## _042513 ## Source details **Canonical URL:** [_042513](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042513.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042513.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042513.pdf.json) --- ### EXECUTIVE SUMMARY - Purpose and scope - Provides operational guidance to staff on the use of the Fund’s institutional view on the liberalization and management of capital flows. - Institutional view: - Provides a consistent basis for advice and assessments in surveillance. - Has no mandatory implications for Fund-supported programs. - Does not alter members’ rights and obligations under the Fund’s Articles of Agreement or other international agreements. - Guidance is intended to evolve based on country experiences, authorities’ views, and research. - Key operational principles for staff - Application must reflect country circumstances and require staff judgment. - Staff are encouraged to: - Incorporate into staff reports policy lessons from country cases and interactions with authorities. - Disseminate among staff new analysis on capital flow liberalization and management. - Maintain a running roster of country experiences with CFMs to support a taxonomy of CFMs and evidence on effectiveness. - Major policy issues for staff advice - Sequenced liberalization to reap benefits while managing risks. - Building resilience to large and volatile capital flows. - Addressing policy issues involving both source and recipient countries. - Responding to macroeconomic and financial stability risks associated with inflow surges and disruptive outflows; macroeconomic and financial policies are central, and CFMs may accompany them in some circumstances. - Surveillance and assessment highlights - Capital flows and related policies should be assessed when they significantly impact domestic or BOP stability. - Staff should flag capital flow issues at the policy consultation stage and may use tools such as the Risk Assessment Matrix. - The institutional view should inform staff assessments for: - Readiness for liberalization (see Section III). - Managing inflow surges and disruptive outflows (see Section IV). - Data adequacy: staff should consider data needed for assessing capital flows when judging adequacy of authorities’ data provision (recall Article VIII, Section 5 relevance). - Legal and Article VIII considerations - Institutional view does not change Fund jurisdiction under Article VIII, Section 2(a) and 3 regarding restrictions on payments/transfers for current transactions and MCPs. - CFMs on outflows that restrict payments/transfers for transactions defined under Article XXX(d) remain subject to Article VIII jurisdiction and prior approval. - MCPs relating solely to capital transactions would not be subject to Fund approval as the Fund has declined to assert jurisdiction over these measures. - Bilateral and multilateral surveillance - Bilateral: under the ISD, staff should take account of capital flows’ size and sustainability when evaluating members’ policies; staff reports should discuss capital flows when they significantly influence domestic or BOP stability. - Multilateral: staff should discuss policies that give rise to spillovers that significantly influence the effective operation of the IMS during Article IV consultations and recommend alternative policy adjustments informed by the institutional view. - Practical mission-level guidance (Box 1 summary) - Before mission: highlight capital flow developments, preliminary views on inflow surges or disruptive outflows; note macro and other policy adjustments, including CFMs or liberalization measures. - During discussions: assess size, sustainability, and impacts of capital flows; discuss appropriateness of policy mix, CFMs and MPMs, financial supervision; assess outward spillovers using G-RAM, VEA/VEE. - For liberalization plans: compare with the “integrated approach”; assess financial sector soundness and capacity; consider inward and outward spillovers. - Staff reports should cover capital flow issues when relevant to domestic, BOP, or IMS stability and ensure adequate detail at mission chiefs’ and reviewers’ discretion. - Use of Fund multilateral products - Use multilateral surveillance products to assess push factors and structural changes in global capital flows and ensure consistency with country assessments. *Source: EXECUTIVE SUMMARY (Guidance Note for the Liberalization and Management of Capital Flows), April 25, 2013.* ### Policy advice: scope, resources, and coordination - Scope and contexts - Institutional view provides basis for policy advice on liberalization or management of capital flows in surveillance, outreach, or technical assistance contexts. - Does not affect scope and nature of technical assistance, which is guided by the Fund’s Policy on Technical Assistance. - Use of Fund resources - Institutional view 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 institutional view would not be considered measures “requested” by the Fund pursuant to Article VI, Section 1. - CFMs maintained inconsistently with the institutional view would not be considered measures the Fund could require members to eliminate as a condition for use of Fund resources. - Institutional view could inform UFR assessments of whether a member’s policies are appropriate for resolving BOP difficulties and regaining external viability. - Limited exception: Fund’s policy on non-accumulation, reduction or elimination of external payments arrears, including arrears evidencing capital restrictions. - Enhanced multilateral coordination - Institutional view does not alter members’ rights and obligations under other international agreements. - Staff could use institutional view in dialogue with members and international organizations to promote consistent approaches to capital flow policies under other agreements. - Staff, particularly in functional departments, should develop ways to exchange data with other institutions, address data gaps, and strengthen technical support through forums such as the FSB, the G-20 Data Gaps Initiative, and the OECD. ### III. Capital flow liberalization — working definition and operational issues - Working definition - “Capital flow liberalization” refers to the removal of CFMs, includes the underlying capital transaction and related payment or transfer, implying unrestricted convertibility of local currency in international financial transactions. - Liberalization does not rule out temporary re-imposition of measures, maintenance of prudential measures needed for financial stability, or measures retained for national security. - When to cover liberalization - Authorities are undertaking or considering liberalization measures. - Staff assess that benefits of further liberalization relative to costs have risen. - Liberalization appears to have outpaced the economy’s capacity to safely handle capital flows. - Operational issues (Annex 3 expands thresholds, pre-conditions, sequencing) - Benefits and risks - Benefits: transfer of technology and management practices (particularly through FDI), financing of current account deficits for productive investment or smoothing consumption, indirect benefits for financial sector development, macroeconomic policy discipline, and economic efficiency. - Freer capital flows can support growth-enhancing investment, lower borrowing costs, fund credit-constrained sectors, bring in technology, and lengthen maturities or improve liquidity in securities markets. - Risks: heightened macroeconomic volatility and vulnerability to crises, magnified when countries lack financial and institutional development; risks can exist even for countries long open to flows and with developed financial markets. - Key consideration: adequacy of financial regulation and supervision to manage capital flow risks. - Thresholds - Benefits of liberalization are largest when countries achieve certain levels (“thresholds”) of financial and institutional development (Figure 1 referenced). - Literature and experience do not provide uniform guides; staff assessments require country-specific judgment on soundness of financial systems, institutions, and fiscal, monetary, and exchange rate policies. - Exchange rate flexibility can help cushion the real economy against capital flow volatility. - A country may progress toward greater liberalization before reaching all thresholds, but must manage liberalization cautiously. - Liberalization direction and process - No presumption that full liberalization is appropriate for all countries at all times; degree depends on country circumstances and objectives. - Staff should emphasize a systematic process and pace consistent with institutional and financial development along the “integrated approach.” - Teams should emphasize progressively deeper and broader reforms to financial and corporate frameworks, coordinating with TA departments and drawing on MCM expertise. - Re-imposition and spillovers - Temporary re-imposition of CFMs is consistent with an overall strategy of liberalization if liberalization outpaces capacity. - Staff should assess outward spillovers, especially for large, systemically important countries. - Country experience examples consistent with the integrated approach - Chile: late 1990s liberalization supported by strong macro frameworks, calibrated and sequenced measures, financial market development, and regulatory improvements. - Korea: late 1990s sequence of financial reforms amid sound macro policies and strong supervision; integration of long-term liberalization goals with short-term CFMs and MPMs. - Mexico: strong macro and prudential frameworks allowed open capital account while weathering external shocks; resilience enhanced by public debt restructuring, inflation targeting with exchange rate flexibility, and strong prudential framework. ### IV. Managing capital flows — operational use of the institutional view - General guidance - Managing large and volatile capital flows often poses policy challenges affecting domestic and BOP stability. - Staff reports should cover and assess such issues comprehensively and even-handedly, referencing the institutional view to ensure consistent advice based on country circumstances. - Staff should ascertain specific objectives of measures (e.g., macroeconomic risk vs. financial stability risk) to frame policy advice. - Key elements of policy for managing flows - Strengthen financial markets, supervision, regulation, and institutional capacity. - Adjust macroeconomic variables, including the real exchange rate; policies should facilitate these adjustments. - Use macroeconomic and financial policies as key parts of the policy mix; CFMs are part of the toolkit under certain conditions but should not substitute for warranted macroeconomic adjustment. - When flows contribute to systemic financial risks, CFMs may in some circumstances help safeguard financial stability. - Even-handedness: source countries and push factors - Push factors include monetary and prudential policies in systemically large economies, global risk appetite, and private liquidity from large cross-border financial intermediaries. - Staff should discuss with source countries the role of their policies in influencing capital flows and ways to internalize spillovers; analysis should cover official flows related to reserve accumulation and sovereign wealth funds. - In assessing push factors, staff should draw on multilateral and other surveillance products. ### Managing inflow surges and disruptive outflows - Identifying surges and drivers - A surge is understood as capital inflows exceeding their historical average over a relevant time frame; identifying a surge is a matter of judgment. - Some surge definitions preserved from source: - “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.” - Ghosh et al., 2012 define a surge as an episode where 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. - Staff should analyze main drivers (pull and push factors) and use G-RAM and empirical methods with market/anecdotal information to distinguish cyclical from structural drivers (e.g., sovereign rating upgrades, discovery of energy resources, benchmark weight adjustments). - Macroeconomic and financial stability risks - Staff should lay out key risks associated with surges and may summarize these in the country RAM; understanding origins and persistence guides response design. - Policy mix: macroeconomic policies - Appropriate options include: - Lowering interest rates in absence of overheating or asset price pressures (monetary easing or fiscal tightening). - Allowing exchange rate appreciation if currency is not overvalued. - Building foreign reserves if these are not more than adequate. - Recommendations to macro policy should not conflict with primary policy objectives (example: inflation-targeting context). - Safe-haven countries typically rely principally on macroeconomic policies given well-developed financial sectors and commitments to free capital flows. - Use of CFMs — when and why - Introducing CFMs can be appropriate in circumstances to support macro adjustment and safeguard financial stability, including: i. Limited room for adjusting macro policies (e.g., signs of overheating, overvalued exchange rate, reserves more than adequate). ii. Inflow surges that raise financial system instability risks; MPMs designed to limit inflows may be useful if they accompany macro policy adjustment and financial regulation. iii. Rapidly changing conditions making macro stance difficult to assess quickly; CFMs can temporarily buy time while assessments and implementations occur. - CFMs should not substitute for warranted macro policies; using CFMs to influence exchange rates for unfair competitive advantage would not be appropriate and could be inconsistent with exchange rate obligations under Article IV.32 - Effectiveness of CFMs is country-specific; larger economies with developed markets may find controls less effective. CFMs may be precluded by international commitments (example: full capital mobility generally required within the EU, with Treaty exceptions in crisis circumstances).33 - Reputational costs: countries with strong openness reputations face higher reputational costs from CFMs. - CFM design principles and operational considerations - CFMs should be transparent, targeted, temporary, and preferably non-discriminatory. - Measures targeting instability directly may be most effective and least costly. - Prefer non-discrimination between residents and non-residents; residency-based measures may be justified if non-discrimination renders policy ineffective. - Continuously review CFM design because efficacy can erode over time. - Price-based measures are typically more transparent than quantity-based measures; evidence suggests price-versus-quantity design does not significantly influence effectiveness. - If liberalization has outpaced capacity, reforms to improve institutional and financial development may be needed before lifting CFMs. - CFMs and macroprudential measures (MPMs) - When inflows contribute to financial stability risks, staff should draw on both the institutional view and the MPM toolkit. - Shared principles: avoid substituting MPMs/CFMs for necessary macro adjustment; seek even-handed treatment of residents and non-residents where possible. - Exit from inflow CFMs - CFMs can impose unnecessary costs once inflows are no longer unduly large or volatile; some MPMs may remain necessary. - Ongoing evaluation of usefulness relative to costs and alternative prudential measures is required. - Staff should assess abatement of pressures using surge analysis and judgment. - Source-country considerations and official reserve related flows - Encourage policymakers to internalize outward spillovers from monetary and prudential policies, especially for jurisdictions with global SIFIs. - Staff reports should include assessment of outward spillovers that significantly influence the effective operation of the IMS, including spillovers via capital flows. - Discuss capital flows related to official foreign asset accumulation by central banks and governments, including sovereign wealth funds. - Managing disruptive outflows - Non-crisis circumstances: scope usually exists to adjust macro and financial policies to address exchange rate, external financing, and interest rate implications. - Crisis-type circumstances: - Disruptive outflows can cause reserve depletion, currency collapse, financial system stress, and output losses. - Temporary CFMs on outflows may be introduced in crisis or imminent-crisis situations to prevent free fall of exchange rate, reserve depletion, and to provide breathing space while fundamental policy adjustment is implemented. - CFMs in crises should be part of a broader policy package, be transparent, temporary, and seek non-discrimination where possible (residency-based measures may be hard to avoid). - Outflow CFMs generally need to be comprehensive, require strong institutional/regulatory support, and need ongoing adjustment; CFMs should avoid causing external payment arrears or sovereign default. - Assessing crisis or imminent crisis requires judgment; common features include currency collapse, debt sustainability pressures, corporate and financial stress, sharp interest rate increases, severe output contractions. Teams should leverage multilateral surveillance and early warning exercises. - Exit from outflow CFMs depends on restoration of macro stability, improved market access, and reserves above critical levels; exit strategies require tailored design, communication, and sequencing. - Country exit examples: - Malaysia (1998): replaced blanket prohibition with exit tax progressively lowered; residents gradually allowed to invest abroad with limits on domestic credit access. - Ukraine: lifted outflow CFMs gradually without major disruptions once crisis abated. - Iceland: 2008 CFMs prevented large-scale outflows; exit phased focusing on reducing offshore krona liquidity before lifting controls. ### International coordination - Rationale - Cross-border coordination among recipient countries and between source and recipient countries can mitigate undesired spillovers and promote globally efficient outcomes. - Coordination may be desirable where CFMs or other policies amplify macroeconomic or financial stability risks elsewhere and it is costly for affected countries to take counter-measures. - Staff points - Source countries should better internalize spillovers from their monetary and prudential policies. - Recipient countries should moderate use of CFMs if these lead to costly spillovers (e.g., deflection of flows). - Coordination forms: - Surveillance discussions with source countries (including through spillover reports). - Regional fora among source and recipient countries (example: European Bank Coordination (Vienna) Initiative). - Multilateral and regional fora among recipients. - Staff can identify coordination opportunities using surveillance tools and may play a catalytic role (e.g., organizing working groups with authorities, international organizations, and private sector). - Financial sector cooperation - Encourage dialogue on cooperation in supervision and regulation (for example, supervisory colleges), consultation on implementation impacts (building on innovations like the Vienna Initiative), data sharing (G-20 Data Gaps Initiative), and completing internationally agreed financial sector reform plans. *Source: GUIDANCE NOTE FOR THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — Excerpt on managing inflow surges and disruptive outflows* ### Annex 1 — Terminology and examples (selected highlights) - CFMs definition and classification - CFMs: measures designed to limit capital flows. - CFMs comprise: - Residency-based CFMs (taxes and regulations discriminating on the basis of residency; generally called capital controls). - Other CFMs (non-residency-discriminating measures designed to limit flows, e.g., some prudential measures differentiating transactions by currency or minimum holding periods applied to non-financial sector). - Measures not designed to limit capital flows are not CFMs (examples: capital-adequacy requirements, loan-to-value ratios, limits on net open FX positions not designed to limit flows). - Classification judgment key considerations - Whether the measure treats international capital transactions less favorably than domestic transactions. - Whether the measure applies only to international capital transactions and imposes or intensifies a limitation. - Context matters: adoption during surges or disruptive outflows can indicate design to limit flows. - Illustrative CFMs — inflows (selected examples) - Brazil 2009: 2 percent tax on portfolio equity and debt inflows. - Indonesia 2011: six-month holding period on central bank bonds; limit on short-term foreign borrowing by banks to 30 percent of 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). - Peru 2010: increase of fee on nonresident purchases of central bank paper to 400 basis points (from 10 basis points). - Thailand 2010: restoration of a 15 percent withholding tax on nonresidents' interest earnings and capital gains on new purchases of state bonds. - Illustrative CFMs — outflows (selected examples) - Argentina 2001: Corralito limiting bank withdrawals and restrictions on transfers and loans in foreign currency. - Iceland 2008: stop of convertibility of domestic currency accounts for capital transactions. - Malaysia 1998: 12-month waiting period for nonresidents to convert proceeds from sale of Malaysian securities. - Ukraine 2008: 5-day waiting period for nonresidents to convert local currency proceeds from investment transactions to foreign currency. - Thailand 1997: limits on forward transactions and export surrender requirements. - Use of terminology - For transparency and even-handedness, CFMs and MPMs should be identified as such in staff reports; where classification is unclear, staff reports can note the lack of clarity. - MPMs and CFMs: distinction and overlap - MPMs: prudential tools primarily designed to limit systemic financial risk irrespective of origin. - CFMs: aim to contain scale or composition of capital flows. - Overlap occurs when capital flows are the source of systemic financial risks; some tools can be both CFMs and MPMs (example: restrictions on financial institutions’ foreign borrowing). ### Annex 2 — Examples in staff reports (selected highlights) - Liberalizing capital flows - China (2011 Article IV): staged approach; initial financial sector reforms; focus on FDI; full liberalization—including short-term flows—wait until bulk of reforms implemented; risk that liberalizing interest rates could raise rates and destabilizing inflows; allowing exchange rate appreciation helps reduce pressures. - Korea (2006 Article IV): role of financial development; priority areas include active money market for forward FX pricing. - Managing inflow surges - Brazil (2012 Article IV): drivers of inflows/outflows; pressures on overvalued real; fiscal tightness to reduce net inflows; IOF tax usefulness; need to address structurally high interest rates; importance of absorptive capacity. - South Africa (2011 Article IV): authorities used exchange rate appreciation and reserve buildup; scope to build reserves further and tighten fiscal policy; case for CFMs in near-term given little policy space but concluded use not warranted due to potential costs and low effectiveness. - Philippines (2009 Article IV): policy mix—higher reserves, exchange rate appreciation, prudential regulation modification, further liberalizing outflows; scope for exchange rate flexibility and further market development. - Managing disruptive outflows - Iceland (2008 SBA Request, 2012 PPM): need for tighter monetary policy and maintenance of exchange controls after banking collapse left private sector debt at over 450 percent of GDP by end-2008; liberalization strategy should be sequenced and paced. - Ukraine (2008 SBA, 2011 EPE): outflow CFMs as temporary response; removal as confidence returned; under 2010 IMF-supported program most controls removed; 2011 Ex Post Evaluation concluded they had not been generally effective. ### Annex 3 — Liberalization: Thresholds, pre-conditions, sequencing (selected highlights) - Preconditions for safe liberalization (key preconditions) - Stable macroeconomic and financial conditions that support flexibility (credible exchange rate arrangement, adequate reserves, low and stable inflation, sustainable fiscal position, absence of credit/asset bubbles). - Financial sector capacity (active/deep money and FX markets; development of equity and bond markets; adequate yield curve). - Ability of financial sector to deal with volatility (bank resilience: reliance on deposits, adequacy of net open FX position limits, credit risk from FX-denominated loans, high NPLs). - High standards of governance and disclosure (international accounting, transparency, shareholder protection). - Strong regulatory standards and effective supervision (micro and macroprudential regulations, cooperation agreements with other supervisors, deposit guarantee frameworks, crisis preparedness). - Strong policy track record. - Footnote: "These conditions need not be taken as given over time, and staff advice should aim to strengthen these conditions for managing capital flows safely and beneficially." - Risk assessment prior to CFM removal - Assess risks removal would pose to macroeconomic and financial stability; identify effective CFMs and design reforms to eliminate or reduce identified risks. - Sequencing principles - Broad sequencing: "long term before short term, FDI and other non-debt before debt, and inflows before outflows." - Consider currency composition of assets; sequence must be calibrated to country-specific circumstances and informed by MCM and other expertise. - General sequencing reference points: - Liberalize FDI inflows and certain short-term bank-related flows facilitating trade and financial transactions. - Liberalize FDI outflows and inflows into traded securities; equities may present fewer complications than bonds; development of bond markets can benefit from foreign participation. - Progressively lift controls on outflows and allow greater foreign investor participation. - Re-assessing and re-imposing CFMs - If liberalization has outpaced capacity, re-imposition of CFMs may be warranted until progress on recommended macroeconomic, financial, governance, and market developments. - If re-introduced, prefer the least discriminatory effective measure. *GUIDANCE NOTE FOR THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — INTERNATIONAL MONETARY FUND* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Purpose and scope - Provides operational guidance to staff on the use of the Fund’s institutional view on the liberalization and management of capital flows. - The institutional view: - Provides a consistent basis for advice and assessments in surveillance. - Has no mandatory implications for Fund-supported programs. - Does not alter members’ rights and obligations under the Fund’s Articles of Agreement or other international agreements. - Guidance is intended to evolve based on country experiences, authorities’ views, and research. ### Key operational principles for staff - Application must reflect country circumstances and require staff judgment in several areas. - Staff are encouraged to: - Incorporate into staff reports policy lessons from country cases and interactions with authorities. - Disseminate among staff new analysis on capital flow liberalization and management. - Maintain a running roster of country experiences with CFMs to support a taxonomy of CFMs and evidence on effectiveness. ### Major policy issues often relevant for staff advice - Liberalization of capital flows in ways that reap benefits while managing risks. - A sequenced approach to liberalization that accounts for levels of development and country circumstances. - Building resilience to large and volatile capital flows. - Addressing policy issues involving both source and recipient countries of capital flows. - Responding appropriately to macroeconomic and financial stability risks associated with capital inflow surges and disruptive outflows: - Macroeconomic and financial policies play a key role. - In some circumstances, these policies may be accompanied by capital flow management measures. ### Structure of the guidance note (high level) - Section II: Operational implications for Fund staff, particularly surveillance. - Section III: Considerations for capital flow liberalization (mainly relevant for removal of long-standing CFMs). - Section IV: Considerations for managing inflow surges and disruptive outflows (mainly relevant for newly-adopted CFMs). - Annex 1: Terminology and examples (discussion of CFMs and definitions for staff use). - Annex 2: Examples of liberalization and management of capital flows in staff reports. - Annex 3: Liberalization thresholds, pre-conditions, sequencing, and operational considerations. ### Surveillance and assessment guidance (highlights) - Capital flows and related policies should be assessed when they have a significant impact on domestic or BOP stability. - Staff should flag capital flow issues at the policy consultation stage and may use tools such as the Risk Assessment Matrix. - The institutional view should inform staff assessments for: - Readiness for liberalization (benefits, risks, and spillovers) — see Section III. - Managing inflow surges and disruptive outflows (policy appropriateness and risks) — see Section IV. - Data adequacy: staff should consider data needed for assessing capital flows when judging adequacy of authorities’ data provision (recall Article VIII, Section 5 relevance). ### Legal and Article VIII considerations - The institutional view does not change Fund jurisdiction under Article VIII, Section 2(a) and 3 concerning restrictions on payments/transfers for current transactions and multiple currency practices. - CFMs on outflows that restrict making of payments and transfers for transactions defined under Article XXX(d) remain subject to Article VIII jurisdiction and prior approval as at present. - CFMs that give rise to exchange restrictions could also affect observance of performance criteria in Fund arrangements that call for avoidance of new/intensified exchange restrictions. - MCPs relating solely to capital transactions would not be subject to Fund approval as the Fund has declined to assert jurisdiction over these measures. ### Bilateral and multilateral surveillance implications - Bilateral surveillance: - Under the ISD, staff should take account of capital flows’ size and sustainability when evaluating members’ economic policies. - Staff reports should discuss capital flows and related policies when they significantly influence domestic or BOP stability. - Certain developments (e.g., introduction or substantial modification for BOP purposes of restrictions/incentives on capital flows) could trigger discussion on observance of the Principles for Guidance of Members’ Policies (PGMs). - Multilateral surveillance: - If a member’s policies give rise to spillovers that significantly influence the effective operation of the IMS, staff should discuss these with the member during Article IV consultations. - Staff may recommend alternative policy adjustments more conducive to IMS stability; recommendations should be informed by the institutional view. - Staff should assess whether country policies have the potential to give rise to outward spillovers transmitted through capital flows that may undermine global economic and financial stability. ### Practical mission-level guidance (Box 1 summary) - Before the mission (Policy Note and Policy Consultation Meeting): - Highlight capital flow developments that raise concerns for domestic and BOP stability, including preliminary views on inflow surges or disruptive outflows. - Note macroeconomic and other policy adjustments, including CFMs, and any announced or implemented liberalization measures. - During discussions: - Discuss developments in capital flows, size and sustainability, and impacts on macroeconomic and financial stability. - When capital flows have domestic/BOP implications or affect the IMS, discuss: - Appropriateness and effects of the policy mix, including CFMs and MPMs, and soundness of financial supervision and regulation. - Potential or actual outward spillovers, drawing on G-RAM, VEA/VEE, and multilateral products. - For proposed or implemented liberalization plans, discuss: - Comparison with the “integrated approach” accounting for country circumstances. - Soundness of the financial sector and capacity to handle capital flows. - Inward and outward spillover implications. - Staff reports: - Should discuss capital flows and related policies when they have implications for domestic or BOP stability or the IMS, based on the institutional view. - Level of detail at mission chiefs’ and reviewers’ discretion, but must adequately cover relevant policy challenges. - Keep in mind capital flow–related data needs for surveillance. ### Use of Fund multilateral products - Use the Fund’s multilateral surveillance products to assess the extent of push factors and structural changes in global capital flows. - Ensure consistency between country assessments and multilateral surveillance. Approved By Siddharth Tiwari Prepared by the Strategy, Policy, and Review Department in consultation with LEG, MCM, RES, and other departments. *Source: EXECUTIVE SUMMARY (Guidance Note for the Liberalization and Management of Capital Flows), April 25, 2013.* ### 8. Policy advice. The institutional view provides a basis for policy advice on the liberalization ### _042513 - 8. Policy advice. The institutional view provides a basis for policy advice on the liberalization ### Policy advice: scope and contexts - The institutional view provides a basis for policy advice on the liberalization or management of capital flows. - Such advice may occur in surveillance, outreach, or technical assistance contexts. - The institutional view does not affect the scope and nature of technical assistance, which is guided by the Fund’s Policy on Technical Assistance.12 ### Use of Fund resources - The institutional view 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 the removal of capital controls as a condition for access to the Fund’s resources.13 - CFMs maintained consistently with the institutional view would not be considered measures “requested” by the Fund pursuant to Article VI, Section 1. - CFMs maintained inconsistently with the institutional view would not be considered measures that the Fund could require members to eliminate as a condition for the use of Fund resources. - The institutional view could inform assessments in a UFR context of whether a member’s policies are appropriate for resolving its balance of payments difficulties and regaining external viability. - Note: A limited exception to this principle is the Fund’s policy on non-accumulation, reduction or elimination of external payments arrears, including arrears evidencing capital restrictions.13 ### Enhanced multilateral coordination - The institutional view does not alter members’ rights and obligations under other international agreements. - Staff could use the institutional view in dialogue with members and international organizations to promote a more consistent approach to policies related to capital flows under other international agreements. - Staff, particularly in functional departments, should develop ways of exchanging data and information with other relevant international institutions, address data gaps, and strengthen technical support to advance regulatory reform through forums such as the FSB, the G-20 Data Gaps Initiative, and the OECD. ### III. Capital flow liberalization — 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 it implies unrestricted convertibility of local currency in international financial transactions. - Liberalization does not rule out: - The temporary re-imposition of such measures under certain circumstances; - The maintenance of prudential measures that, while possibly CFMs, are needed for financial system stability; - Measures that members may retain for reasons of national security. ### Use of the institutional view and operational issues for capital flow liberalization - The institutional view provides principles for staff advice on capital flow liberalization. - Capital flow liberalization should be covered when: - Authorities are undertaking or considering liberalization measures; - Staff assess that benefits of further liberalization relative to costs have risen; - Liberalization appears to have outpaced the economy’s capacity to safely handle capital flows. - Operational issues likely to arise (Annex 3 provides further details on thresholds, pre-conditions, and sequencing): - Benefits and risks - Benefits of greater openness: transfer of technology and management practices (particularly through FDI), financing of current account deficits for productive investment or smoothing consumption, indirect benefits for financial sector development, macroeconomic policy discipline, and economic efficiency. - Staff could assess how freer capital flows could support objectives such as boosting growth-enhancing investment, lowering borrowing costs, providing funding to credit-constrained sectors, bringing in new technology, and lengthening maturities or improving liquidity in securities markets. - Risks: heightened macroeconomic volatility and vulnerability to crises, magnified when countries lack sufficient financial and institutional development.14 - Capital flows can pose risks even for countries long open to flows and with highly developed financial markets. - Key consideration: adequacy of financial regulation and supervision to manage risks associated with capital flows.15 - Thresholds - Benefits of capital flow liberalization are largest when countries have achieved certain levels (“thresholds”) of financial and institutional development (Figure 1). - Literature and experience do not provide a uniform guide for adequate levels of relevant variables; staff assessments require country-specific judgment on soundness of financial systems, institutions, and fiscal, monetary, and exchange rate policies.16 - Exchange rate flexibility can help cushion the real economy against capital flow volatility. - A country may progress toward greater liberalization before reaching all thresholds, but liberalization needs to be managed cautiously in those circumstances. - Liberalization direction - Staff advice should not presume full liberalization is appropriate for all countries at all times. - The appropriate degree of liberalization depends on country circumstances and economic objectives. - Discussions could cover: strength of macroeconomic cushions (growth, price stability, foreign reserves), composition of external flows (e.g., a large share of equity and FDI), and trends in financial development, trade openness, and institutional quality. - Liberalization process - For countries choosing to liberalize, staff should emphasize a systematic process and pace consistent with institutional and financial development along the “integrated approach.”17 - Teams should emphasize progressively deeper and broader supporting reforms to financial and corporate frameworks, working with TA departments as relevant. - Staff advice should use recent financial and institutional assessments (e.g., FSAPs, ROSCs) and cross-country examples. - Where detailed recommendations are warranted, staff should draw on MCM expertise, which has provided TA on capital flow liberalization. - Re-imposition of CFMs - Temporary re-imposition of CFMs under certain circumstances is consistent with an overall strategy of liberalization. - If liberalization has outpaced the economy’s capacity to handle flows, re-imposition of CFMs may be warranted until progress is made on conditions recommended by the integrated approach. - Input from relevant functional departments is useful for forming staff views. - Spillovers - Spillovers may significantly impact the effective operation of the IMS, especially for large, systemically important countries. - Staff should assess implications of liberalization measures for outward spillovers. ### Country experiences with liberalization - Examples consistent with the integrated approach: - Chile: since the late 1990s, liberalization supported by strong macroeconomic frameworks (including fiscal policy and exchange rate flexibility), calibrated and sequenced measures, financial market development, and regulatory improvements addressing related lending and exposures.18 - Korea: since the late 1990s, liberalization proceeded through a sequence of financial reforms amid sound macroeconomic policies and strong financial sector supervision; illustrates integration of long-term liberalization goals with short-term use of CFMs and MPMs.19 - Mexico: strong macroeconomic and prudential policy frameworks have allowed maintenance of an open capital account while weathering severe external shocks; resilience enhanced by improving public sector debt structure, the inflation targeting regime (including exchange rate flexibility), and a strong prudential framework.20 ### IV. Managing capital flows — Operational use of the institutional view - Managing large and volatile capital flows often poses policy challenges affecting domestic and balance of payments stability. - When capital flows raise such challenges, staff reports should cover and assess the issue comprehensively and even-handedly, and refer to the institutional view to ensure consistent advice based on country circumstances. - In discussing policy responses, staff should ascertain the objectives of specific measures (e.g., targeted at macroeconomic risks, financial stability risks) to help frame policy advice.21 ### Key elements of policy for managing capital flows - Strengthen financial markets, supervision and regulation, and institutional capacity to improve ability to absorb and handle capital flows. - Capital flows generally warrant adjustments in macroeconomic variables, including the real exchange rate; policies should facilitate these adjustments. - Volatile capital flows can give rise to stability risks; macroeconomic and financial policies are key parts of the appropriate policy mix. - CFMs are part of the toolkit under certain conditions, but should not substitute for warranted macroeconomic adjustment. - When capital flows contribute to systemic financial risks, CFMs may in some circumstances help safeguard financial stability. ### Even-handedness: source countries and push factors - Push factors: monetary and prudential policies in systemically large economies, global risk appetite, private liquidity from large cross-border financial intermediaries and liquidity-creating instruments. - Staff should discuss with source countries, where relevant for surveillance, the role of their policies in influencing capital flows and ways to internalize spillovers (including consideration of alternative policies with fewer spillovers).22 - Staff analysis should also seek to cover official flows related to reserve accumulation by central banks and foreign asset purchases by governments, including sovereign wealth funds. - In assessing push factors, staff should draw on the Fund’s multilateral and other surveillance products. *Source: _042513 - 8. Policy advice. The institutional view provides a basis for policy advice on the liberalization* ### 17. Managing inflow surges. A policy problem on which country teams often need to provide ### _042513 - 17. Managing inflow surges. A policy problem on which country teams often need to provide ### Identifying surges and their drivers - A surge is understood as capital inflows exceeding their historical average over a relevant time frame; identifying a surge is a matter of judgment.23 - A rise in inflows relative to history could reflect a long-term structural increase (e.g., portfolio readjustment), which may warrant macroeconomic (including exchange rate) adjustment.24 - Staff should analyze main drivers of capital flow surges, including pull and push factors. - The Global Risk Assessment Matrix (G-RAM) is useful for assessing the global environment for capital flows and the risks for an individual country. - Empirical methods, supplemented with market and anecdotal information, are often used to distinguish cyclical from structural drivers (examples: sovereign credit rating upgrades, discovery of recoverable energy resources, portfolio benchmark weight adjustments). - Footnote examples of surge definitions preserved from source: - “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.”23 - Ghosh et al., 2012 define a surge as an episode where 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.23 ### Macroeconomic and financial stability risks - Staff should clearly lay out key macroeconomic and financial stability risks associated with surges and may summarize these in the country Risk Assessment Matrix (RAM). - Understanding origins, characteristics and likely persistence of a surge helps determine risks and craft an appropriate policy response. ### Policy mix: macroeconomic policies - Staff should assess appropriate policy mix based on country-specific considerations. Appropriate options include: - Lowering interest rates in the absence of overheating or asset price pressures (through monetary easing or fiscal tightening). - Allowing exchange rate appreciation if the currency is not overvalued (temporary overshooting relative to fundamentals may not necessarily call for policy response). - Building foreign reserves if these are not more than adequate.25 - Staff reports already include views on overheating risks, macroeconomic policies, exchange rates, and reserves and can draw on these views to discuss responses.26 - Recommendations to macropolicy should not conflict with primary policy objectives (example: in an inflation-targeting country, monetary easing is appropriate only if inflation remains consistent with the authorities’ target).25 - Safe-haven countries typically must rely principally on macroeconomic policies given well-developed financial sectors and commitments to free capital flows.25 ### Use of capital flow measures (CFMs) — when and why - Introducing CFMs can be appropriate in certain circumstances to support macroeconomic adjustment and safeguard financial stability. Circumstances include: i. Limited room for adjusting macroeconomic policies (e.g., signs of overheating or asset bubbles, overvalued exchange rate, or reserves more than adequate). (Illustrated in Figure 2.) ii. Inflow surges that raise risks of financial system instability; macroprudential measures (MPMs) designed to limit these inflows may be useful if they accompany needed macroeconomic policy adjustment and financial regulation. iii. Rapidly changing underlying conditions that make macroeconomic stance difficult to assess quickly, or when warranted policy adjustments take long to implement; CFMs can be temporarily useful to buy time while assessments and implementations occur. - CFMs should not substitute for warranted macroeconomic policies; using CFMs to influence exchange rates to gain unfair competitive advantage would not be appropriate and could be inconsistent with exchange rate obligations under Article IV.32 - Effectiveness of CFMs is country-specific and a matter of judgment; larger economies with more developed financial markets may find controls less effective. CFMs may be precluded by international commitments (example: full capital mobility generally required within the EU, with Treaty exceptions in crisis circumstances).33 - Reputational costs: countries with strong reputations for openness face higher reputational costs from CFMs. ### CFM design principles and operational considerations - Broad principles from the institutional view: - CFMs should be transparent, targeted, temporary, and preferably non-discriminatory. - Measures that target the instability as directly as possible may be the most effective and least costly.34 - CFMs should generally be temporary and scaled back when capital inflow pressures abate, though some measures (including residency- or nationality-based measures) may be maintained longer if imposed for reasons other than balance of payments purposes.35 - Prefer non-discrimination between residents and non-residents; if non-discrimination renders policy ineffective, residency-based measures may be justified.36 - Continuously review CFM design because efficacy can erode over time due to incentives for circumvention. - Price-based measures are typically more transparent than quantity-based measures; evidence suggests price-versus-quantity design does not significantly influence effectiveness.34 - If liberalization has outpaced domestic capacity to handle flows safely, reforms to improve institutional and financial development may be needed before CFMs can be safely lifted.35 ### CFMs and macroprudential measures (MPMs) - When inflows contribute to financial stability risks, staff should draw on both the institutional view on capital flows and the MPM toolkit developed by Fund staff.37 - Key shared principles: - Avoid using MPMs/CFMs as substitutes for necessary macroeconomic adjustment. - Seek even-handed treatment of residents and non-residents where possible. ### Exit from inflow CFMs - CFMs can impose unnecessary costs once inflows are no longer unduly large or volatile; some MPMs may remain necessary for systemic financial risk management. - Ongoing evaluation needed of usefulness relative to costs and whether alternative prudential measures (not designed to limit capital flows) can address concerns. - Staff should assess when capital flow pressures have abated sufficiently using surge analysis and judgment. ### Source-country considerations and official reserve related flows - Staff should encourage policymakers to consider how their policies affect others and to internalize outward spillovers from monetary and prudential policies, especially relevant for jurisdictions with global systemically important financial institutions. - Staff reports should include assessment of outward spillovers that significantly influence the effective operation of the IMS, including spillovers transmitted via capital flows. - Staff should discuss capital flows related to official foreign asset accumulation by central banks and governments, including sovereign wealth funds.38 - Spillovers from policies to manage capital flows should be discussed when they may potentially arise (Section II). ### Managing disruptive outflows - Outflows that are large, sudden, or sustained pose significant policy challenges; operational issues differ by circumstance. Policy in non-crisis circumstances - Usually scope exists to adjust macroeconomic and financial policies to address exchange rate, external financing, and interest rate implications (examples: Korea, Russia, South Africa). Policy in crisis-type circumstances - Disruptive outflows in crises can cause reserve depletion, currency collapse, financial system stress, and output losses. - Temporary role for introduction of CFMs on outflows may exist in crisis or imminent-crisis situations to prevent free fall of exchange rate, reserve depletion, and to provide breathing space while fundamental policy adjustment is implemented.39 - CFMs in crises should be part of a broader policy package and not substitute for warranted policy adjustments (e.g., fiscal and exchange rate adjustment). - Crisis outflow CFMs should be transparent, temporary, and seek non-discrimination where possible (residency-based measures may be hard to avoid).40 - Unlike inflow CFMs, outflow CFMs generally need to be comprehensive to be effective, require strong institutional and regulatory support, and need ongoing adjustment.41 - CFMs should avoid causing external payment arrears or sovereign default. Assessing crisis or imminent crisis - Determination of “crisis” or “imminent crisis” requires judgment based on country-specific circumstances and authorities’ views. - Common crisis features: currency collapse, debt sustainability pressures, corporate and financial stress, sharp interest rate increases, severe output contractions.42 - Teams should leverage the Fund’s multilateral surveillance, including early warning and vulnerability exercises. Exit from outflow CFMs - Timing and strategy to lift outflow CFMs depend on conditions (not calendar dates). - General criteria for lifting: restoration of macroeconomic stability (exchange rate, debt sustainability, financial stability), improved market access prospects, and reserves above critical levels. - Exit strategy elements: design and incentives, communication, and sequencing tailored to country-specific challenges. Country experience highlights on exits - Malaysia (1998 measures): replaced blanket prohibition on non-residents’ repatriation with an exit tax progressively lowered as stability was restored; residents were gradually allowed to invest abroad with limits on domestic credit access; early removal and gradual liberalization helped minimize impact on investor sentiment and country risk premium.43 - Ukraine: lifted outflow CFMs gradually and without major disruptions once crisis abated. - Iceland: timely imposition of CFMs in 2008 prevented large-scale capital outflows; success partly owed to effective enforcement. Challenges include a large volume of offshore krona liquidity that may leave abruptly upon lifting controls; exit is being phased focusing first on reducing liquidity overhang and second on gradually lifting restrictions on capital account transactions. *Source: GUIDANCE NOTE FOR THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — Excerpt on managing inflow surges and disruptive outflows* ### 19. International Coordination. Cross-border policy coordination among recipient countries, ### 19. International Coordination. Cross-border policy coordination among recipient countries, ### Overview - Cross-border policy coordination among recipient countries, and between source and recipient countries, can help to mitigate undesired spillover effects of policy and promote globally efficient outcomes. - Coordination may be desirable where CFMs or other policies amplify macroeconomic or financial stability risks in other countries and it is costly for those other countries to take counter-measures. ### Points for staff to note - If CFMs or other policies amplify macroeconomic or financial stability risks in other countries, and it is costly for those other countries to take counter-measures to manage those risks, coordination may be desirable whereby countries partially internalize the spillovers from their policies. - This may require: - Source countries to better internalize the spillovers from their monetary and prudential policies. - Recipient countries to moderate their use of CFMs if these lead to costly spillovers (such as deflection of flows) to other recipient countries. - In practice, coordination could take place in several forms: - During surveillance discussions with source countries (including through the spillover reports). - Among source and recipient countries in regional fora (example: the European Bank Coordination (Vienna) Initiative). - Among recipients in multilateral and regional fora. - Staff (in both area and functional departments) could identify opportunities for coordination through surveillance tools, including the multilateral surveillance products. - Where appropriate, staff can play a catalytic role in promoting coordination, for example, by organizing “working groups” with key stakeholders (which could include country authorities, international organizations and the private sector). ### Financial sector cooperation - Staff should encourage dialogue with partners on: - Cooperation in supervision and regulation (for example, supervisory colleges). - Consultation on the impact of the implementation of financial supervision and regulation (for example, building on such innovations as the Vienna Initiative). - Data sharing (for example, the G-20 Data Gaps Initiative). - The need to complete implementation of internationally agreed financial sector reform plans. *Ostry et al., 2012, provides a useful analytical framework for assessing the multilateral aspects of capital flow management.* ### Annex 1 — Terminology: The Institutional View on the Liberalization and Management of Capital Flows - Capital Flow Management Measures (CFMs) - 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. - 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 are not CFMs. Examples of non-CFMs: 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; macroeconomic policies; structural and other policies not designed to limit capital flows. - Classification judgment - Determination whether a measure is a CFM requires judgment as to whether the measure is designed to limit capital flows. - Key considerations in the determination: - 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); or - 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). - Transactions considered: international capital transactions generally are capital transactions, i.e., transactions that are not current transactions as defined in Article XXX(d) which have an impact on a member’s balance of payment. Transactions associated with certain payments identified in Article XXX(d), namely, normal short-term banking and credit facilities, and payments of moderate amount for amortization of loans or for depreciation of direct investments, that have such an impact are also considered capital transactions for the purposes of the institutional view. - Context matters: even if a measure is not a CFM by design, it may be judged to be designed to limit capital flows based on context (for example, adoption during a period of surges in inflows or disruptive outflows). - Illustrative indicators a measure is designed to limit capital flows: - It explicitly discriminates on the basis of residency (for example, restrictions on non-resident investments or residents’ access to foreign financing). - It directly targets a cross-border capital flow (for 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, would not be CFMs (examples: increasing liquidity and capital requirements for financial institutions that rely on short-term wholesale offshore financing; instituting tax and other fiscal measures that do not differentiate between residents and non-residents to address potential bubbles in asset prices). ### Use of terminology - For transparency and even-handedness, CFMs and MPMs should be identified as such in staff reports and other papers. - If the classification is unclear, or the staff and authorities have different interpretations, the staff report can note the lack of clarity or difference in interpretation. - Staff should focus discussions on the policy context and appropriateness of particular measures and avoid attaching any sense of stigma or preference to one term or other. - The terminology is intended only in the context of the institutional view and its application in the Fund’s advice and assessments; it is not intended to supplant terms used in other contexts (for example, OECD or Treaty on the Functioning of the European Union frameworks). - In the institutional view, “capital flow liberalization” is understood as the removal of CFMs, but other frameworks may differ (example: OECD concept applies only to elimination of measures discriminating between residents and nonresidents; Treaty on the Functioning of the European Union generally prohibits all restrictions on capital flows even if they do not discriminate based on residency). ### MPMs and CFMs - Distinction and overlap: - MPMs (Macroprudential Measures) are prudential tools primarily designed to limit systemic financial risk and maintain financial system stability irrespective of whether the origin of the risk is domestic or cross-border. - CFMs aim to contain the scale or influence the composition of capital flows. - Example contrasts: - A tax on specific cross-border inflows is a CFM and may only indirectly affect financial stability. - A capital surcharge on systemically important financial institutions or counter-cyclical provisioning is an MPM that has only an indirect impact on capital flows. - Overlap occurs when capital flows are the source of systemic financial sector risks; tools used to address those risks can be both CFMs and MPMs. Example: restriction on financial institutions’ foreign borrowing (levy on foreign exchange inflows or required reserves on foreign exchange liabilities) that aims to limit inflows, slow domestic credit and asset price increases, and reduce liquidity and exchange rate risks. ### Source and recipient countries - Terms based on gross flows: - Source countries: countries from which significant gross flows originate (operationally). - Recipient countries: countries that receive gross flows on a scale that is substantial relative to the domestic economy. - Push factors originate from source countries; pull factors originate from recipient countries. ### Selected Capital Flow Management Measures — illustrative examples - 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. - Thailand 2010 - Restoration of a 15 percent withholding tax on nonresidents' interest earnings and capital gains on new purchases of state bonds. - Increased the tax rate for foreign investors with the stated intention of reducing capital inflows (even though it led to equal treatment). - 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. - Note: This table provides illustrative examples of adopted measures that are assessed to be CFMs. It is not comprehensive and does not assess appropriateness or effectiveness. ### Annex 2 — Liberalization and Management of Capital Flows in Staff Reports: Some Relevant Examples - Liberalizing Capital Flows - China (2011 Article IV Consultation). Key elements: staged approach to liberalization; initial financial sector reforms and focus on removing restrictions on more stable, long-term sources of financing such as FDI; full liberalization—including short-term flows—waiting until the bulk of financial sector reforms have been implemented; risk that liberalizing interest rates could raise rates in a way that leads to potentially destabilizing capital inflows; allowing the exchange rate to appreciate would help reduce these pressures. - Korea (2006 Article IV Consultation). Key elements: role of financial development for handling capital flows; authorities’ policies to further develop the financial sector, including proposed removal of remaining restrictions on the capital account; priority areas for further financial development, especially an active money market to provide a pricing mechanism for forward transactions in foreign exchange. - Managing Capital Inflow Surges - Brazil (2012 Article IV Consultation). Key elements: drivers of inflows and outflows, pressures from inflows on the already overvalued real; fiscal policy tightness as part of policy mix conducive to a reduction in net capital inflows; usefulness of CFMs (the IOF tax on portfolio inflows) as part of the policy toolkit; costs of CFMs and need to address underlying causes of Brazil’s structurally high interest rates—a key pull factor; importance of increasing the financial sector’s absorptive capacity. - South Africa (2011 Article IV Consultation). Key elements: authorities’ responses to capital inflow episodes, including exchange rate appreciation while building international reserves, accommodative monetary policy, and further liberalizing capital outflows; medium-term scope to build up reserves further and to tighten fiscal policy to create more room for monetary policy to manage the impact of capital flows; case for CFMs in the near-term given little short-term policy space and overvalued rand, and the conclusion that their use was not warranted owing to their potential costs and low effectiveness. - Philippines (2009 Article IV Consultation). Key elements: authorities’ policy mix for managing inflows—higher reserves, exchange rate appreciation, modification of prudential regulations, and further liberalization of capital outflows; scope for greater exchange rate flexibility to manage additional inflows, given that reserves assessed to be adequate and exchange rate broadly in line with medium-term fundamentals; scope for further financial market development to boost absorptive capacity. - Managing Disruptive Capital Outflows - Iceland (2008 SBA Request, 2012 Second Post-Program Monitoring Report). Key elements: need for tighter monetary policy and maintenance of recently introduced exchange controls to prevent an exit of large non-resident krona holdings and preserve exchange rate stability after collapse of oversized banking sector left private sector debt at over 450 percent of GDP by end-2008; need for liberalization strategy to lift these controls to be appropriately sequenced and paced to avoid disorderly capital outflows that would put the krona under pressure. - Ukraine (2008 SBA request, 2011 Ex Post Evaluation). Key elements: recently introduced outflow CFMs as a temporary response to large capital outflows and sharp currency depreciation, to be removed as confidence returned; importance of: (i) tight fiscal and monetary policy; (ii) flexible exchange rate, while avoiding excessive depreciation; and (iii) restoring confidence in the banking system. (Under the 2010 IMF-supported program, most controls were in fact removed, and the Ex Post Evaluation in 2011 concluded that they had not been generally effective.) *GUIDANCE NOTE FOR THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS — INTERNATIONAL MONETARY FUND* ### Annex 3. Liberalization: Thresholds, Pre-Conditions, ### _042513 - Annex 3. Liberalization: Thresholds, Pre-Conditions, ### Preconditions for safe liberalization - Staff should analyze whether preconditions for safe liberalization are in place.1 - Key preconditions include: - Stable macroeconomic and financial conditions that also support flexibility. - 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 from carry trade and capital flight caused by depreciation expectations. - Building and maintaining macroeconomic and financial sector buffers can 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 reliance on 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. - Liberalizing and developing the financial sector, and ensuring sound governance and risk management in financial institutions, strengthens ability to deal with capital flows. - Evaluating banks’ resilience requires 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 the 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 can significantly contain risks of greater openness. - Cooperation agreements with supervisory authorities of other countries, particularly important source/destination countries, can 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 gain importance with 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 the risk that operations through the informal financial sector can undermine prudential effectiveness 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 can facilitate managing its risks. - Footnote: "These conditions need not be taken as given over time, and staff advice should aim to strengthen these conditions for managing capital flows safely and beneficially." ### Information sources and comparative analysis - Rely on a range of available sources of relevant information. - The macroeconomic assessment should be based on the analysis for bilateral and multilateral surveillance (see surveillance guidance note). - Staff should draw on examples of other similarly situated countries that have liberalized successfully. ### Risk assessment prior to CFM removal - Assess the risks that removal of the CFMs would pose to macroeconomic and financial stability. - Identify CFMs that are effective and assess the risks their liberalization would pose to the economy and financial sector. - Design reforms to support liberalization by eliminating or reducing identified risks. ### Sequencing of liberalizing reforms - Plan sequencing to match achievement of preconditions and thresholds to reduce risks. - Broad sequencing principle: "long term before short term, FDI and other non-debt before debt, and inflows before outflows." - Consider currency composition of financial assets as it may have stability implications. - Sequence must be calibrated to country-specific circumstances and allow flexibility and judgment, informed by dialogue between authorities and staff and expertise from MCM and others. - General sequencing reference points: - 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). - 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 used liberalization into traded securities to lengthen maturities (for example, initially allowing inflows only for long maturities). - In this stage, 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. ### Re-assessing and, if needed, re-imposing CFMs - Evaluate whether the current stage of liberalization is appropriate given benefits and risks and existing preconditions. - If liberalization has outpaced the economy’s capacity to safely handle resulting flows, re-imposition of CFMs may be warranted until sufficient progress is made on macroeconomic, financial, governance policies and market development recommended by the integrated approach. - If CFMs are re-introduced, prefer the least discriminatory measure that is effective. *Annex 3. Liberalization: Thresholds, Pre-Conditions,* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042513.pdf_