IMF Ecperiences in Managing Capital Inflows

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    INTERNATIONAL MONETARY FUND

    Recent Experiences in Managing Capital InflowsCross-Cutting Themes and Possible

    Policy Framework

    Prepared by the Strategy, Policy, and Review Department

    In consultation with Legal, Monetary and Capital Markets, Research, and other Departments

    Approved by Reza Moghadam

    February 14, 2011

    Contents Page

    I. Overview and Introduction .....................................................................................................3 II. Stylized Facts About Capital Flows ......................................................................................8

    A. Capital Flows Then and Now ..................................................................................11B. Push and Pull Factors ..............................................................................................16

    III. Selected Country Experiences with Capital Inflows .........................................................18A. Nature of Capital Inflows ........................................................................................18B. Drivers of Inflows ...................................................................................................21

    C. Domestic Macroeconomic Implications..21D. Recent Policy Responses ........................................................................................25

    IV. A Possible Policy Framework for Managing Capital Inflows ...........................................39 A. Macroeconomic Policies .........................................................................................43B. Capital Flow Management Policies.........................................................................44C. Applying the Framework ........................................................................................48

    V. Issues for Discussion ...........................................................................................................51Tables

    1. Inflow Episodes: Summary Statistics ..........................................................................152. Examples of Factors Affecting Capital Inflows to EMs ..............................................16 3. Determinants of Capital Inflows: Panel Regression Results .......................................184. Capital Flow Management (CFM) and Other Measures by Country ..........................37

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    Figures1. Capital Flows and Policy Responses in Selected EMs ..................................................42. Gross and Net Capital Inflows .......................................................................................93. Net Inflows and Nominal Effective Exchange Rates in Selected EMs .......................104.

    Gross Capital Inflows, by Types of Flows for Each Wave..........................................14

    5. Inflation and Target Policy Interest Rates: A Historical Perspective ..........................286. Exchange Rates and Use of CFMs in Selected EMs ...................................................327. Recent Use of CFMs and Other Measures ...................................................................418. Coping with Capital Inflows: Policy Considerations ..................................................449. Policies to Cope with Inflows: Judgment-based Illustrative Exercise .........................4910. Policies to Cope with Inflows: Threshold-based Illustrative Exercise ........................51Boxes1. Key Elements of a Possible Policy Framework for Managing Capital Inflows ............72. The Impact of Brazils IOF..........................................................................................35 3.

    The Impact of Thailands Withholding Tax ................................................................36

    AnnexesI. High Frequency Proxies for Capital Flows Data .........................................................52II. Identifying Episodes of Large Capital Inflows ............................................................55III. Brazil ............................................................................................................................58IV. Indonesia ......................................................................................................................65V. Korea ............................................................................................................................71VI. Peru ..............................................................................................................................74VII. South Africa .................................................................................................................79VIII. Thailand .......................................................................................................................85IX.

    Turkey ..........................................................................................................................90

    References ................................................................................................................................96

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    I. OVERVIEW AND INTRODUCTION1

    Emerging markets (EMs) are experiencing a surge in capital inflows, lifting asset prices and

    growth prospects. While inflows are typically beneficial for receiving countries, inflow surges

    can carry macroeconomic and financial stability risks. This paper reviews the recent

    experience of EMs in dealing with capital inflows and suggests a possible framework for IMF

    policy advice on the spectrum of measures available to policymakers to manage inflows,

    including macroeconomic policies, prudential measures and capital controls. Illustrative

    applications of this framework suggest that it may be appropriate for several countries, based

    on their current circumstances, to consider prudential measures or capital controls in

    response to capital inflows. The suggested framework is intended to inform staff policy advice

    to all Fund members with open capital accounts. It forms part of a broader effort to sharpen

    Fund surveillance, preserve evenhandedness, and foster greater global policy coordination.

    As indicated in theSupplementto this paper, this broader effort includes the development ofglobal rules of the game on macroprudential policies, capital account liberalization, and

    reserve adequacy, and the preparation of spillover reports assessing spillovers from the five

    systemic economiesall of which will inform the current and broader framework being

    developed.

    1. A rising tide. Capital flows to EMs have rebounded with the ebbing of the globalfinancial crisis. The largest recipients are Asian and Latin American EMs, South Africa andTurkey. In several countries, netinflows are close to all-time highs, although on a gross basistotal inflows to EMs have yet to reach their pre-crisis peak. Compared to other waves ofinflows, the current episode is characterized by a predominance of volatile portfolio inflows.The shift towards portfolio flows could be structural in nature and imply continued volatility.Gross inflows have reached 6 percent of GDP in only three quarters since the post-crisistroughit took three years to reach a similar magnitude in the surge that preceded the globalcrisis. Portfolio inflows account on average for almost one-half of inflows (Brazil and Koreaare the top two recipients), much more than in the previous wave. Direct investment and cross-border bank lending are less predominant this time, reflecting lagging economic performanceand impaired financial intermediation in advanced economies (AEs) (Section II.A.).

    2. Drivers. Improved fundamentals and growth prospects in EMs and loose monetarypolicy in AEs are among the main pull and push factors behind the recent acceleration ofcapital flows from advanced to emerging economies. From a structural perspective, the globalcrisis and the more recent jitters in Europe have exposed balance sheet vulnerabilities in AEsand appear to have triggered a gradual shift in the portfolio allocation of institutional investorstoward EMs, many of which are enjoying low debt, proven resilience to shocks, and improvedratings. From a cyclical perspective, the two-speed nature of the ongoing global recovery will

    1 This paper was prepared by a team led by R. Baqir and V. Chensavasdijai, comprising R. Benelli, M. Goretti,R. Llaudes, Y. Miao, T. Miyoshi, J. Noah Ndela, M. Pant, F. Presciuttini, M. Saenz (all SPR), and C. Oner(APD), under the guidance of A. Husain, L. Giorgianni (both SPR), and M. Pradhan (APD). R. Weeks-Brown(LEG), K. Habermeier and A. Kokenyne (MCM), and J. Ostry and A. Ghosh (RES) provided valuable inputs.This paper has also benefited from staff analysis in Ostry et al. (2010 and forthcoming), Eyzaguirre et al.(forthcoming), and IMF Policy Paper 10/116,How Did Emerging Markets Cope in the Crisis?, and complementsstaff work presented in the upcoming World Economic Outlook and Global Financial Stability Report.

    http://www.imf.org/external/np/pp/eng/2011/031111.pdfhttp://www.imf.org/external/np/pp/eng/2011/031111.pdfhttp://www.imf.org/external/np/pp/eng/2011/031111.pdfhttp://www.imf.org/external/np/pp/eng/2011/031111.pdfhttp://www.imf.org/external/np/pp/eng/2011/031111.pdf
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    likely keep interest rate differentials between EMs and AEs wide for a prolonged period oftime. Surging commodity prices are an additional cyclical force pushing capital towardcommodity exporters such as Brazil and Peru. In relative terms, more liquid EMs