The IMF first adopted the Institutional View in 2012. The framework sought to provide a balanced and consistent approach to guide IMF’s policy advice to its member countries on issues of capital account liberalization and capital flow management.
Key principles. It recognized that capital flows are desirable because they can bring substantial benefits to recipient countries, but they can also result in macroeconomic challenges and financial stability risks.
It incorporated capital flow management measures (CFMs) and CFMs that are also macroprudential measures (CFM/MPMs) into the policy toolkit in a limited manner (during inflow surges and disruptive outflows), setting out the circumstances in which they might be useful, while stressing that they should not be a substitute for necessary macroeconomic adjustments.
It considered CFMs or CFM/MPMs useful to restrict inflows during inflow surges and on outflows when they risk causing a crisis.
It also provided guidance on capital flow liberalization while acknowledging that full liberalization is not an appropriate goal for all countries at all times.
The Review expands the policymakers’ toolkit by recognizing that pre-emptive use of CFM/MPMs on inflows may be useful even in the absence of a surge, if these inflows were to exacerbate existing stock vulnerabilities related to external debt.
The Review also allows for special treatment of certain categories of CFMs, which will not be guided by the advice outlined in the IV, such as those governed by separate international frameworks such as the Basel Framework, the standards by the Financial Action Task Force (FATF) to combat money laundering and the financing of terrorism, and certain international standards against the avoidance or evasion of taxes or introduced for national or international security reasons. These changes mainly aim to ensure that unintended conflicts do not arise between those international frameworks and the IV.
With respect to measures for national and international security reasons, the IV recognizes that the Fund is not an appropriate forum to discuss the security considerations that lead to the imposition of such measures although the economic impact of these measures may be relevant for the discussion between the country and the IMF.
Capital inflows can bring substantial benefits, helping smooth consumption and finance investment and growth, diversify risks, and contribute to a more efficient allocation of resources. They can also foster economic growth by facilitating the transfer of technology and managerial skills, stimulating financial sector developments, and generating incentives for better governance and stronger macroeconomic policy discipline.
At the same time, surges in capital inflows can lead to currency overvaluation, overheating, and financial stability risks by encouraging excessive borrowing and/or currency mismatches, and fueling asset price bubbles. When the inflows reverse, the economy may experience a financial crisis and a deep recession.
The 2012 IV already recognized the role of CFMs and CFM/MPMs on inflows to mitigate the risks associated with capital inflow surges, as well as CFMs on outflows during crises or imminent crisis situations.
The 2022 Review highlighted that financial stability risks may also arise from a gradual buildup of external debt, even in the absence of an inflow surge. These risks can arise from:
The accumulation of currency mismatches (i.e., liabilities denominated in foreign currency not matched by foreign assets or covered by hedges and maturity mismatches in FX denominated assets and liabilities).
In narrow and exceptional circumstances, they may also arise from the gradual buildup of large amounts of external debt denominated in local currency.
The Review recognizes that when these risks are present, the use of CFM/MPMs in a preemptive manner (i.e., outside of inflow surges) may play a useful role in mitigating them.
Differentiating CFMs and MPMs is important because they pursue different policy objectives, though these can sometimes overlap.
CFMs are measures designed to limit capital flows; while MPMs are primarily prudential measures designed to limit systemic financial risks. Assessments whether a measure is a CFM, an MPM, or a CFM/MPM is made based on all the relevant circumstances. Measures that are both CFMs and MPMs are called CFM/MPMs.
Example of CFMs on inflows: ceilings/limits on nonresident purchases of domestic securities (bonds, equity), ban on nonresident investments in certain sectors, higher stamp duties on nonresident purchases of houses than on resident purchases.
Examples of MPMs: loan-to-value limits and debt-to-income limits on bank lending, higher reserve requirements on FX liabilities of banks than on local currency liabilities, minimum capital requirements for financial institutions.
Examples of CFM/MPMs: limits on foreign borrowing by banks, higher reserve requirements on liabilities to nonresidents than on liabilities to residents.
