Managing Capital Flows: Lessons from Emerging Markets for Frontier Economies
IMF News, March 2, 2015
Source details
- Canonical URL
- Managing Capital Flows: Lessons from Emerging Markets for Frontier Economies
Other formats
Bibliographic details
- Authors: David Lipton First Deputy Managing Director
- Published: March 2, 2015
Overview
- By David Lipton, First Deputy Managing Director, International Monetary Fund.
- Balaclava, Mauritius, March 2, 2015.
- Conference focus: applying lessons from emerging markets to frontier economies as they attract rising volumes and diversity of private capital.
Context and motivation
- Post-global financial crisis context: sizable inflows to emerging markets driven by quantitative easing, unconventional monetary policies, and widening growth differentials with advanced economies.
- IMF work program culminating in an “Institutional View on the Liberalization and Management of Capital Flows” endorsed in 2012, building on analytical work shared at a 2011 conference.
- Rationale for focus on frontier economies: “just as today’s emerging markets were yesterday’s frontier economies, so will today’s frontier economies be tomorrow’s emerging markets.”
Growth and capital-market trends in frontier economies
- Growth improvements:
- African frontier economies: raised growth rates from an average of 3½ percent per year in the 1990s to more than 6 percent per year in the 2000s.
- Types and modalities of capital flows to frontier economies:
- Predominantly foreign direct investment (often linked to natural resources).
- Private capital financing public sector borrowing (sovereign issuances, local bond markets).
- Flows to financial, corporate, and household sectors via debt or equity instruments.
- Implication: different flow compositions require different policy emphases.
Benefits of capital flows (as listed)
- Better ability to take advantage of investment opportunities and achieve higher growth, especially for infrastructure needs.
- Transfer of cutting-edge technologies, know-how, and ancillary benefits.
- Promotion of financial development, improved absorption against output shocks, and greater risk-sharing via international portfolio diversification.
- More efficient global allocation of capital benefiting both capital-importing and capital-exporting countries.
Risks and challenges from inflows
- Public-sector-focused flows:
- Ensuring productive use of capital and public debt sustainability; repaying debt will require higher government revenues and greater foreign exchange earnings.
- Macroeconomic concerns:
- Overvaluation of the currency undermining competitiveness.
- Overheating of the economy with inflationary pressures and excessive credit growth.
- Private-sector exposures:
- Fragile external liability structures (excessive reliance on short-term debt).
- Foreign currency exposure of unhedged domestic balance sheets (example: Swiss Franc mortgage holders in Poland, Hungary, and Croatia).
- Recognition that not all borrowing/lending decisions are rational; inflow-fueled credit booms can inflate asset prices and understate risks.
Core policy framework: a balanced approach
- Overarching principle: reap benefits of financial globalization while minimizing risks associated with inflow surges.
- Central elements:
- Maintain macroeconomic policy discipline.
- Strengthen financial supervision and regulation.
- Use the IMF-World Bank debt sustainability framework and modeling advances to assess public-sector financing of large projects.
- Specific policy instruments and guidance:
- Exchange rate:
- In countries without fixed exchange rates, allow appreciation provided it does not become overvalued.
- Monetary policy:
- May be eased absent overheating to reduce incentives for further inflows.
- Tighten policy interest rate if inflows cause inflationary pressures and credit booms to protect inflation targets.
- Fiscal policy:
- Gear fiscal policy to maintain a counter-cyclical stance, typically tightening in the face of inflows.
- Foreign exchange reserves:
- Accumulate reserves in face of appreciation pressure, especially if reserves are low by country insurance metrics, sterilization costs are manageable, and there is little risk to clarity and credibility of the monetary framework.
- Macroprudential measures:
- Apply to safeguard financial stability when inflows fuel excessive credit growth.
- Capital flow management measures (capital controls):
- Can be deployed to help stem aggregate inflows if other instruments are insufficient.
- Should not substitute for warranted macroeconomic adjustment.
- Addressing balance-sheet mismatches:
- Use macroprudential measures to limit systemic risks and shift composition toward less risky liabilities (FDI; equity; local currency instruments).
Multilateral and cross-border considerations
- Management of capital flows is a shared responsibility between recipient and source countries.
- IMF promotes a cooperative approach by examining cross-border spillovers, applying its Integrated Surveillance Decision, and analyzing the impact of policies “at both ends” of capital flows.
From theory to practice — key practical questions for frontier economies
- What is the appropriate extent and pace of capital account liberalization?
- How to maintain budgetary discipline when foreign money is plentiful and cheaply available?
- To what extent do frontier economies face generalized inflow surges, especially portfolio flows to the non-official sector that might necessitate broader policy responses?
- How to determine whether the exchange rate is broadly consistent with fundamentals and desirable policies?
- How effective is sterilized intervention? How does monetary policy operate in the economy?
- What macroprudential tools are available, and how to calibrate them?
- How to build capacity and coordinate the central bank, fiscal authorities, and macroprudential regulator to ensure an effective response while respecting operational independence?
Implementation and learning
- Emphasis on peer-to-peer exchanges among academics, officials, and practitioners to learn what has worked and what has not in managing volatile capital flows.
- Goal: harness private capital flows to obtain sustained growth and economic prosperity in frontier, emerging market, and advanced economies alike.
Source: Speech by David Lipton, First Deputy Managing Director, IMF; Balaclava, Mauritius, March 2, 2015.