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Managing Capital Flows in Frontier Economies

There has been a remarkable increase in financial flows to frontier economies from private sources which, in relation to their economic size, are now on par with those to emerging economies (see chart).

Ostry Capital Flows

These large private flows can be volatile—responding strongly to changes in global conditions—as emerging economies’ experience has shown, and generate financial-stability and macroeconomic risks.

The anticipated rise in U.S. interest rates sometime this year is thus expected to create macroeconomic volatility for both emerging and frontier economies. How policymakers in frontier economies can navigate this uncharted territory of volatility and risks from capital flows, and what is the optimal pace and degree of financial liberalization that they should pursue to meet their developmental objectives are pressing policy questions confronting many of these countries.

To debate the issues and policies, and benefit from peer-to-peer learning, the IMF recently brought together experts from both emerging and frontier economies.

Here are some key insights that emerged from the discussions: 

So where do we go from here? The discussions at the conference highlighted that while progress has been made in recent years in thinking about the liberalization and management of capital flows, many questions remain subject to debate.

Is more liberalization always desirable, or might it frustrate other economic goals, including income convergence with high-income countries? Does full liberalization expose FMs to a greater risk of destabilizing shocks that are difficult to manage in practice, and outweigh the benefits of financial integration, or can such risks be offset by more vigorous deployment of different policy tools? What is the role, right combination, and possible effectiveness of the different policy tools—including foreign exchange intervention and capital controls—to manage capital flow volatility?

Clearly, we need more research and debate to explore these issues. The conference was a step in the right direction. We have much to gain from peer-to-peer discussions, and the exchange of information on policy options among policymakers, as well as from debating these issues more broadly with academics and financial sector experts.