## All Hands on Deck: Confronting the Challenges of Capital Flows

_IMF Blog, August 2, 2017_

## Source details

**Canonical URL:** [All Hands on Deck: Confronting the Challenges of Capital Flows](https://www.imf.org/en/blogs/articles/2017/08/02/all-hands-on-deck-confronting-the-challenges-of-capital-flows)

## Other formats

- [Markdown version](/en/blogs/articles/2017/08/02/all-hands-on-deck-confronting-the-challenges-of-capital-flows/index.md)
- [Structured JSON version](/en/blogs/articles/2017/08/02/all-hands-on-deck-confronting-the-challenges-of-capital-flows/index.json)
- [Bundle manifest](/en/blogs/articles/2017/08/02/all-hands-on-deck-confronting-the-challenges-of-capital-flows/bundle-manifest.json)

## Bibliographic details
- Authors: Atish Rex Ghosh, Jonathan D Ostry, Mahvash S Qureshi
- Published: August 2, 2017

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### Overview
- Authors: Atish Rex Ghosh, Jonathan D. Ostry, Mahvash S. Qureshi.
- Date: August 2, 2017.
- Data: Quarterly data over 2005–13.
- Central question: Do emerging market economies adopt a proactive approach in practice to manage capital inflows and avoid crises when flows recede?

### Menu of policies
- Five policy tools available to emerging market policymakers:
  - Monetary policy.
  - Fiscal policy.
  - Exchange rate policy (including foreign exchange intervention).
  - Macro-prudential measures (examples: reserve requirements, capital adequacy ratios, dynamic loan loss provisioning).
  - Capital controls (on inflows and outflows).
- Mapping of instruments to risks:
  - Monetary and fiscal policies address inflation and economic overheating.
  - Foreign exchange intervention limits currency appreciation that threatens competitiveness when the currency is not undervalued.
  - Macroprudential measures curb excessive credit growth and related financial stability risks.
  - Capital inflow controls limit volume of inflows or tilt composition toward less risky liabilities.
  - Capital outflow controls can be relaxed to lower net flows and reduce overheating and appreciation pressures.

### Proactive central bank response
- Finding: Emerging markets’ central banks respond to capital flow volatility rather than remain indifferent.
- Foreign exchange intervention:
  - Reserve accumulation strongly corresponds to net inflows.
  - On average, emerging markets’ central banks purchase some 30–40 percent of the inflow.
  - Heavier intervention observed in some Asian and Latin American economies (examples: India, Indonesia, Malaysia, Brazil, Peru).
  - Lower intervention observed in others (examples: Mexico, South Africa).
- Monetary policy:
  - Capital inflows elicit higher policy rates on average.
  - The monetary response depends on inflation, the output gap, and the real exchange rate.
  - Policy rates are raised in response to higher inflation or a larger output gap (counter-cyclical stance).
  - Policy rates are lowered in response to real exchange rate appreciation.

### Procyclical fiscal policy
- Finding: Fiscal policy stance is strongly procyclical in the face of capital inflows.
- Observed behavior:
  - Government consumption expenditure rises as capital inflows surge.
  - Government consumption expenditure falls as capital inflows decrease.
- Possible explanations:
  - Political economy constraints.
  - Difficulty accessing international credit markets in bad times.

### Less orthodox policies (macroprudential measures and capital controls)
- General pattern:
  - Macroprudential measures and capital controls on inflows are generally tightened as inflows surge and relaxed when flows recede.
- Cross-country variation:
  - Countries that tend to tighten these measures more often include Brazil, Korea, Turkey.
- Capital outflow controls:
  - These measures are relaxed when inflows surge, but primarily in countries without fully open capital accounts (examples: India, South Africa).

### Natural mapping between risks and instruments
- Observed correspondences:
  - Foreign exchange intervention is generally used when the real effective exchange rate is appreciating.
  - Monetary policy tightening is driven more by the output gap.
  - Macroprudential measures are deployed in response to rapid domestic credit growth.
  - Inflow controls are tightened when both credit growth and currency appreciation are concerns.

### Bottom line and open questions
- Summary findings:
  - Many emerging markets have internalized the need to manage capital flows to benefit from financial globalization while minimizing risks.
  - Emerging markets typically deploy a combination of instruments, with some correspondence between the nature of the risk and the tool deployed.
  - Important differences in policy response persist across countries, even in similar macroeconomic circumstances.
- Implication: Structural characteristics and political economy considerations likely shape country-specific policy responses.
- Open research question: Whether active policy management by emerging economies has contributed to fewer financial crises in recent years remains to be determined; future research is needed.

*Source: All Hands on Deck: Confronting the Challenges of Capital Flows, Atish Rex Ghosh, Jonathan D. Ostry, Mahvash S. Qureshi, August 2, 2017.*

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## References

- [recent research](https://www.imf.org/en/Publications/WP/Issues/2017/03/27/Managing-the-Tide-How-Do-Emerging-Markets-Respond-to-Capital-Flows-44766)
- [https://www.imf.org/wp-content/uploads/2017/07/ENG_Jul_19_capital_flows_1.jpg](https://www.imf.org/wp-content/uploads/2017/07/ENG_Jul_19_capital_flows_1.jpg)
- [https://www.imf.org/wp-content/uploads/2017/07/ENG_Jul_19_capital_flows_2.jpg](https://www.imf.org/wp-content/uploads/2017/07/ENG_Jul_19_capital_flows_2.jpg)

_Source: https://www.imf.org/en/blogs/articles/2017/08/02/all-hands-on-deck-confronting-the-challenges-of-capital-flows_