## _pdp02 ## Source details **Canonical URL:** [_pdp02](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf.json) --- ### Introduction - Capital inflows are generally beneficial to recipient countries but can complicate macroeconomic management by: - overheating the economy, - deteriorating the external balance, - increasing vulnerability to a change in market sentiment. - Periods of growing global liquidity amplify these challenges; for example, between early 2003 and mid-2007 there was abundant global liquidity. - Between early 2003 and mid-2007 many emerging market economies (EMEs) ran current account surpluses, further contributing to positive balance of payments (BOP) pressures. - Despite recent turmoil in financial markets, many EMEs continue to face positive capital flows and balance of payments pressures. - Institutional requests for guidance: - The International Monetary and Finance Committee called for work on the Fund's policy advice to emerging market economies (IMFC Communiqué, October 2007). - The IMF’s Executive Board called for additional research to provide guidance on policy choices. - Prior IMF work informing this paper: - The October 2007 WEO examines the impact of different policy measures across a large sample and concludes that nominal exchange rate appreciation and fiscal restraint are advisable during periods of large inflows as they limit real currency appreciation and foster better growth outcomes. - The October 2007 GFSR examined the relationship between capital flows, market depth, and liquidity. - Earlier studies include Schadler and others (1993) and Ul Haque and others (1997). - The paper builds a conceptual taxonomy to refine general policy prescriptions and recognizes the need to account for country-specific factors while still nuancing the general recommendations of allowing exchange rate appreciation and tightening fiscal policy during capital inflows. - The paper addresses three questions: - How should the policy response to capital surges in most EMEs be differentiated according to the source and magnitude of the BOP pressures? - Do EMEs respond to capital inflows as the taxonomy would suggest? - What is the effect of policy responses on the behavior of the real exchange rate? ### Conceptual considerations for policy response - Key determinants of whether and how to respond to inflows: - Exchange rate regime: a country with a floating exchange rate would simply allow appreciation in the face of positive BOP pressures, but many central banks are not indifferent to exchange rate levels because of inflationary pressures, balance sheet exposures, or competitiveness concerns. - Fiscal policy: even under flexible regimes, countries may wish to respond with fiscal policy adjustments. - Nature of capital flows: official versus private; FDI versus portfolio flows; fixed income versus equity. - Expected duration: temporary versus persistent. - Impact on domestic balance sheets: risk of exacerbating mismatches. - Net external asset/debt dynamics and the cyclical position of the economy. - Country-specific examples of differing preferences: - Capital-poor developing and EMEs may welcome inflows if debt sustainability and financial system soundness are not jeopardized. - Countries may wish to build up savings abroad because of aging populations or dependence on nonrenewable resource exports. ### Recent capital flows in emerging market economies — Stylized facts - Over the past couple of decades, capital flows to emerging markets have followed several cycles, with a generally rising trend until end-2007. - Two episodes of large inflows identified: - Early 1990s, which peaked prior to the 1997 East Asian crisis. - The period building since early 2002. - Measured magnitude: - Annual net capital inflows to EMEs averaged slightly over 4 percent of GDP during 2004–06. - These increases are a notch below the net capital inflows that preceded the East Asian crisis. - Four key differences of the recent surge versus previous ones: - It is occurring against a backdrop of current account surpluses—not deficits. - Private capital is playing a dominant role. - FDI accounts for a larger share of the total. - The macroeconomic situation in most recipient EMEs is stronger—public sector deficits are smaller, exchange rate regimes are more flexible, inflation is lower, and foreign exchange reserves are larger. - Regional differences in reserve increases: - Middle East: 8 percent of GDP - Asia: 4 percent of GDP - Central and South America: 2 percent of GDP - Europe: 1 percent of GDP ### Regional patterns and macro trends - Asia: the 1997–98 financial crisis shifted the current account balance from deficits of about 3 percent of GDP to surpluses of the same magnitude. - Asia, the Middle East, and Central and South America: real exchange rate appreciation often took the form of higher inflation. - Europe: reserve accumulation slow and inflation differentials small. - Europe (average pattern): large current account deficits financed initially by FDI until 2001; since then non-FDI flows account for about one half of total external financing. - Western Hemisphere and Middle East: current account balances improved but, on average, still in deficit; most inflows are in the form of FDI. - Aggregate outcomes (EMEs, average, period 2002–07): - CPI-based real exchange rates appreciated by 7 percent over the period 2002–07. - Reserves increased from about 18 percent of GDP at end-2002 to 22 percent of GDP by end-2007. - Inflationary pressures were subdued for much of the decade though picked up with rising commodity prices. ### Taxonomy of balance of payments (BOP) pressures (flow-based) - Two-dimensional mapping: net capital flows (vertical axis, excludes reserves transactions) and current account balances (horizontal axis), segmented into five cases: - Case 1. Capital Inflows Responding to Current Account Financing Needs (northwest quadrant below the 45 degree line). - Net BOP pressure negative (net total capital flows plus current account balance). - Concerns: debt sustainability and exposure to sudden stops, especially if inflows are non-FDI. - Policy aim: reduce current account imbalance and cool the economy. - Case 2. Capital Inflows in Search of Yield (northwest and northeast quadrants above 45 degree lines). - Net total capital flows driven by supply-side factors (abundant liquidity in search of yield). - BOP pressures dominated by capital inflows irrespective of current account sign. - Policy aim: reduce capital inflows and complicating macroeconomic management. - Case 3. BOP Pressures from Current Account Surplus (northeast quadrant under 45 degree line and southeast quadrant with positive BOP pressures). - Current account surplus dominates; small capital outflows can still represent positive BOP pressures. - Policy aim: narrow excessive surplus or encourage capital outflows if surplus appropriate. - Case 4. Current Account Surplus Offset by Outflows (southeast quadrant under 45 degree line): outflows offset surplus — negative BOP pressures. - Case 5. Pre-Crisis Region (southwest quadrant): large capital outflows and current account deficits, potentially portending a capital account crisis. ### Descriptive statistics (Table 1, 1989–2007 and 1999–2007; In percent of GDP) - Case 1 (1989-2007 / 1999-2007) - Number of observations: 181 / 181 - Mean: Current account balance -6.83 / -5.5 ; Total capital flows 3.9 / 3.8 ; BOP pressures -2.9 / -1.8 - Standard deviation: Current account 7.5 / 4.0 ; Total capital flows 4.1 / 3.1 ; BOP pressures 6.4 / 2.2 - Case 2 (1989-2007 / 1999-2007) - Number of observations: 447 / 223 - Mean: Current account balance -3.7 / -4.1 ; Total capital flows 7.0 / 7.7 ; BOP pressures 3.3 / 3.5 - Standard deviation: Current account 4.3 / 5.3 ; Total capital flows 5.7 / 6.1 ; BOP pressures 3.6 / 3.2 - Case 3 (1989-2007 / 1999-2007) - Number of observations: 158 / 112 - Mean: Current account balance 6.3 / 7.0 ; Total capital flows -1.8 / -2.1 ; BOP pressures 4.5 / 4.9 - Standard deviation: Current account 5.3 / 5.7 ; Total capital flows 4.2 / 4.6 ; BOP pressures 3.4 / 3.5 - Case 4 (1989-2007 / 1999-2007) - Number of observations: 38 / 20 - Mean: Current account balance 3.6 / 5.1 ; Total capital flows -5.8 / -7.3 ; BOP pressures -2.1 / -2.2 - Standard deviation: Current account 3.2 / 3.5 ; Total capital flows 4.2 / 5.0 ; BOP pressures 2.8 / 3.3 - Case 5 (1989-2007 / 1999-2007) - Number of observations: 36 / 14 - Mean: Current account balance -3.1 / -1.6 ; Total capital flows -1.7 / -1.8 ; BOP pressures -4.8 / -3.3 - Standard deviation: Current account 3.4 / 1.5 ; Total capital flows 1.4 / 1.7 ; BOP pressures 3.4 / 1.7 - Source noted in table: IMF, World Economic Outlook. ### Expected policy responses by case (flow approach) - Case 1 (capital inflows responding to current account financing needs) - Limit nominal exchange rate appreciation. - Sterilize reserves accumulation. - Tighten fiscal policy. - Tighten monetary policy. - Do not impose controls on inflows (unless inflows fuel the deficit or external sustainability is a concern). - Case 2 (capital inflows in search of yield) - Allow limited nominal exchange rate appreciation. - Do not sterilize reserves accumulation (sterilization likely unsuitable). - Tighten fiscal policy. - Do not tighten monetary policy. - Relax controls on capital outflows. - Possibly impose controls on inflows (effectiveness limited; costs high). - Case 3 (BOP pressures from current account surplus) - Allow nominal exchange rate appreciation. - Do not sterilize reserves accumulation. - Do not tighten fiscal policy (loosening fiscal policy may be appropriate if surplus excessive). - Do not tighten monetary policy. - Possibly relax controls on outflows. ### Modifying considerations and caveats - The taxonomy is flow-based and does not explicitly account for net foreign asset position dynamics or the cyclical position of the economy; empirical work includes controls for these factors. - Policy options should be considered as a package and tailored to country-specific factors (balance sheets, cyclical positions, financial and institutional characteristics). - If external sustainability is not a concern and the economy is well below potential, Case 1 policy prescription may be overturned (expansionary policies could be appropriate while avoiding nominal appreciation). - Controls on inflows may be justified in blended cases where inflows fuel the current account deficit; prudential measures and targeted tax measures have trade-offs (distortions, administrative costs). ### Empirical evidence on observed policy responses (1999–2007 and high global liquidity periods) - Exchange rate behavior: - Once controls added (output gap, external liquidity, solvency, exchange rate regime), observed pattern: Case 1 countries have the least nominal exchange rate appreciation, followed by Case 2 and Case 3. - Case 3 countries experience the largest appreciation pressures when global liquidity is high. - Exchange rate volatility: Case 1 allows the lowest volatility and Case 3 the largest. - Monetary policy and sterilization: - All three cases show some monetary loosening on average; Case 1 has the least loosening, followed by Case 3; greatest loosening among Case 2 countries. - Sterilization occurs partially in all cases; least sterilization in Case 2 (columns close to zero where -1 implies full sterilization and 0 implies no sterilization). - Fiscal policy: - During high global liquidity, fiscal tightening per unit of BOP pressures is greatest in Case 1, followed by Case 2, and least in Case 3. - Real exchange rate outcomes: - Case 1: smallest real exchange rate appreciation per unit of BOP pressure and small depreciation when global liquidity is high. - Case 2: slightly greater real appreciation, especially in high global liquidity. - Case 3: greatest real exchange rate appreciation when global liquidity is high. - Data and estimation: - Results based on an unbalanced panel dataset of 50 EMEs using annual data over 1999–2007. - Columns with controls derived from fixed effects estimation with time dummies; controls include lagged economic policies and initial conditions (output gap, short-term debt-to-reserves, debt-to-GDP, inflation, exchange rate regime). - Periods of high global liquidity identified where growth rate of capital flows to EMEs exceeds GDP growth rates in advanced economies (G7 only) by more than 10 percent (per WEO April 2007 methodology). ### Conclusions and policy implications - Recent capital inflows and large current account surpluses have produced positive BOP pressures in many EMEs; in other cases, inflows financed current imbalances. - Depending on net foreign asset dynamics, reserves, form of flows, domestic balance sheets, and cyclical position, capital inflows can be benign or pose challenges requiring policy action. - The flow-based taxonomy provides structured guidance on tailoring policy responses; correspondence exists between taxonomy prescriptions and observed EME policies—especially during high global liquidity episodes. - Remaining challenges: - Determining the appropriate "level" for policy instruments (not just relative patterns). - Anticipating transitions in taxonomy classification over relevant horizons. - Accounting for country-specific factors not captured (e.g., financial soundness indicators). - Further research on the effectiveness of capital controls, particularly given financial innovation and globalization. ### Appendix I. Market Access Developing Countries in Sample - Countries in sample: - ArgentinaKorea - Azerbaijan, Rep. ofLatvia - BrazilLebanon - Bulgaria Lithuania - ChileMalaysia - China, P. R.Mexico - ColombiaMorocco - Costa Rica Pakistan - CroatiaPeru - Czech RepublicPhilippines - Dominican RepublicPoland - EcuadorRomania - EgyptRussia - El Salvador Slovak Republic - Estonia Slovenia - Guatemala South Africa - Hong KongSri Lanka - Hungary Thailand - IndiaTrinidad and Tobago - Indonesia Tunisia - Iran, I. R. ofTurkey - Israel Ukraine - Jamaica Uruguay - JordanVenezuela, Rep. Bol. - Kazakhstan Vietnam ### References (selected from source) - Cardenas, M. and F. Barrera, 1997, “On the Effectiveness of Capital Controls: The Experience of Colombia during the 1990s,” Journal of Development Economics, Vol. 54, Issue 1, pp 27–58. - Cardoso, Eliana and Ilan Goldfajn, 1998, “Capital Flows to Brazil: the Endogeneity of Capital Controls,” IMF Staff Papers, Vol. 45, No. 1, pp 161–202. - Cordella, Tito, 2003, “Can Short-term Capital Controls Promote Capital Inflows?” Journal of International Money and Finance, Vol. 22, pp. 737–745. - Dooley, Michael, 1995, “A Survey of Academic Literature on Controls over International Capital Transactions,” NBER Working Paper No. 5352. - Edwards, Sebastian, 1999, “How Effective Are Capital Controls?,” Journal of Economic Perspectives, Vol. 13, No. 4, pp 65–84. - Ghosh, Atish, 1995, “Capital Mobility Among the Major Industrialized Countries: Too Little or Too Much?” Economic Journal, 105, pp. 107–28. - International Monetary Fund, 2000, “Capital Controls: Country Experiences with Their Use and Liberalization,” International Monetary Fund, Occasional Paper No. 190. - ———, 2007 (April), World Economic Outlook (Washington, D.C.: International Monetary Fund). - ———, 2007 (October), World Economic Outlook (Washington, D.C.: International Monetary Fund). - ———, 2007 (October), Global Financial Stability Report (Washington, D.C.: International Monetary Fund). - Schadler, Susan, Maria Cakovic, Adam Bennett, and Robert Kahn, 1993, “Recent Experiences with Surges in Capital Inflows,” International Monetary Fund, Occasional Paper No. 108. - Ul Haque, Nadeem, Donald Mathieson, and Sunil Sharma, 1997, “Causes of Capital Inflows and Policy Responses to Them,” Finance and Development (March), pp. 3–6. *Source: _pdp02 - References (PDF), https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf* ### References.............................................................................................................. ### _pdp02 - References.............................................................................................................. ### Introduction - Capital inflows are generally beneficial to recipient countries but can complicate macroeconomic management by: - overheating the economy, - deteriorating the external balance, - increasing vulnerability to a change in market sentiment. - Periods of growing global liquidity amplify these challenges; for example, between early 2003 and mid-2007 there was abundant global liquidity. - Between early 2003 and mid-2007 many emerging market economies (EMEs) ran current account surpluses, further contributing to positive balance of payments (BOP) pressures. - Despite recent turmoil in financial markets, many EMEs continue to face positive capital flows and balance of payments pressures. - Institutional requests for guidance: - The International Monetary and Finance Committee called for work on the Fund's policy advice to emerging market economies (IMFC Communiqué, October 2007). - The IMF’s Executive Board called for additional research to provide guidance on policy choices. - Prior IMF work informing this paper: - The October 2007 WEO examines the impact of different policy measures across a large sample and concludes that nominal exchange rate appreciation and fiscal restraint are advisable during periods of large inflows as they limit real currency appreciation and foster better growth outcomes. - The October 2007 GFSR examined the relationship between capital flows, market depth, and liquidity. - Earlier studies include Schadler and others (1993) and Ul Haque and others (1997). - The paper builds a conceptual taxonomy to refine general policy prescriptions and recognizes the need to account for country-specific factors while still nuancing the general recommendations of allowing exchange rate appreciation and tightening fiscal policy during capital inflows. - The paper addresses three questions: - How should the policy response to capital surges in most EMEs be differentiated according to the source and magnitude of the BOP pressures? - Do EMEs respond to capital inflows as the taxonomy would suggest? - What is the effect of policy responses on the behavior of the real exchange rate? ### Conceptual considerations for policy response - Key determinants of whether and how to respond to inflows: - Exchange rate regime: a country with a floating exchange rate would simply allow appreciation in the face of positive BOP pressures, but many central banks are not indifferent to exchange rate levels because of inflationary pressures, balance sheet exposures, or competitiveness concerns. - Fiscal policy: even under flexible regimes, countries may wish to respond with fiscal policy adjustments. - Nature of capital flows: official versus private; FDI versus portfolio flows; fixed income versus equity. - Expected duration: temporary versus persistent. - Impact on domestic balance sheets: risk of exacerbating mismatches. - Net external asset/debt dynamics and the cyclical position of the economy. - Country-specific examples of differing preferences: - Capital-poor developing and EMEs may welcome inflows if debt sustainability and financial system soundness are not jeopardized. - Countries may wish to build up savings abroad because of aging populations or dependence on nonrenewable resource exports. ### Recent capital flows in emerging market economies — Stylized facts - Over the past couple of decades, capital flows to emerging markets have followed several cycles, with a generally rising trend until end-2007. - Two episodes of large inflows identified: - Early 1990s, which peaked prior to the 1997 East Asian crisis. - The period building since early 2002. - Measured magnitude: - Annual net capital inflows to EMEs averaged slightly over 4 percent of GDP during 2004–06. - These increases are a notch below the net capital inflows that preceded the East Asian crisis. - Four key differences of the recent surge versus previous ones: - It is occurring against a backdrop of current account surpluses—not deficits. - Private capital is playing a dominant role. - FDI accounts for a larger share of the total. - The macroeconomic situation in most recipient EMEs is stronger—public sector deficits are smaller, exchange rate regimes are more flexible, inflation is lower, and foreign exchange reserves are larger. - Regional differences in reserve increases (as reported): - Middle East: 8 percent of GDP - Asia: 4 percent of GDP - Central and South America: 2 percent of GDP - Europe: 1 percent of GDP ### Structure and scope of the paper - Organization: - Section II discusses stylized facts on recent capital flows to EMEs. - Section III presents a conceptual taxonomy based on the nature and source of BOP pressures and discusses policy responses for each category, and examines whether observed policy choices are consistent with the taxonomy’s predictions. - Section IV concludes. - Data and coverage note: - Discussion in the paper is based on simple averages for 50 “market access” EMEs; see Appendix I for the list of countries. - Reference to indicators and earlier analysis: - Periods of high global liquidity are identified based on the indicators in World Economic Outlook (April 2007). - See World Economic Outlook (October 2007) for more details on related findings. *Source: _pdp02 - References (PDF), https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf* ### 1. Moreover, while most regions experienced real exchange rate appreciation, in Asia, the ### _pdp02 - 1. Moreover, while most regions experienced real exchange rate appreciation, in Asia, the ### Regional patterns and macro trends - Asia: the 1997–98 financial crisis shifted the current account balance from deficits of about 3 percent of GDP to surpluses of the same magnitude. - Asia, the Middle East, and Central and South America: real exchange rate appreciation often took the form of higher inflation. - Europe: reserve accumulation slow and inflation differentials small. - Europe (average pattern): large current account deficits financed initially by FDI until 2001; since then non-FDI flows account for about one half of total external financing. - Western Hemisphere and Middle East: current account balances improved but, on average, still in deficit; most inflows are in the form of FDI. - Aggregate outcomes (EMEs, average, period 2002–07): - CPI-based real exchange rates appreciated by 7 percent over the period 2002–07. - Reserves increased from about 18 percent of GDP at end-2002 to 22 percent of GDP by end-2007. - Inflationary pressures were subdued for much of the decade though picked up with rising commodity prices. ### Taxonomy of balance of payments (BOP) pressures (flow-based) - Two-dimensional mapping: net capital flows (vertical axis, excludes reserves transactions) and current account balances (horizontal axis), segmented into five cases: - Case 1. Capital Inflows Responding to Current Account Financing Needs (northwest quadrant below the 45 degree line). - Net BOP pressure negative (net total capital flows plus current account balance). - Concerns: debt sustainability and exposure to sudden stops, especially if inflows are non-FDI. - Policy aim: reduce current account imbalance and cool the economy. - Case 2. Capital Inflows in Search of Yield (northwest and northeast quadrants above 45 degree lines). - Net total capital flows driven by supply-side factors (abundant liquidity in search of yield). - BOP pressures dominated by capital inflows irrespective of current account sign. - Policy aim: reduce capital inflows and complicating macroeconomic management. - Case 3. BOP Pressures from Current Account Surplus (northeast quadrant under 45 degree line and southeast quadrant with positive BOP pressures). - Current account surplus dominates; small capital outflows can still represent positive BOP pressures. - Policy aim: narrow excessive surplus or encourage capital outflows if surplus appropriate. - Case 4. Current Account Surplus Offset by Outflows (southeast quadrant under 45 degree line): outflows offset surplus — negative BOP pressures. - Case 5. Pre-Crisis Region (southwest quadrant): large capital outflows and current account deficits, potentially portending a capital account crisis. ### Descriptive statistics (Table 1, 1989–2007 and 1999–2007; In percent of GDP) - Case 1 (1989-2007 / 1999-2007) - Number of observations: 181 / 181 - Mean: Current account balance -6.83 / -5.5 ; Total capital flows 3.9 / 3.8 ; BOP pressures -2.9 / -1.8 - Standard deviation: Current account 7.5 / 4.0 ; Total capital flows 4.1 / 3.1 ; BOP pressures 6.4 / 2.2 - Case 2 (1989-2007 / 1999-2007) - Number of observations: 447 / 223 - Mean: Current account balance -3.7 / -4.1 ; Total capital flows 7.0 / 7.7 ; BOP pressures 3.3 / 3.5 - Standard deviation: Current account 4.3 / 5.3 ; Total capital flows 5.7 / 6.1 ; BOP pressures 3.6 / 3.2 - Case 3 (1989-2007 / 1999-2007) - Number of observations: 158 / 112 - Mean: Current account balance 6.3 / 7.0 ; Total capital flows -1.8 / -2.1 ; BOP pressures 4.5 / 4.9 - Standard deviation: Current account 5.3 / 5.7 ; Total capital flows 4.2 / 4.6 ; BOP pressures 3.4 / 3.5 - Case 4 (1989-2007 / 1999-2007) - Number of observations: 38 / 20 - Mean: Current account balance 3.6 / 5.1 ; Total capital flows -5.8 / -7.3 ; BOP pressures -2.1 / -2.2 - Standard deviation: Current account 3.2 / 3.5 ; Total capital flows 4.2 / 5.0 ; BOP pressures 2.8 / 3.3 - Case 5 (1989-2007 / 1999-2007) - Number of observations: 36 / 14 - Mean: Current account balance -3.1 / -1.6 ; Total capital flows -1.7 / -1.8 ; BOP pressures -4.8 / -3.3 - Standard deviation: Current account 3.4 / 1.5 ; Total capital flows 1.4 / 1.7 ; BOP pressures 3.4 / 1.7 - Source noted in table: IMF, World Economic Outlook. ### Expected policy responses by case (flow approach; summary of Figure 3) - Case 1 (capital inflows responding to current account financing needs) - Limit nominal exchange rate appreciation. - Sterilize reserves accumulation. - Tighten fiscal policy. - Tighten monetary policy. - Do not impose controls on inflows (unless inflows fuel the deficit or external sustainability is a concern). - Case 2 (capital inflows in search of yield) - Allow limited nominal exchange rate appreciation. - Do not sterilize reserves accumulation (sterilization likely unsuitable). - Tighten fiscal policy. - Do not tighten monetary policy. - Relax controls on capital outflows. - Possibly impose controls on inflows (effectiveness limited; costs high). - Case 3 (BOP pressures from current account surplus) - Allow nominal exchange rate appreciation. - Do not sterilize reserves accumulation. - Do not tighten fiscal policy (loosening fiscal policy may be appropriate if surplus excessive). - Do not tighten monetary policy. - Possibly relax controls on outflows. ### Modifying considerations and caveats - The taxonomy is flow-based and does not explicitly account for net foreign asset position dynamics or the cyclical position of the economy; empirical work includes controls for these factors. - Policy options should be considered as a package and tailored to country-specific factors (balance sheets, cyclical positions, financial and institutional characteristics). - If external sustainability is not a concern and the economy is well below potential, Case 1 policy prescription may be overturned (expansionary policies could be appropriate while avoiding nominal appreciation). - Controls on inflows may be justified in blended cases where inflows fuel the current account deficit; prudential measures and targeted tax measures have trade-offs (distortions, administrative costs). ### Empirical evidence on observed policy responses (1999–2007 and high global liquidity periods) - Exchange rate behavior: - Once controls added (output gap, external liquidity, solvency, exchange rate regime), observed pattern: Case 1 countries have the least nominal exchange rate appreciation, followed by Case 2 and Case 3. - Case 3 countries experience the largest appreciation pressures when global liquidity is high. - Exchange rate volatility: Case 1 allows the lowest volatility and Case 3 the largest. - Monetary policy and sterilization: - All three cases show some monetary loosening on average; Case 1 has the least loosening, followed by Case 3; greatest loosening among Case 2 countries. - Sterilization occurs partially in all cases; least sterilization in Case 2 (columns close to zero where -1 implies full sterilization and 0 implies no sterilization). - Fiscal policy: - During high global liquidity, fiscal tightening per unit of BOP pressures is greatest in Case 1, followed by Case 2, and least in Case 3. - Real exchange rate outcomes: - Case 1: smallest real exchange rate appreciation per unit of BOP pressure and small depreciation when global liquidity is high. - Case 2: slightly greater real appreciation, especially in high global liquidity. - Case 3: greatest real exchange rate appreciation when global liquidity is high. - Data and estimation: - Results based on an unbalanced panel dataset of 50 EMEs using annual data over 1999–2007. - Columns with controls derived from fixed effects estimation with time dummies; controls include lagged economic policies and initial conditions (output gap, short-term debt-to-reserves, debt-to-GDP, inflation, exchange rate regime). - Periods of high global liquidity identified where growth rate of capital flows to EMEs exceeds GDP growth rates in advanced economies (G7 only) by more than 10 percent (per WEO April 2007 methodology). ### Conclusions and policy implications - Recent capital inflows and large current account surpluses have produced positive BOP pressures in many EMEs; in other cases, inflows financed current imbalances. - Depending on net foreign asset dynamics, reserves, form of flows, domestic balance sheets, and cyclical position, capital inflows can be benign or pose challenges requiring policy action. - The flow-based taxonomy provides structured guidance on tailoring policy responses; correspondence exists between taxonomy prescriptions and observed EME policies—especially during high global liquidity episodes. - Remaining challenges: - Determining the appropriate "level" for policy instruments (not just relative patterns). - Anticipating transitions in taxonomy classification over relevant horizons. - Accounting for country-specific factors not captured (e.g., financial soundness indicators). - Further research on the effectiveness of capital controls, particularly given financial innovation and globalization. *Source: IMF, World Economic Outlook.* ### Appendix I. Market Access Developing Countries in Sample ### Appendix I. Market Access Developing Countries in Sample ### Countries in sample - ArgentinaKorea - Azerbaijan, Rep. ofLatvia - BrazilLebanon - Bulgaria Lithuania - ChileMalaysia - China, P. R.Mexico - ColombiaMorocco - Costa Rica Pakistan - CroatiaPeru - Czech RepublicPhilippines - Dominican RepublicPoland - EcuadorRomania - EgyptRussia - El Salvador Slovak Republic - Estonia Slovenia - Guatemala South Africa - Hong KongSri Lanka - Hungary Thailand - IndiaTrinidad and Tobago - Indonesia Tunisia - Iran, I. R. ofTurkey - Israel Ukraine - Jamaica Uruguay - JordanVenezuela, Rep. Bol. - Kazakhstan Vietnam ### References - Cardenas, M. and F. Barrera, 1997, “On the Effectiveness of Capital Controls: The Experience of Colombia during the 1990s,” Journal of Development Economics, Vol. 54, Issue 1, pp 27–58. - Cardoso, Eliana and Ilan Goldfajn, 1998, “Capital Flows to Brazil: the Endogeneity of Capital Controls,” IMF Staff Papers, Vol. 45, No. 1, pp 161–202. - Cordella, Tito, 2003, “Can Short-term Capital Controls Promote Capital Inflows?” Journal of International Money and Finance, Vol. 22, pp. 737–745. - Dooley, Michael, 1995, “A Survey of Academic Literature on Controls over International Capital Transactions,” NBER Working Paper No. 5352. - Edwards, Sebastian, 1999, “How Effective Are Capital Controls?,” Journal of Economic Perspectives, Vol. 13, No. 4, pp 65–84. - Ghosh, Atish, 1995, “Capital Mobility Among the Major Industrialized Countries: Too Little or Too Much?” Economic Journal, 105, pp. 107–28. - International Monetary Fund, 2000, “Capital Controls: Country Experiences with Their Use and Liberalization,” International Monetary Fund, Occasional Paper No. 190. - ———, 2007 (April), World Economic Outlook (Washington, D.C.: International Monetary Fund). - ———, 2007 (October), World Economic Outlook (Washington, D.C.: International Monetary Fund). - ———, 2007 (October), Global Financial Stability Report (Washington, D.C.: International Monetary Fund). - Schadler, Susan, Maria Cakovic, Adam Bennett, and Robert Kahn, 1993, “Recent Experiences with Surges in Capital Inflows,” International Monetary Fund, Occasional Paper No. 108. - Ul Haque, Nadeem, Donald Mathieson, and Sunil Sharma, 1997, “Causes of Capital Inflows and Policy Responses to Them,” Finance and Development (March), pp. 3–6. *Source: _pdp02 - Appendix I. Market Access Developing Countries in Sample* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/pdp/2008/_pdp02.pdf_