskiness of capital flows. ### The Fund’s proposed institutional view and its role - The Fund needs to be in a position to provide clear and consistent advice with respect to capital flows and policies related to them. - In 2011, the International Monetary and Financial Committee (IMFC) called for ―further work on a comprehensive, flexible, and balanced approach for the management of capital flows.‖ - This paper proposes an institutional view to underpin that approach, drawing on earlier Fund policy papers, analytical work, and Board discussions on capital flows. - The proposed view clarifies the trade-offs between policy options for dealing with capital flows, harnessing the benefits of capital mobility, and addressing the implications of capital flow management for global economic and financial stability. - The proposed view will guide Fund advice to members and, where relevant, Fund assessments in the context of surveillance. - The proposed view does not alter members‘ rights and obligations as this would require an amendment of the Articles of Agreement. Members‘ rights and obligations under other international agreements also remain unaffected. - The Fund is well-placed to provide relevant advice and assessments to its members in close cooperation with country authorities and other international organizations. ### Implementation and next steps - The proposed institutional view builds on previous Fund policy papers, research, and Board discussions, and strengthens consideration of issues such as the role of source countries and the relationship between policies related to capital flows and macro-prudential measures. - The view is intended to be flexible and to incorporate new experience, analysis, and empirical evidence going forward. - In coming months, Fund staff would prepare a guidance note on the liberalization and management of capital flows on the basis of the proposed institutional view. November 14, 2012 *THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS INTERNATIONAL MONETARY FUND* ### 12. In recent decades, there has been a gradual trend toward liberalization of capital ### _111412 - 12. In recent decades, there has been a gradual trend toward liberalization of capital ### Global trend and recent patterns - In recent decades, there has been a gradual trend toward liberalization of capital flows, both inward and outward, among member countries (Figure 1). - The trend has been particularly pronounced in emerging Europe; systemically important emerging economies (including, for example, China and India) have also announced plans for further liberalization. - The pace of liberalization moderated slightly in the wake of the global crisis, but the general trend across the world remains one of increasing openness to cross-border capital flows. - Where authorities have intervened to influence capital flows, they have generally done so not by re-regulating permanently significant parts of the capital account but by targeting temporarily specific types of flows. ### Costs and drawbacks of capital flow management measures (CFMs) - CFMs can impose costs: - reduce discipline in financial markets and public finances, - tighten financing constraints by restricting availability of foreign capital, - limit residents‘ options for diversifying their assets. - CFMs can also be costly to monitor and enforce, promote rent-seeking behavior and corruption, and facilitate repression of the financial sector, impeding financial development and distorting the allocation of capital. ### Benefits of capital flow liberalization - Microeconomic benefits: - enhance the efficiency of resource allocation and the competitiveness of the domestic financial sector; - transfer technology and management practices, particularly through foreign direct investment (FDI). - Macroeconomic benefits: - enable countries to fund welfare-enhancing current account imbalances (for example, for productive investment or consumption smoothing); - enable beneficial portfolio diversification. - Empirical evidence: - relationship between capital flows and growth is well documented for FDI and other non-debt flows, including for low-income countries; - relationship is less clear cut for debt-creating flows. ### Measurement note (Figure 1 indices) - De jure index: - based on staff estimates of the average ratio of the number of restricted transaction categories in the capital account to the total number of transaction categories for which information is available in the AREAER; - index ranges from 0 to 1, and a decrease in the index indicates greater openness. - De facto index: - based on the staff-updated Milesi-Ferretti de facto openness index; - it is the sum of gross stocks of foreign assets and liabilities for each country in the group as a ratio of the group's total GDP; - an increase in the de facto index thus indicates greater openness. - Data for 2005 onward are affected by methodological changes implemented in 2005 that harmonized the AREAER capital control entries and the OECD Code of Liberalization of Capital Movements. ### Preconditions and when benefits are largest - Benefits of capital flow liberalization are largest when countries have achieved certain levels of financial and institutional development. - Necessary capacities include: - financial systems able to mediate flows safely, allow firms to access capital for productive investment, and give households and firms the ability to diversify portfolios while managing risks; - institutions that bolster the resilience of financial, corporate, and household balance sheets. - Supporting policies and conditions: - sound fiscal, monetary, and exchange rate policies; - exchange rate flexibility can help cushion the real economy against capital flow volatility; - greater trade openness can support liberalization by raising ability to attract foreign capital and supplementing domestic demand with external demand. ### Risks and empirical experience - Risks magnified when countries lack sufficient financial and institutional development: - heightened macroeconomic volatility and vulnerability to crises; - incentives for financial institutions to take excessive risks in absence of adequate financial regulation and supervision; - historically, capital flow liberalization has often been followed by financial crises. - Even financially open and advanced economies faced large risks during the recent global financial crisis: - failures in financial supervision and regulation allowed unsustainable asset bubbles and booms partly fueled by cheap external financing. - Presence of CFMs does not fully eliminate contagion risk; re-imposition of CFMs has coincided with contagion in some cases. ### No presumption of full liberalization for all countries - Degree of liberalization appropriate for a country depends on specific circumstances, notably financial and institutional development. - Careful liberalization can provide significant benefits and countries could make progress toward greater liberalization before reaching all thresholds for development, but liberalization needs to be managed cautiously if thresholds are not met. - Exceeding key thresholds does not eliminate risks associated with capital flows. ### The integrated approach to capital flow liberalization - Purpose: harness benefits while managing risks via a systematic process and pace consistent with each country’s institutional and financial development. - Key elements: - removal of CFMs timed and sequenced taking into account other policies and conditions, notably macroeconomic and financial sector prudential policies. - path toward and extent of liberalization tailored to country circumstances; liberalization could take advantage of periods of lower external vulnerability. - Stylized phasing (successive and often overlapping): - first, liberalization of FDI inflows (more stable and correlated with growth); - second, liberalization of FDI outflows and long-term portfolio flows; - finally, liberalization of short-term portfolio flows. - Supporting reforms required progressively deeper and broader changes to legal, accounting, financial, and corporate frameworks: - strengthen prudential regulation and supervision, and risk management; - restructure financial and corporate sectors; - revise financial legal framework; - improve accounting and statistics; - strengthen systemic liquidity arrangements and related monetary and exchange operations; - develop capital markets, including pension funds. - Summary sequencing mnemonic: "long term before short term, FDI (and non-debt) before debt, and inflows before outflows." ### Temporary re-imposition of CFMs and policy guidance - Temporary re-imposition of CFMs under certain circumstances is consistent with an overall strategy of liberalization. - Appropriate when a country faces an inflow surge or an outflow crisis to manage risks associated with volatility. - Such use of CFMs should generally be limited and temporary to avoid: - moral hazard; - undermining market discipline by weakening financial institutions‘ incentives to develop proper risk management; - adversely affecting investor confidence (damage is not inevitable if policy basis is well communicated and widely understood). - If liberalization has outpaced the capacity to safely handle resulting flows, re-imposition of CFMs may be warranted until sufficient progress on macroeconomic, financial, and governance policies has been achieved. ### Country experiences and lessons - Countries that mirrored the integrated approach generally withstood external shocks better during and after liberalization: - Korea: sequence of financial reforms against sound macroeconomic policies led to high degree of financial integration; experienced bouts of capital flow volatility and rollover difficulties during the global financial crisis owing to substantial foreign-currency short-term debt accumulation. - Nordic countries: strong legal institutions, bankruptcy procedures, and macroeconomic policy transparency helped restore growth relatively quickly after 1990s financial crises. - Most countries only partly followed the integrated approach, which contributed to adverse outcomes in some cases. - Although many countries sequenced lifting of CFMs appropriately over the past decade, liberalization was not always supported by financial sector and macroeconomic policies. *THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS INTERNATIONAL MONETARY FUND* ### 25. A range of policies is needed to reap the benefits of more open capital flows while ### 25. A range of policies is needed to reap the benefits of more open capital flows while ### Overview - Strengthening and deepening financial markets, and improving countries‘ institutional capacity, would help improve their ability to handle capital flows. - Capital flows, both inward and outward, generally warrant adjustments in macroeconomic variables, including the real exchange rate, and policies need to facilitate these adjustments. - Volatile capital flows can give rise to macroeconomic and financial stability risks; the appropriate combination of policies depends on country circumstances and includes macroeconomic and financial policies. - Capital flow measures (CFMs) are part of the toolkit and may be appropriate under certain conditions, but they should not substitute for warranted macroeconomic adjustment. - When capital flows contribute to systemic financial risks, CFMs in combination with macro-prudential measures (MPMs) can help safeguard financial stability, although their costs must be considered. ### Push and pull factors - Policies in source countries matter because flows are influenced by both push and pull factors. - Push factors include monetary and prudential policies in systemically large economies and global risk appetite. - Pull factors include institutions, policies, and macroeconomic fundamentals, including growth prospects, in recipient countries. - Empirical findings summarized: push factors influence whether inflow surges occur and the riskiness of flows, while pull factors determine the direction and magnitude of such surges (Ghosh et al., 2012). ### Inflows: benefits and absorptive capacity - Inflows can: - Supplement domestic saving to finance domestic investment. - Entail technological spillovers (particularly through green-field FDI). - Expand trade finance. - Structural reforms to better absorb inflows include: - Deepening domestic bond and equity markets. - Developing financial products in a safe manner. - Strengthening financial regulation and supervision while streamlining rigidities. - Infrastructure investment requires long-term and large scale funds that non-resident investment can help supplement; well-developed and integrated local bond markets can facilitate raising and intermediating such resources. - Deeper capital markets increase absorptive capacity and reduce volatility from inflow surges (e.g., Burger and Warnock, 2006). ### Risks from surges of inflows - Surges of inflows can: - Overwhelm domestic financial markets and stretch macroeconomic policy capacity. - Lead to asset price volatility and bubbles, rapid exchange rate appreciation, credit booms, and unsustainable drops in risk premia. - Distort money markets and disrupt monetary policy transmission. - Lead to a build-up in balance sheet and other vulnerabilities and be followed by sudden stops or reversals. - For the analysis in this paper, a "surge" is broadly defined as rapid capital inflows beyond historical trends. Examples of specific operational definitions cited: - Net capital inflows to a country exceed the 30th percentile of the historical trend in the country as well as in a cross-country sample (Ghosh et al., 2012). - A surge is identified as a period when net inflows exceed the historical trend by one standard deviation and are larger than 1½ percent of GDP (IMF, 2011d). ### Policy options for responding to capital inflow surges - Countries have used a variety of responses: - Macroeconomic policies: maintenance of a low policy rate in Turkey; foreign exchange market intervention in Japan and Switzerland; currency appreciation in South Africa. - Macroeconomic policies combined with CFMs and prudential measures: Brazil‘s tax on certain types of inflows; Indonesia‘s holding period on central bank bond purchases; Korea‘s leverage caps on banks‘ derivatives positions. - Appropriate macroeconomic responses include: - Lowering interest rates in the absence of overheating or asset price inflation; if scope for monetary easing is limited, fiscal tightening would reduce the interest differential between domestic and foreign assets. - Allowing the currency to strengthen if it is not overvalued relative to fundamentals; temporary overshooting relative to fundamentals may be warranted given faster adjustment in foreign exchange markets relative to goods markets. - Intervening in the foreign exchange market to accumulate international reserves if reserves are not more than adequate; but when reserves are already relatively high, intervention costs such as sterilization costs and valuation losses on foreign assets can outweigh benefits. Heavy intervention during sustained inflows can exacerbate inflows by fueling expectations of further appreciation. ### When CFMs can be useful - CFMs can be useful to support macroeconomic adjustment and safeguard financial stability in certain circumstances: - When room for adjusting macroeconomic policies is limited (e.g., economy overheating, exchange rate overvalued, reserve accumulation inappropriate or unduly costly). - When needed policy steps require time to take effect (e.g., fiscal policy implementation lags, weak monetary transmission); CFMs can be temporarily useful while adjustments occur. - When an inflow surge raises risks of financial system instability; systemic financial risks unrelated to capital flows are better addressed by MPMs, but if inflows contribute to systemic risk, MPMs designed to limit inflows (and therefore also CFMs) may be useful provided they accompany needed macroeconomic adjustment and financial sector regulation and do not divert flows in ways that exacerbate vulnerabilities. ### Limits and cautions on the use of CFMs - CFMs should not substitute for macroeconomic policies needed for warranted external adjustment, domestic macroeconomic stability, and effective operation of the international monetary system; using CFMs to influence exchange rates for unfair competitive advantage would be inappropriate and could be inconsistent with exchange rate obligations under Article IV. - In most cases there will be a need and room to adjust macroeconomic and structural policies; only rarely would CFMs be the sole warranted policy response. - CFMs‘ effectiveness may be limited if not accompanied by needed macroeconomic adjustment; some measures implemented in response to the 2009-2010 surge reduced external vulnerabilities but were insufficient to achieve external adjustment or significantly influence capital flows, in part owing to insufficient exchange rate adjustment. - Efficacy of measures can erode over time due to incentives for circumvention despite efforts to close loopholes. ### Design and implementation principles for CFMs - CFMs should be: - Transparent and targeted: - Communicate policy objectives and specific CFMs to avoid unduly disrupting market and public expectations. - CFMs that address sources of instability directly may be least costly and most effective; broader measures suit overall macroeconomic concerns. - Evaluate trade-offs among scope, cost, and effectiveness in a country-specific context. - Temporary: - Scale back CFMs when capital inflow pressures abate to minimize distortions. - Certain residency- or nationality-based measures may be maintained longer if imposed for reasons other than balance of payments (such as financial stability), and where no less discriminatory effective measure exists. - Non-discriminatory where possible: - Prefer measures that do not discriminate between residents and non-residents and choose the least discriminatory effective measure. - When non-discrimination renders the policy ineffective, residency-based measures may be justified. - Preference for non-discrimination reflects standards of fairness and equal treatment expected of Fund members and aligns with the Fund‘s mandate regarding transactions between residents and non-residents. ### CFMs and MPMs: overlap and exit considerations - When inflow surges contribute to both macroeconomic and systemic financial risks, the approach should draw on both the institutional view on capital flows and the MPM toolkit. - A particular measure may be both an MPM and a CFM when it is designed to limit capital inflows and address systemic financial risks. - Key principles: (i) avoid using CFMs/MPMs as substitutes for necessary macroeconomic adjustment; (ii) use instruments that are most effective, efficient, direct, and least distortive; (iii) seek to treat residents and nonresidents even-handedly. - Exit from CFMs/MPMs: - When inflows are no longer unduly large or volatile, CFMs may impose unnecessary costs or be ineffective. - Some prudential measures may remain useful after a surge on grounds of managing systemic risk; ongoing evaluation of usefulness relative to costs is required. - Assess whether alternative ways exist to address prudential concerns that are not designed to limit capital flows. - If liberalization has outpaced an economy‘s capacity to safely handle flows, further reforms to improve institutional and financial development may be required before CFMs can safely be lifted. - Examples of exit adjustments: - In Brazil, the IOF tax rate on inflows was adjusted after inflows slowed in 2011. - In Korea, measures introduced in response to the surge in 2010 were kept in place on macro-prudential grounds even after inflows abated. *Source: _111412 - 25. A range of policies is needed to reap the benefits of more open capital flows while* ### 36. In general, policy options for managing inflow surges depend upon country-specific ### _111412 - 36. In general, policy options for managing inflow surges depend upon country-specific ### Policy options for managing inflow surges (paras 36–37) - Policy choices depend on country-specific factors that determine feasibility and effectiveness. - Larger economies with more developed financial markets may find foreign exchange intervention or administrative controls ineffective. - International obligations (for example, within the EU where full capital mobility is generally required) constrain available options. - All policy options involve costs and trade-offs: - Exchange market intervention and CFMs can “over-smooth” volatility, creating incentives for one-way bets and stifling market development. - Keeping interest rates too low for too long can create overheating pressures or asset bubbles. - Sustained intervention can add to sterilization costs that weaken central bank capital. - CFMs can generate negative market reactions if costly for investors or misconstrued, affecting future willingness to invest. - CFMs can lead to distortions, divert flows to particular segments of the economy, create new vulnerabilities, and entail administrative costs. - Guiding principle: use each policy only to the extent that benefits outweigh costs. ### Push factors and the role of source-country policies (paras 38–41) - Push factors from advanced economies have been well documented contributors to capital flows. - Funds originating in advanced economies dominate capital flows to large emerging economies. - Advanced-economy policies (monetary policy, financial supervision and regulation) influence both the volume and riskiness of cross-border capital flows. - Developments over the last two decades expanded the role of large cross-border financial intermediaries and liquidity-creating instruments. - Increased use of collateralized capital market funding changed the relationship between monetary policy and market liquidity. - In the run-up to the crisis this contributed to an endogenous expansion in global liquidity generated by both official and private sectors. - Since the onset of the crisis, advanced country central banks have injected substantial official liquidity as market-generated liquidity declined. - Official flows (reserve accumulation by central banks and foreign asset purchases by governments, including sovereign wealth funds) have become increasingly important, even as a majority of emerging economies still have negative net international investment positions and remain net debtors. - Reserve accumulation can: - Reflect intervention policies that limit adjustment to global imbalances and contribute to inefficient global allocation of saving and investment. - Unduly influence prices in government securities markets because reserve holdings largely comprise government securities issued by a small number of reserve currency issuers. - Policy recommendation: countries should consider measures to address macroeconomic and financial stability risks associated with cross-border activities of markets and institutions in their jurisdictions. - National and international regulatory and supervisory reforms are underway; completion of key aspects is important for mitigating cross-border risks. - Progress note: as of end-May 2012, 20 of 27 members of the Basel Committee on Banking Supervision had implemented Basel rules related to strengthening capital charges and issued drafts or final Basel III regulations. - Further reform priorities to reduce flow riskiness: - Further progress on capital, liquidity, and supervisory standards. - Consideration of restrictions on business models. - Careful monitoring of systemic nonbank financial institutions (shadow banking). - Progress on recovery and resolution planning for large institutions, including cross-border resolution. - Members hosting global systemically important financial institutions should play a role. ### Managing capital outflows (paras 42–51) - Large, sustained, or sudden capital outflows can pose significant policy challenges and, in extreme cases, lead to reserve depletion, currency collapse, financial system stress, and output losses. - Drivers of disruptive outflows include domestic factors and international factors (global risk appetite, liquidity, interest rates, global growth) and contagion through trade, financial linkages, and investor confidence. - Policy emphasis: build economic and financial resilience through macroeconomic, structural, and MPMs to increase resilience to capital flow volatility. - Sound macroeconomic policy reduces likelihood of large flow imbalances and heavy dependence on foreign financing. - Large stock imbalances can exacerbate balance-sheet vulnerabilities and raise crisis risks (evidence from CEE and southern European countries preceding the global crisis). - Typical policy approach: - Outflows should usually be handled primarily with macroeconomic, structural, and financial policies. - Example: Korea, Russia, and South Africa adjusted macroeconomic and financial sector policies during 2009–2011 when outflows occurred without immediate threat of crisis. - Role for outflow CFMs: - In crisis situations, or when a crisis may be imminent, there could be a temporary role for CFMs on outflows to prevent free-fall of the exchange rate and depletion of reserves. - CFMs may be desirable if they can help prevent a full-blown crisis when shocks are large relative to the ability of other policies to respond or when shock size/duration is highly uncertain. - Design and implementation principles for outflow CFMs: - CFMs should be part of a broader policy package including macroeconomic, financial sector, and structural adjustment; they are not substitutes for policy adjustment. - CFMs can provide breathing space while other policies are implemented. - CFMs should avoid causing external payment arrears or default, particularly on sovereign debt. - Fairness and international monetary system considerations suggest giving precedence to outflow CFMs that do not discriminate on the basis of residency; prefer the least discriminatory effective measure. - Residency-based measures may be hard to avoid in crisis situations; CFMs should be implemented transparently. - Crisis identification and monitoring: - Disruptive outflows are usually associated with currency, sovereign debt, and banking/financial crises and characterized by corporate and financial distress, depressed asset prices, sharply higher interest rates, significant exchange rate depreciation, and lower output. - The Fund uses models, indicators, market intelligence, and staff judgment assembled into early warning and vulnerability exercises to monitor crisis risks. - A global financial and economic stress indicator identifies periods of severe stress and contagion across countries and maps historical periods of systemic stress relatively well. - Historical experience with outflow CFMs: - Only a few countries tightened CFMs on outflows as part of crisis responses over the past decade, mainly Argentina (2001–2002 and since 2011), Iceland (2008), and Ukraine (2008). - Large outflows in these cases were driven mainly by unsustainable macroeconomic policies (Argentina), banking sector collapse (Iceland), and banking and currency crises deepened by insufficient macroeconomic adjustment (Ukraine). - Russia experienced large outflows early in the recent global financial crisis but did not tighten its CFMs. - Among countries implementing broad-based measures, only Iceland’s controls appear to have been effective (noting small country size and highly restrictive nature of measures). - Types of outflow CFMs: - Residency-based measures: limits on residents’ investments and transfers abroad (Iceland); waiting periods for nonresidents to transfer proceeds from domestic securities (Ukraine); minimum holding periods (Chile in the 1990s); taxes on transfer of proceeds (Malaysia). - Non-residency-based measures: prohibitions on conversion and transfer of domestic currency assets (Iceland); limits on deposit withdrawals (Argentina). - Restrictions on nonresidents’ access to funding in local currency can make currency speculation more difficult. - Example nuance: Iceland’s ban on conversion and transfer of domestic currency assets no longer applies to assets acquired post-November 2009 financed with foreign currency exchanged into domestic currency in the onshore market and registered as new investment with the Central Bank. - Effectiveness considerations: - Outflow CFMs are more likely to be effective if they accompany sound macroeconomic policies, are well designed and enforced, are comprehensive, and are adjusted ongoingly to avoid circumvention. - CFMs in response to disruptive outflows should be temporary. - General criteria for lifting outflow CFMs: restoration of macroeconomic stability (exchange rate, debt sustainability, financial stability), regained confidence in domestic assets, resumed access to international capital markets, and foreign reserves climbing above critical levels. ### International coordination (paras 52–53) - Cross-border policy coordination among recipient countries, and between source and recipient countries, can mitigate undesired spillovers and achieve globally efficient outcomes. - If CFMs or other policies amplify risks in other countries and impose costs on those countries, coordination may be desirable so countries partially internalize spillovers. - This may require source countries to better internalize spillovers from their monetary and prudential policies. - Recipient countries should moderate CFM use if measures lead to costly spillovers (such as deflection of flows) to other recipients. - Further work needed on policy coordination in the financial sector: - Progress on financial regulation and supervision reforms would contribute to more robust infrastructure for intermediating capital flows. - Cross-border cooperation on resolution plans and treatment of global systemically important financial institutions remains at an early stage; many jurisdictions need to address supervisory weaknesses. - The European Coordination “Vienna Initiative” is an important multilateral and public-private effort to guard against disorderly deleveraging in Central and Eastern Europe and may provide lessons on cross-border collaboration and coordination. *International Monetary Fund* ### 54. The design and implementation of new MPM frameworks in member countries will ### 54. The design and implementation of new MPM frameworks in member countries will ### Multilateral aspects of capital flows and macroprudential frameworks - Macroprudential perspective helps authorities better assess and address cross border risks, including systemic risks posed by capital flows. - Coordination is important: - Among domestic policymakers. - Between domestic policymakers and foreign macroprudential authorities and international bodies. - Collaboration could: - Narrow data gaps in systemic risk monitoring. - Improve awareness of multilateral effects of country policies with potential systemic consequences. - Cross-border coordination of macroprudential measures may take time as national frameworks are in many cases still in early stages of development. - Capital outflows from a country in crisis or near-crisis can have spillover effects to countries perceived as similar, and contagion could spread via large interconnected institutions or perceptions of global stability implications. - The imposition of outflow CFMs by a country may lead other countries to take similar actions or fuel contagion expectations among market participants. - Stronger global and regional financial safety nets could reduce the need for CFMs by: - Providing temporary liquidity. - Reducing contagion concerns. - Bolstering market confidence. - Examples during the global crises since mid-2007 include actions by groups of central banks, international and regional institutions, and various coordinated efforts. (See footnote 75 for illustrations.) ### IV. ROLE OF THE FUND — Relationship to the Fund’s Mandate (paragraphs 56–63) - Legal asymmetry: - Article VIII, Section 2(a) generally prohibits members from imposing restrictions on the making of payments and transfers for current international transactions unless authorized by the Fund. - Article VI, Section 3 recognizes the right of members to “exercise such controls as are necessary to regulate international capital movements.” - This asymmetry reflects historical emphasis on international trade and negative perceptions of capital flows at Fund establishment. - Members’ right to regulate international capital movements is not unlimited; Article IV introduction qualified rights under Article VI, relating to the stability of the system of exchange rates. - The Fund’s legal framework for surveillance recognizes capital flows’ importance. The Integrated Surveillance Decision (ISD) (Decision No. 15203-(12/72), 07/18/12) reaffirms this importance: - Bilateral surveillance: - The ISD maintains the requirement that the Fund include capital flows in its analysis when evaluating members’ economic policies. - The introduction or substantial modification by a member for balance of payments purposes of restrictions on, or incentives for, inflow or outflow of capital is an indicator that could trigger discussion about observance of guiding principles for economic, financial and exchange rate policies (ISD paragraphs 18 and 22). - Multilateral surveillance: - The ISD reaffirms that arrangements respecting regulation of international capital movements are an element of the IMS and that volatile capital flows may signal its malfunction (ISD paragraphs 9-11). - The Fund will focus on issues affecting the operation of the IMS, including spillovers from individual members’ policies that significantly influence system operation. - Multilateral surveillance imposes no substantive obligations with respect to policies that cause such spillovers, but encourages members to implement exchange rate and domestic economic and financial policies conducive to effective operation of the IMS (ISD paragraph 23). - Fund practice: - Members are increasingly requesting Fund policy advice on capital flow–related policies. - The Fund is asked to provide objective assessments of aims, trade-offs, and multilateral implications, and to identify welfare-enhancing actions that can de-stigmatize such measures. ### Uses of the proposed institutional view (paragraphs 60–63) - Policy Advice: - When requested by a member, the Fund would use the proposed institutional view as basis for policy advice. - This advice is legally distinct from surveillance and does not impose obligations on members. - Benefits: consistency, even-handedness, flexibility, and country-specific considerations. - Bilateral Surveillance: - The institutional view would not be systematically used to assess compliance with Article IV, Section 1. - No expectation that all Article IV consultations include analysis under the institutional view. - If capital flow management policies significantly affect domestic or balance of payments stability, the Fund must assess those policies under the ISD (paragraph 6) and may take the institutional view into account. - Capital flow policies may trigger indicators relevant to observance of the Principles (ISD paragraph 22(iii)(b), 22(iv), 22(vii)). - Multilateral Surveillance: - If spillovers from a member’s policies significantly influence the IMS, these policies would be discussed during Article IV consultations. - The Fund could recommend alternative adjustments informed by the institutional view; members are not obligated to follow recommendations. - Financing Role and Jurisdiction: - The institutional view would have no mandatory implications for the Fund’s financing role. - CFMs maintained consistently with the institutional view would not be considered measures “requested” by the Fund under Article VI, Section 1. - CFMs maintained outside the institutional view would not be measures the Fund could require members to eliminate as a condition for Fund resource use. - The institutional view does not alter Fund jurisdiction or policies under Article VIII, Section 2(a) and 3: - CFMs on outflows that restrict making of payments and transfers for items defined as “payments for current transactions” in Article XXX(d) remain subject to Article VIII jurisdiction and prior approval. - CFMs giving rise to exchange restrictions could lead to non-observance of standard performance criteria under Fund arrangements avoiding new/intensified exchange restrictions. - CFMs giving rise to multiple currency practices (MCPs) remain subject to Fund policies on MCP approval, except MCPs relating solely to capital transactions which the Fund has declined to assert jurisdiction over. ### Data initiatives and surveillance support (paragraph 63) - Ongoing data initiatives will support bilateral and multilateral surveillance. - Joint IMF–FSB work requested by the G-20 has identified data gaps that masked vulnerabilities before the financial crisis. - New standards including BPM6 entail significant new reporting: - Cross-border activities of nonbank financial institutions. - Currency composition of assets and liabilities. - Encouraged reporting of remaining maturity of debt. - Remaining gaps include timeliness, analytical coverage (e.g., gross balance sheet positions), and country coverage. - Reference: G-20 Data Gaps Initiative (Progress Report on the G-20 Data Gaps Initiative: Status, Action Plans, and Timetables) underpins 2011 Triennial Surveillance Review and strengthening of the Fund’s Data Standards Initiative; enhancements include CPIS frequency, timeliness, scope, and quarterly international investment position data based on BPM6. ### Scope for enhanced multilateral coordination and collaboration (paragraphs 64–67) - Institutional view would not alter members’ rights and obligations under other international agreements; conformity continues to be determined by those agreements. - The institutional view could promote a more consistent approach toward treatment of CFMs under other international agreements. - Most current bilateral and regional agreements on capital flow liberalization do not take macroeconomic and financial stability into account and form a patchwork less conducive to IMS stability. - Broad acceptance of the institutional view could foster global dialogue on managing capital flows to support macroeconomic and financial system stability and reduce volatility/distortions from the patchwork of agreements. - The institutional view could help design policy space for CFMs under bilateral and regional agreements: - Signatories and international bodies promoting agreements could take the institutional view into account when designing circumstances for imposing inflow and outflow CFMs. - Sequenced approach to liberalization under the integrated approach could guide pace and sequencing of liberalization obligations and re-imposition of CFMs due to institutional considerations. - Some agreements explicitly defer to Fund Articles (examples referenced in footnote 92). - Strengthening collaboration with other institutions: - The Fund could work with the OECD and other international organizations to coordinate positions on capital flows. - Enhanced collaboration with the FSB is useful given overlaps between prudential and capital account policies; multilateral consultations or Fund-organized working groups could include country representatives. - Areas for collaboration include sharing experiences, assessment of externalities, measurement and monitoring of global liquidity, multilateral dialogue and policy coordination, and structural reforms (see IMF, 2010a). ### Issues for discussion (paragraph 68) - Do Directors: - (i) endorse the proposed institutional view on capital flows and policies related to them, whose key elements are summarized in Box 3, and - (ii) agree that this institutional view should be the basis for Fund advice and, where relevant, assessments on issues of liberalization and management of capital flows? *Source: Excerpt from "The Liberalization and Management of Capital Flows" (IMF). PDF section covering paragraphs 54–68.* ### Box 3. Institutional View on Liberalization and Management of Capital Flows: Key Elements ### Box 3. Institutional View on Liberalization and Management of Capital Flows: Key Elements ### Capital flow liberalization - Capital flow management measures (CFMs) are measures that are specifically designed to limit capital flows (as explained in Annex II). Capital flow liberalization refers to the removal of CFMs. Liberalization does not rule out the maintenance of prudential measures nor the temporary re-imposition of CFMs under certain circumstances, if capital flows pose risks to macroeconomic or financial system stability. - Countries are better placed to benefit from capital flow liberalization if they have achieved certain thresholds of financial and institutional development. Risks can be magnified by gaps in countries‘ financial and institutional development. Even at high levels of financial and institutional development, risks need to be managed carefully. - The degree of liberalization that is appropriate for a country at a given time depends on it specific circumstances, notably its financial and institutional development. Countries with extensive and long-standing CFMs would likely benefit from careful further liberalization in an orderly manner. There is, however, no presumption that full liberalization of capital flows is an appropriate goal for all countries at all times. There is some scope for the long-term maintenance of CFMs provided they are not adopted for balance of payments purposes and that there are no less distortive measures available that are effective. - Capital flow liberalization needs to be well planned, timed, and sequenced, especially in order to ensure that its benefits outweigh the costs, as it could have significant domestic and multilateral effects. The ―integrated approach‖ proposes a systematic approach to liberalization that is consistent with each country‘s institutional and financial development. ### Managing capital flows - Countries can better absorb capital flows and reap their benefits by implementing sound macroeconomic policies, deepening financial markets, strengthening financial regulation and supervision, and improving institutional capacity. - Inflow surges or disruptive outflows can give rise to macroeconomic and financial stability risks. In order to manage these risks, a key role needs to be played by macroeconomic policies, including monetary, fiscal, and exchange rate management, as well as by sound financial supervision and regulation and strong institutions. - CFMs should not be used to substitute for or avoid warranted macroeconomic adjustment. In certain circumstances, introducing CFMs can be useful for supporting macroeconomic policy adjustment and safeguarding financial system stability. CFMs should seek to avoid discrimination based on residency, and the least discriminatory measure that is effective should be preferred. - In practice, policy advice on CFMs in response to managing capital inflow surges or disruptive outflows would mainly apply to CFMs introduced to previously open portions of the capital account. - Policymakers in all countries, including those that generate capital flows, should take into account how their policies affect others. Source countries should better internalize the spillovers from their monetary and prudential policies, because push factors, including changes in global liquidity conditions, also contribute importantly to capital flows, in addition to pull factors. - Spillovers from prudential policies in source countries include the global economic and financial stability risks associated with cross-border activities of institutions in their jurisdictions. Progress with global financial regulatory and supervisory reform will help in this respect, as will reform and implementation of new macroprudential frameworks in member countries. Members with global systemically important financial institutions and systemic nonbank financial institutions in their jurisdictions would play an important role in this effort. - Cross-border coordination of policies would help to better harness the benefits of capital flows, mitigate the multilateral risks, and encourage the implementation of policies that are conducive to the effective operation of the international monetary system. ### For managing inflow surges - The appropriate policy mix depends on a variety of country-specific conditions, including macroeconomic and financial stability, financial development, and institutional capacity. - In certain circumstances, introducing CFMs can be useful, particularly when underlying macroeconomic conditions are highly uncertain, the room for macroeconomic policy adjustment is limited, or appropriate policies take undue time to be effective. - CFMs could also be appropriate to safeguard financial stability when inflow surges contribute to systemic risks in the financial sector. Systemic financial risks that are unrelated to capital flows may be better addressed by macro-prudential measures that are targeted specifically to deal with such challenges. - CFMs should be targeted, transparent, and generally temporary—being lifted once the surge abates, in light of their costs. - When capital inflow surges contribute to both macroeconomic and systemic financial sector risks, a measure that is designed to limit capital inflows in order to address such risks can be both a CFM and an MPM. Some prudential measures can continue to be useful after a surge abates for managing systemic risks. Their usefulness relative to their costs needs to be evaluated on an ongoing basis, including by assessing whether there are alternative ways to address the prudential concerns that are not designed to limit capital flows. ### For responding to disruptive outflows - When responding to disruptive outflows, CFMs should generally be used only in crisis situations or when a crisis is considered to be imminent. - CFMs are more effective when they are implemented as part of a broad policy package that includes sound macroeconomic policies as well as financial regulation. - CFMs should be temporary, being lifted once crisis conditions abate, and may need to be adjusted on an ongoing basis in order to remain effective. ### ANNEX I. G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences (November 3-4, 2011) - Capital flows are a central feature of the international monetary system. A key challenge facing policy makers worldwide, and especially among G20 countries, is how to reap the benefits from financial globalization, while preventing and managing risks that could undermine financial stability and sustainable growth at the national and global level. In order to help address the challenges posed by large and volatile capital flows, G20 members, drawing on countries‘ experiences, have come to the following conclusions, which should be seen as a non-binding contribution to their decision making process regarding capital flow management measures, and not as a limitation of national policy choices. 1. Precise classifications of different policy measures are hard to draw in some instances; in particular there is an overlap between capital flow management measures and macro-prudential policies. For the purposes of these conclusions, capital flow management measures are those designed to influence capital flows and comprise residency-based capital flow management measures, often referred to as capital controls, and other capital flow management measures that do not discriminate on the base of residency but are nonetheless designed to influence flows. The latter category would typically include (a) measures that differentiate transactions on the basis of currency, including a subset of prudential measures, and (b) other measures (e.g. taxes on certain investments) that are typically applied in the non-financial sector. 2. Capital flow management measures may constitute part of a broader approach to protect economies from shocks. In circumstances of high and volatile capital flows, capital flow management measures can complement and be employed alongside, rather than substitute for, appropriate monetary, exchange rate, foreign reserve management and prudential policies. 3. The decision about whether and how to use capital flow management measures should be approached from a practical economic and financial risk management perspective, taking into account that the coordinated use of different policy tools is key for an effective and coherent approach. Sound macroeconomic policies bear the prime responsibility for ensuring overall economic health, and an appropriate structural environment, including effective financial regulation and supervision, is important for financial stability. 4. Capital flow management measures should not be used to avoid or unduly delay necessary adjustments in the economy. In particular, we will move towards more market-determined exchange rate systems, enhancing exchange rate flexibility to reflect underlying economic fundamentals and refraining from competitive devaluation of currencies. 5. There is no one-size-fits-all approach or rigid definition of conditions for the use of capital flow management measures. Country-specific circumstances have to be taken into account when choosing the overall policy approach to deal with capital flows. 6. The size, depth, and level of development of the local financial sector, as well as the institutional and regulatory strength of a country, play a key role in assessing the appropriateness and relative strengths and drawbacks of different policy measures. 7. Recognizing that sudden stops and reversals can undermine financial stability, capital flow management measures should operate in a countercyclical fashion, according to the specific global and domestic macroeconomic and financial stability situation. Capital flow management measures should be transparent, properly communicated, and be targeted to specific risks identified. In order to respond properly to the specific risks identified, capital flow management measures should be regularly reviewed by national or regional authorities as appropriate. In particular, capital controls should be adapted or reversed as destabilizing pressures abate. Capital flow management frameworks need to maintain sufficient flexibility in order to be effective under varying circumstances and challenges, including in order to help prevent circumvention efforts. 8. It is important to further strengthen domestic financial sectors. The development and deepening of local capital and bond markets can help absorb capital flows and deal with their volatility, direct them to productive activities in the real sector, promote growth and development of the local economy, and maintain a financing base in case of international financial turmoil. As a more sophisticated financial market tends to attract capital flows and, thus, can give rise to sudden outflows, it is important that adequate regulation and prudential practices are set up commensurate with financial sector development and a prudent balance with the real sector economy is maintained. An appropriate macro-prudential framework should also be considered. 9. Both push and pull factors, such as global liquidity conditions, long-term growth prospects, and global risk perception, play a role in determining size and composition of capital flows. Any country that has the potential to affect others through its national policy decisions (including, in this particular context, exchange rate management policies, monetary policy in reserve currency issuing countries and regions, regulatory and supervisory policies, and capital flow management measures) should take the potential impact of such spillovers into account when weighing different policy options consistent with national macroeconomic frameworks. These policies should be the object of regular, credible and even-handed multilateral surveillance to assess both their individual impact and aggregate spillover effects. 10. The macroeconomic policies of reserve currency issuers can have a central impact on global liquidity and, therefore, on capital flows. Those countries bear a special responsibility in keeping a sound and sustainable macroeconomic policy with a view to avoid excessive imbalances and sharp reversals of policy. 11. There is no obligation to capital account liberalization under the IMF‘s legal framework. However, there is agreement that the flow of capital may entail important benefits for the country concerned as well as the global economy, provided that important preconditions for successful capital account openness, including in particular a robust regulatory and supervisory framework, are sufficiently met. An important long-term goal for G20 countries should be to put in place, domestically and internationally, through enhanced cooperation, the conditions that allow members to reap the benefits from free capital movements, while preventing and managing risks that could undermine financial stability and sustainable growth, and avoiding financial protectionism. ### ANNEX II. Capital Flow Management Measures: Terminology - For the purposes of the institutional view, the term capital flow management measures (CFMs) is used to refer to 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; and - 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. - Based on this definition, if a measure is not designed to limit capital flows it would not fall under the CFM nomenclature. These measures that are not designed to influence capital flows are neutral in their application in that they do not discriminate according to residency and do not, typically, differentiate by currency. Prudential measures such as capital-adequacy requirements, loan-to-value ratios, and limits on net open foreign exchange positions, that are not designed to limit capital flows but rather to ensure the resilience and soundness of the financial system are not CFMs. Macroeconomic policies, similarly, would not normally be CFMs and nor would structural and other policies that, while they may directly or indirectly inhibit capital flows, are not designed to limit capital flows. In practice, the classification of a particular measure as a CFM would require judgment as to whether the measure is, in fact, designed to limit capital flows. This assessment in turn needs to be based on country-specific circumstances, such as whether the measure was introduced or intensified in response to an inflow surge or disruptive outflows. - In the proposed institutional view, “capital flow liberalization” is understood as the removal of CFMs, while in other international frameworks the understanding differs in some respects. For example, the OECD concept of liberalization applies only to the elimination of measures that discriminate between residents and nonresidents, while the obligations with respect to capital flow liberalization in the Treaty on the Functioning of the European Union generally prohibit all restrictions on capital flows even if they do not discriminate based on residency (both among EU members and between members and third countries). *Source: Box 3. Institutional View on Liberalization and Management of Capital Flows: Key Elements (extracted from the provided content).* ### ANNEX III. Implications of the Fund’s Proposed Institutional ### ANNEX III. Implications of the Fund’s Proposed Institutional View for Members’ Other International Obligations ### Interactions with other international agreements - Many Fund members have assumed legal obligations to liberalize capital movements under a broad range of international agreements with varying objectives and scope. - The nature and scope of the Fund‘s proposed institutional view may differ from those of other agreements, creating circumstances where differences arise. - Possible areas of divergence: - Bilateral and regional agreements may establish liberalization obligations that are broader and more accelerated than recommended under the integrated approach. - Some agreements contain unqualified obligations to avoid CFMs that are not compatible with the policy space for both inflow and outflow CFMs recommended under the proposed institutional view. - The proposed view recognizes that, in some circumstances, residency-based CFMs—although generally much less preferred than non-residency-based measures—could nonetheless be maintained; such maintenance could conflict with national treatment provisions under many international agreements. - Footnote 1 (source text): - "For example, most bilateral and regional agreements do not allow for the introduction of restrictions on capital outflows in the event of a balance of payments crisis and also effectively limit the ability of signatories to impose controls on inflows." - Footnote 2 (source text): - "These provisions generally mandate that residents of the agreement‘s other counterparties should be allowed to carry out transactions in the territory of a signatory under terms that are no less favorable than those applying to that signatory‘s own residents." ### Legal status of the Fund’s proposed institutional view and conformity - The Fund’s proposed institutional view would not (and legally could not) alter members’ rights and obligations under other international agreements. - Conformity with obligations under other agreements continues to be determined solely by the existing provisions of those agreements. - Practical implication: - Even where the proposed Fund institutional view recognizes the use of inflow or outflow CFMs as an appropriate policy response, these measures could still violate a member‘s obligations under other international agreements if those agreements do not contain temporary safeguard provisions compatible with the Fund‘s approach. _International Monetary Fund — ANNEX III. Implications of the Fund’s Proposed Institutional View for Members’ Other International Obligations_ --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_111412.pdf_