Why the IMF is Updating its View on Capital Flows

IMF Blog, March 30, 2022

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Authors: Tobias Adrian, Gita Gopinath, Pierre-Olivier Gourinchas, Ceyla Pazarbasioglu, Rhoda Weeks-Brown
Published: March 30, 2022

Publication date: March 30, 2022.
Authors: Tobias Adrian, Gita Gopinath, Pierre-Olivier Gourinchas, Ceyla Pazarbasioglu, Rhoda Weeks-Brown.
Core message: The IMF updated its Institutional View to give countries more flexibility to introduce measures that lie at the intersection of capital flow management measures (CFMs) and macroprudential measures (MPMs) — referred to as CFM/MPMs — including the option to apply some of these measures pre-emptively to safeguard macroeconomic and financial stability.

Capital flows deliver benefits (growth, risk sharing) but can also cause macroeconomic challenges and financial stability risks, especially for economies with large external debts.
External liabilities are riskiest when they generate currency mismatches: external debt is in foreign currency and is not offset by foreign currency assets or hedges.
Recent episodes highlighted: dramatic capital outflows at the start of the global pandemic; turbulence following the war in Ukraine.
Since the beginning of the pandemic many countries have spent to support the recovery, leading to a build-up of their external debt; in some cases increases in foreign currency debt were not offset by foreign currency assets or hedges.
Research findings: risks to financial stability can arise from a gradual buildup of external debt denominated in foreign currency even without an inflow surge; in narrow and exceptional cases, risks can also arise from external debt denominated in local currency.
Global financial intermediation is evolving beyond the banking system, which can limit the effectiveness of MPMs alone to contain risks (e.g., foreign currency borrowing of non-financial corporates and shadow banks).

The IMF first adopted the Institutional View in 2012 when many emerging markets faced large and volatile capital flows.
The 2012 Institutional View reflected lessons from the financial crises of the 1990s and the global financial crisis of 2008-09.
Core principles maintained: capital flows are desirable but can create macroeconomic and financial-stability challenges; the role of source countries and international cooperation is important.
The review preserves existing advice on liberalization, the use of CFMs and CFM/MPMs during inflow surges, and CFMs during disruptive outflows.

The main change: addition of CFM/MPMs that can be applied pre-emptively, even when there is no surge in capital inflows.
Rationale: informed by the Integrated Policy Framework (IPF) and related research that systematize policy options and tradeoffs given country-specific characteristics.
Purpose: pre-emptive CFM/MPMs to restrict inflows can mitigate risks from external debt buildup and financial-stability threats.
Constraints and cautions:
- Such measures should not be used in a manner that leads to excessive distortions.
- They should not substitute for necessary macroeconomic and structural policies.
- They should not be used to keep currencies excessively weak.

Some CFMs receive special treatment and are not governed by the Institutional View’s general policy advice because they are covered by separate international frameworks or are introduced for specific non-economic considerations.
Categories given special treatment include:
- Certain macroprudential measures imposed in line with the Basel framework.
- Tax measures based on certain international cooperation standards against the avoidance or evasion of taxes.
- Measures implemented in line with international standards to combat money laundering and financing of terrorism.
- Measures introduced for national or international security reasons.

The review explains how to use the IPF to inform key judgments under the Institutional View, including:
- Relating the nature of shocks and relevant market imperfections to the necessary macroeconomic adjustments.
- Practical guidance for policy advice related to CFMs, such as how to identify capital inflow surges, how to decide whether it is premature to liberalize capital flows, and which CFMs are significant enough to highlight in surveillance.

The Institutional View remains a living framework: it will continue to be informed by advances in research, global developments, and members’ experiences.
Objective of the update: expand the policy toolkit for policymakers, particularly in emerging and developing countries, so they can preserve macroeconomic and financial stability while reaping the benefits of capital flows.

Source: IMF blog post “Why the IMF is Updating its View on Capital Flows,” March 30, 2022.