## Global Capital Flows: Raising the Returns and Reducing the Risks

_IMF News, June 17, 1997_

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**Canonical URL:** [Global Capital Flows: Raising the Returns and Reducing the Risks](https://www.imf.org/en/news/articles/2015/09/28/04/53/spmds9709)

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## Bibliographic details
- Published: June 17, 1997

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### Overview
- Address by Michel Camdessus, Managing Director of the International Monetary Fund, at the World Affairs Council of Los Angeles, California, June 17, 1997.
- Central question: Why is private capital surging into emerging markets, is it beneficial, and how can returns be raised while risks are reduced?
- Key context: Private flows to developing and transition economies reached a record high of $235 billion last year--five times the level in 1990.

### Drivers of large private capital flows
- Removal of restrictions on overseas investment by institutional investors.
- Elimination of capital controls in developing countries.
- Technological advances in telecommunications increasing mobility of capital.
- Low interest rates in advanced countries and the search for portfolio diversification.
- Improved macroeconomic management and structural reforms in many developing and transition countries (prudent fiscal and monetary policies, low inflation, trade liberalization, streamlined investment procedures, financial liberalization, privatization).

### Benefits (recipient countries, investors, and global economy)
- Recipient countries:
  - Higher levels of investment.
  - Faster economic growth.
  - Rising standards of living.
  - Non-debt-creating foreign direct investment transfers technology and business skills with less risk of ballooning debt-service payments.
- Investors:
  - Increased returns on saving.
  - Portfolio diversification opportunities.
- Global economy:
  - More efficient allocation of resources where returns on capital are higher.
  - Emerging markets become important sources of demand, sustaining world growth during weak advanced-country conditions (example: cushioning effect in 1991-93).
  - Competition for capital fosters a "virtuous circle" of reform, investment, and growth.

### Risks and channels of vulnerability
- Policy mistakes in recipient countries can trigger sudden loss of market confidence and capital outflows with spillover effects.
- Strong inflows may:
  - Put upward pressure on exchange rates.
  - Constrain monetary policy.
  - Fuel domestic demand and inflation if not sterilized.
  - Widen current account deficits amid strong domestic demand.
  - Create strains in labor and real estate markets.
- Banking system weaknesses:
  - Rapid credit expansion and poor lending decisions can undermine loan portfolio quality.
  - Liberalization/privatization without adequate supervision increases bank exposure to credit, exchange rate, interest rate, and market risks.
  - Policymakers may be reluctant to tighten policy for fear of exacerbating banking sector problems.
- Market sentiment and contagion:
  - Perceived vulnerabilities or high current account deficits can prompt abrupt reversals.
  - Loss of confidence in one country can affect others perceived as similar, even across regions.
  - Market judgments can be capricious—money can flow in despite weak policies, then flow out on changing sentiment.

### Country experiences and lessons
- Mexico (end-1994 crisis):
  - Highlighted importance of sound macroeconomic policies, solid domestic institutions (independent central banks, strong banking systems), structural reforms, and timely, comprehensive information to markets.
- Asia and Eastern Europe:
  - Some countries tightened policies to avoid overheating; recent slowdown in Asia viewed as appropriate correction after very rapid growth.
- China:
  - Appeared to achieve a "soft landing" while maintaining very large capital inflows.
- India:
  - Kept inflation and current account deficits at manageable levels while markedly raising growth and gradually opening to foreign equity capital.
- Malaysia:
  - Output growth moderated to a more sustainable rate; inflation remained low.
  - Current account deficit narrowed substantially; fiscal surplus increase targeted for the year expected to help consolidation.
  - Improvements in bank soundness: non-performing loan ratios have fallen markedly; risk-weighted capital ratios are above Basle recommendations; steps taken to restrain lending for property and stock markets.
  - Early adopter of the Fund's Special Data Dissemination Standard.

### IMF role and policy priorities
- IMF mandate and member expectations (181 members):
  - Encourage sound economic and financial policies to attract private capital via policy advice, technical assistance, and financial support.
  - Reduce the risk of sudden reversals of capital flows and their spillovers through emphasis on appropriate policies.
  - Help manage crises when they occur to avoid outcomes detrimental to international prosperity.
  - Provide a forum for members to discuss policy experiences, assess global developments, and defuse emerging problems.

- Four priority issues highlighted:
  1. Capital account liberalization
     - Current mandate focuses on eliminating "foreign exchange restrictions that hamper the growth of world trade"; more than three quarters of members (139 countries) have, for the most part, eliminated restrictions on current transactions.
     - Membership agreement to add an amendment to the charter to promote capital account liberalization and give the Fund appropriate oversight over restrictions on capital movements.
     - Emphasis: not to encourage premature removal of controls or forbid temporary use of controls in emergencies; promote liberalization consistent with sustainable macroeconomic policies, strong monetary and financial sectors, and lasting liberalization.
  2. Soundness of domestic financial and banking systems
     - Next major crises likely to start with or be intensified by banking crises.
     - Emphasis on strengthening internal bank management, reinforcing market discipline, and improving bank regulation and supervision.
     - Support for internationally recognized "best practices" such as the Basle Committee's "Core Principles for Effective Banking Supervision."
  3. Transparency
     - Higher premium on accurate, timely information about economic policies and performance to reduce market surprises.
     - Development and dissemination of standards on data coverage, frequency, timeliness, quality, integrity, and public availability.
     - Special Data Dissemination Standard: 42 advanced and emerging market economies have subscribed; of these, 7 have established "hyperlinks" to their actual economic data.
  4. Integration and "good governance" for countries without market access
     - Countries face a choice: integrate into the international economy or risk marginalization and falling behind in growth and development (a major danger for Africa).
     - "Second generation" structural reforms required: simple, transparent regulatory systems; independent and professional judicial systems; government that makes cost-effective use of public resources.
     - IMF focus on governance aspects most closely related to macroeconomic surveillance, including increasing transparency of government accounts and encouraging reallocation from unproductive public expenditure toward health, education, and infrastructure.

### IMF financing, quotas, and the case for strong Fund resources
- IMF as a financial cooperative: members subscribe "quotas" paid partly in national currency and partly from reserves.
- Quota subscriptions enable members to access temporary balance of payments financing by exchanging currencies among members.
- For a member, subscribing to a quota increase is described as an exchange of assets, not a budgetary outlay; example cited: the United States considers quota subscription an exchange of assets and has in many years earned interest and realized exchange rate gains on its SDR-denominated position.
- Membership was considering an increase in IMF quotas to ensure continued financial strength and credibility.

*Source: Address by Michel Camdessus, Managing Director of the International Monetary Fund, World Affairs Council of Los Angeles, California, June 17, 1997.*

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## References

- [Mexico and the IMF](http://www.imf.org/external/country/MEX/index.htm)
- [Malaysia and the IMF](http://www.imf.org/external/country/MYS/index.htm)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/spmds9709_