Jonathan D. Ostry*Research Department, IMF
United Nations Conference on Capital FlowsRio De Janeiro
August 23, 2011
*The views expressed in this presentation are those of the presenter and do not necessarily represent those of the IMF or IMF policy. This presentation draws on joint work with Atish Ghosh, Karl Habermeier, Luc Laeven, Marcos Chamon, Mahvash Qureshi, and Annamaria Kokenyne.
MANAGING CAPITAL INFLOWS: WHAT TOOLS TO USE?
There is a tendency to regard foreign exchange controls, or any interference with the free movement of funds as, ipso facto, bad ... [but] there are times when it is in the best economic interest of a country to impose restrictions on movements of capital…[and] there are periods when failure to impose controls…have led to serious economic disruption.
The task before us is not to prohibit instruments of control but to develop those measures of control, those policies of administering such control, as will be the most effective in obtaining the objectives of world-wide sustained prosperity
HARRY DEXTER WHITE
The advocacy of a control of capital movements must not be taken to mean that the era of international investment should be brought to an end. On the contrary, the system contemplated should greatly facilitate the restoration of international loans and credits for legitimate purposes.
JOHN MAYNARD KEYNES
Capital Controls: Not Just An EME Phenomenon
33
0.0
0.2
0.4
0.6
0.8
1.0
1960-1969 1970-1979 1980-1989 1990-1999 2000-2006
Capital Account Restrictiveness in Selected Advanced Economies 1960-2006
Canada France Germany UK US
0.0
0.2
0.4
0.6
0.8
1.0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Canada France Germany United Kingdom United States
UK: Purchases of foreign securities by UK residents required foreign exchange bought at a premium
Canada: Interest payments on inward financial credits, and inter -bank loans and deposits subject to a withholding tax
Germany: Ban on non-resident purchases of German bonds introduced in 1972 (and lifted in 1974). Discriminatory reserve requirements employed
France: "Devise-titre” system: residents couldonly reinvest the proceeds of sales of previously held foreign securities; could not increase their foreign asset holdings
Capital Account Restrictiveness in Advanced Economies: Some Examples 1960-2006
USA: Interest Equalization Tax (IET) on purchases of foreign, fixed interest securities; tax was abandoned in 1974 soon after the adoption of floating exchange rates
Note: Capital account restrictiveness index (0=highly restrictive; 1=fully liberalized).Source: Quinn and Toyoda (2008).
Note: Capital account restrictiveness index (0=highly restrictive; 1=fully liberalized).Source: Quinn and Toyoda (2008), and OECD (1982).
4
Context
44
4
Capital Inflows: Recovery or Historic Surge?
5
Net Quarterly Capital Flows into EMEs, 2006Q1-11Q1 (billions of US dollars)
Net Annual Capital Flows into EMEs,
2001-2016 (billions of US dollars)
-100
0
100
200
300
400
500
600
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Emerging Europe Emerging Asia Excl. ChinaLatin America OtherNet Capital Flows WEO Projections 5
-250
-150
-50
50
150
250
2006
Q1
2006
Q2
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
2009
Q4
2010
Q1
2010
Q2
2010
Q3
2010
Q4
2011
Q1
Emerging Europe Emerging AsiaLatin America OtherNet Capital Flows
Source: International Financial Statistics.
6
Strong Fundamentals in EMEs
Source: IMF’s WEO database.Note: Average year-on-year growth (in percent).
Annual Real GDP Growth (in percent) Public Debt to GDP (in percent)
Source: IMF’s WEO database.Note: Average gross general government debt to GDP ratio (in percent).
35
55
75
95
115
135
2005 2007 2009 2011 2013 2015
BRICSEMEsG7
Projection
-4
-2
0
2
4
6
8
10
2005 2007 2009 2011 2013 2015
BRICSEMEsG7
Projection
7
The Search for Yield…
Gold
GBI-EM Global div
US High Grade
US High Yield
EMBIG
CEMBI Broad
ELMI+
EM equities
Commodities
UST
S&P 500
136.4
54.6
42.5
40.2
40.0
36.0
30.1
10.2
9.9
1.7
-10.5
Returns on Assets (in percent)
Source: J.P. Morgan.Note: Returns as of June 29, 2007 to May 31, 2011 (in percent).
Interest Rate Differential (in basis points)
Source: Bloomberg.Note: 10-year government bond yield minus 3-month US T-bill rate in basis points.
Jan-0
7
May-0
7
Sep-0
7
Jan-0
8
May-0
8
Sep-0
8
Jan-0
9
May-0
9
Sep-0
9
Jan-1
0
May-1
0
Sep-1
0
Jan-1
1
May-1
1
-300
-100
100
300
500
700
900
1100
1300 Brazil
South Africa
Korea
China
Mexico
8
Improved Sovereign Credit Ratings
Sovereign Rating Upgrades & DowngradesEMBI Global Average Credit Rating
EMBIG Rating
BBB-/Baa3
BB+/Ba1
BB/Ba2
BBB/Baa2
BB-/Ba3
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
EMBIG Moody’s
EMBIG S&P
EMBIG Avg
Source: Chang (2011).Note: EM fixed income indices are now investment grade. (> BBB-).
2007 2008 2009 2010 2011YTD
1 0 0 0 00
7
10 11 12
35
19
14
28
65
28 28
4
14
Developed Up Developed Down
Emerging Up Emerging Down
Source: Chang (2011).Note: the total number of upgrades and downgrades includes both S&P and Moody’s actions. Last developed market sovereign rating upgrade occurred in 2007.
Is it Push or Pull Factors?
9
Large literature on determinants of capital flows to EMEs identifies: Push factors—Interest rate in advanced economies, commodity
prices, investor risk appetite, regional contagion Pull factors—Macroeconomic performance, trade and financial
openness, institutional quality, external vulnerability Ghosh et al. (2011) examine inflow surges to EMEs over 1980-2009
Surges are highly synchronized across regions; but Considerable heterogeneity in the amount of inflow in a surge Both push and pull factors matter—but in different ways
For surge occurrence, push factors matter (notably, the real US interest rate; international market uncertainty)
For surge magnitude, domestic conditions are important (e.g. macroeconomic performance, trade & financial openness, exchange rate flexibility)
10
Inflation and Credit Growth: Selected Cases
Magnitude of Net Inflows1
Maximum Net Inflow2
Composition of Gross Inflows3 Inflation4 Real Credit
Growth5
(In percent of GDP) (In percent of GDP) (In percent; y/y) (In percent; y/y)
(2009Q1-2011Q1) (2009Q1-2011Q1) (2009M1-2011M4) (2009M1-2011M2)
Brazil 8.16 14.61 5.14 10.35(2010Q4)
Indonesia 5.95 12.18 5.25 8.78(2009Q3)
Korea 7.69 15.06 3.08 1.86(2009Q3)
Peru 7.28 12.50 2.30 10.78(2009Q4)
South Africa 6.02 13.02 5.46 -0.68(2010Q3)
Thailand 9.06 19.00 1.53 4.84(2010Q4)
Turkey 3.28 11.35 6.74 13.39(2010Q4)
Source: IMF's IFS, INS, and WEO databases.1/ Average net f inancial f low to GDP (in percent). For Peru and Thailand, data end in 2010Q2 and 2010Q4, respectively.
3/ Composition of gross inf low s in 2010.4/ Average year-on-year inf lation over 2009M1 to 2011M4.5/ Average year-on-year real credit grow th over 2009M1 to 2011M2.
Red=Portfolio Yellow=Other
Investment Green=FDI
2/ Maximum net f inancial f low to GDP (in percent) in 2009Q1 and 2011Q1. For Peru and Thailand, data end in 2010Q2 and 2010Q4, respectively. Quarters in parentheses refer to the quarter in w hich net capital inf low w as the largest.
11
Are New Bubbles Emerging in EMs?
Note: Non-weighted averages of the real house price index. 2007Q3 is set to equal 100. Source: OECD, Global Property Data, Haver Analytics and national sources.
Note: Non-weighted averages of the annual growth of real private credit. (in percent). The group of “other emerging economies” lies below the 75th percentile of the distribution of the 2010Q1-2010Q4 average of the annual growth of real domestic credit to the private sector.Source: IMF IFS.
Real Credit to the Private Sector
-5
0
5
10
15
20
2006
Q2
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
2009
Q4
2010
Q1
2010
Q2
2010
Q3
2010
Q4
2011
Q1
Top Quartile (Argentina, Bolivia, Brazil, China, Hong Kong, Indonesia, Sri Lanka, Turkey)
Other Emerging Economies
60
70
80
90
100
110
120
130
2006
Q1
2006
Q2
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
2009
Q4
2010
Q1
2010
Q2
2010
Q3
2010
Q4
Top Quartile (China, Columbia, Hong Kong,
Israel, Malaysia )
Other EmergingEconomies
Central EasternEuropean Countries
Real House Prices
12
Policy Responses to Capital Inflows
Currency Appreciation1
Reserve Increase2 Policy Rate3 Fiscal
Tightening4Prudential Policies/
Capital Controls
(In percent) (In percentage points) (Structural Balance)(2009Q1-2011Q1) (2008Q4-2010Q4)
Brazil 29.91 2.10 Raised No Yes
Indonesia 16.41 3.58 Raised Yes Yes
Korea 15.84 7.90 Raised Yes Yes
Peru 4.06 4.40 Raised No Yes
South Africa 30.30 -0.05 Lowered Yes No*
Thailand 3.06 12.44 Raised No Yes
Turkey -2.32 1.64 Lowered No Yes
Source: IMF's INS and WEO databases, and national sources.1/ Cumulative percentage change in NEER from 2009Q1 to 2011Q1.2/ Change in reserves to GDP ratio over end-2008 to end-2010.3/ Monetary policy is the change in policy rates over 2009Q3 to 2011Q1.4/ Fiscal policy is the change in cyclically adjusted f iscal stance betw een 2009 and 2010.
*South Africa has liberalized capital controls on outf low s in response to the surge in capital inf low s.
13
Capital Controls, Macroeconomic and Prudential Risks
13
When are Capital Controls Appropriate?
14
IMF staff (Ostry et al., Feb. 2010) argued that capital controls appropriate for inclusion in the policy toolkit to address: Macroeconomic risks, when
Currency overvalued Further reserve accumulation undesirable Inflation/overheating concerns Limited scope for fiscal tightening
Financial-stability risks, when Prudential framework still leaves high risk of financial fragility
14
Key Questions to be Addressed
15
How macroeconomic and prudential rationales for capital controls fit together?
What are the main elements of the policy toolkit (once macro-policy space is exhausted)?
What combination of prudential measures and controls should be deployed to address inflow-induced risks?
How should capital controls be designed?
Ostry et al. (2011) examine:
15
How do Macro and Prudential Concerns Fit Together?
16
Prudential policies: Strengthen/introdu
ce prudential measures
Macroeconomic concerns
Financial-stability risks
Macro policies: exchange rate
appreciation, reserves accumulation, fiscal and
monetary policy mix
Impose/intensify capital controls (or measures that act like them) subject
to multilateral considerations and macro tests
Primary responses
Macro policy options
exhausted? Residual risks?
Capital inflow surge
16
How do Macro and Prudential Concerns Fit Together?
17
Both macroeconomic and prudential considerations suggest that capital controls are appropriate
No real conflict—but possible design issues Macro considerations say yes, but prudential ones
say no No conflict of principle, but again possible conflict of design Controls as transitional measure given macro policy
implementation lags? Macro considerations say no, prudential ones say yes
Genuine conflict Multilaterally-consistent approach implies the bar is much higher
for the use of capital controls—especially broad-based controls Exhaust the available macro policy space and allow exchange rate
appreciation before tightening capital controls on inflows for prudential risks
17
18
The Policy Toolkit
18
What’s in the Toolbox?
19
FX-related prudential measures Discriminate according to the currency, not the residency, of the flow Applied to regulated financial institutions, primarily banks Examples: limits on banks’ open FX position (as a proportion of their
capital), and limits on FX lending by domestic banks (or higher capital requirements)
Other prudential measures Reduce systemic risk without discriminating based on
residency/currency Examples: LTV ratios, limits on credit growth and sectoral lending,
dynamic loan-loss provisions, and counter-cyclical capital requirements Capital controls
Discriminate between residents and non-residents in cross-border capital movements (OECD Code of Liberalization of Capital Movements, 2009)
Economy-wide or sector specific (usually the financial sector) or industry specific
Cover all flows, or target specific types (debt, equity, FDI; short vs. long-term)
Examples: taxes, URRs, licensing requirements, and outright limits or bans
19
How Common are the Measures?
2020
21
•Tax on equity and bond inflows (Brazil)•Fee on NR purchases of central bank paper (Peru)•Reserve requirements on NR deposits (Peru)
Capital controls
•Reserve requirements on foreign currency deposits (Peru)
•Limits on banks FX derivative positions in percent of bank capital (Korea)
•Capital requirements for FX loans (Peru)•Limits on banks net open FX positions (Peru)•Limits on ratio of banks FX loans and securities to FX
borrowing (Korea)
FX-related measures•Reserve requirements for local currency deposits (Brazil,
Turkey)•LTV ratios (Korea, Peru, Thailand, Turkey)•Levy on interest from consumer loans (Turkey)•Capital requirements for specific loans (Brazil)
Other prudential measures
Recent Examples of Measures
Issues in Classifying Instruments
22
De jure prudential tools may operate like capital controls A regulation differentiating based on the currency of denomination may
operate like a capital control to the degree that most FX liabilities are to nonresidents
A measure that requires banks to pay a tax on their non-core liabilities could well in practice operate just like a capital control if most of the funding that banks receive comes from abroad
A regulation discouraging FX lending to unhedged borrowers may act as a capital control (reduce inflow) or prudential measure (change currency composition of foreign liabilities). Difficult to tell at implementation stage
De jure capital controls may have primarily prudential intent (e.g. differential reserve requirements by residence of liability)
Fine line between FX-related and other prudential measures (e.g. differential LTV ratio by currency of denomination)
22
23
Alternative Classification
Capital Flow Management Measures (CFMs)—measures designed to influence capital flows
Residency-based—commonly referred to as capital controls Other—measures that do not discriminate on the basis of residency,
but are nonetheless designed to influence capital inflows (including a subset of prudential measures that discriminate on the basis of currency)
Non-CFMs—structural and prudential policies not designed to influence capital flows. Include measures that do not discriminate by residency and typically, but not always, do not differentiate by currency
24
Matching Risks and Tools
24
25
Ceilings on banks’ foreign derivative positions/Capital
controls on banks (esp. short-term debt), e.g., taxes/reserve
requirements
Open FX limits/higher capital requirements on
loans to unhedged borrowers
Cyclical capital requirements, LTV limits
Legal or other
impediments to capital controls?
FX-related prudential
Capital controls
Fragile external liability structure (maturity
mismatch/sudden-stop risk)
Currency risk (due to open FX position) or credit risk
(due to unhedged borrower)
Credit boom/asset price bubble
FX-related prudential1/
Other prudential
Flows to domestic banks
Concerns about
access to finance/
distortions?
FX-related prudential/
Capital controls1/
1/ Once macro policy space exhausted, and taking due account of multilateral considerations.
Choice of Instruments: Flows Intermediated through the Financial Sector
25
Direct flows or through unregulated financial
sector
Fragile external liability structure (debt,
especially short-term)
Currency risk (due to lack of natural or financial hedge)
Asset price bubble
Capital controls1/
Capital controls to discourage debt
instruments
Capital controls to discourage FX borrowing
by unhedged entitiesBroad-based capital
controls
Capital controls1/
Capital controls1/
Borrower-based FX-measures
Legal or other
impediments to capital
controls?
261/ Once macro policy space exhausted, and taking due account of multilateral considerations
Choice of Instruments: Flows Not Intermediated through the Financial Sector
Exceptions to Flow Chart
27
Playing field for access to credit of large firms vs. SMEs
Prudential regulations may cause flows to be intermediated through the unregulated financial sector (e.g. Croatia)
- Extend the perimeter of regulation? Not easy in short run
- Regulatory arbitrage more likely in countries with weak supervision, sophisticated financial institutions, and deep capital markets
International obligations may prohibit or constrain the use of capital controls (e.g., the EU treaty, the GATS, the OECD code, or various bilateral investment treaties)
27
Policy Measures and Financial Stability Risks: Some Suggestive Evidence
28
Empirical Evidence: External Liability Structure
Debt in proportion to total external liabilities Cross section (2007; measures in 2003-05, 38 countries)
Economy-wide, and financial sector capital controls significantly associated with lower debt (controlling for external vulnerability)
FX regulations significantly associated with lower debt (though FX regulations lose significance when included together with economy-wide capital controls)
Moving from 25th to 75th percentile of economy-wide capital controls or FX-regulation lowers debt share by almost 10 ppt
Panel data (1995-2008) Economy-wide, and financial sector capital controls significantly
associated with lower debt External vulnerability index, region and time effects, and per capita
income included as additional regressors29
Capital controls and FX-related prudential measures associated with smaller proportionof debt in external liabilities …
30
External Liability Structure: Cross-Sectional Evidence*
Source: Authors’ estimates.*Sample: 38 EMEs over 2003-07. Debt liabilities is the residual (including constant) obtained after regressing the share of debt liabilities in total external liabilities in 2007 (in percent) on a (lagged) composite external vulnerability index.
Debt Liabilities
0
10
20
30
40
50
60Below mean indexAbove mean index
Economywide capital controls
Financial sector capital controls
Forexregulations
Macroprudential measures
***** *
Deb
tlia
bilit
ies
in t
otal
ext
erna
l lia
bilii
ties
(in p
erce
nt)
Empirical Evidence: FX Lending
Foreign currency loans in total domestic credit Cross section (2007; measures in 2003-05, 28 countries)
Economy-wide, and financial sector capital controls significantly associated with lower proportion of FX credit (controls: initial private credit ratio; exchange rate regime)
FX regulations significantly associated with lower FX credit Both economy-wide capital controls and FX regulations significant
when included together Moving from 25th to 75th percentile of economy-wide capital controls
and FX regulations lowers proportion of FX credit by 20-25 ppt Panel data (1995-2008)
Results similar to those above Private credit (lagged, in % of GDP); exchange rate regime; per capita
income; institutional quality index; region and time dummies included as additional regressors 31
0
5
10
15
20
25Below mean indexAbove mean index
Fore
xcr
edit t
o G
DP
(in p
erce
nt)
Economy wide capital controls
Financial sector capital controls
Forexregulations
Macroprudential measures
Forex credit
*** ***
* Capital controls and FX-related prudential measures associated with lower foreign currency denominated lending by domestic banks
32
FX Lending: Cross-Sectional Evidence*
Source: Authors’ estimates.*Sample: 28 EMEs over 2003-07. Forex credit is the residual (including constant) obtained after regressing forex credit to GDP in 2007 on private credit to GDP in 2005 and a binary variable (=1) if fixed exchange rate regime in place.
Empirical Evidence: Credit Booms
Change in private sector credit to GDP ratio Cross section (change in credit ratio 2003-07; measures in
2000-02, 28 countries) Prudential regulations significantly associated with smaller credit booms
(controls: real per capita income in 2005; political stability index; financial market development; exchange rate regime; and credit bureaus)
Prudential regulations significant if capital controls/FX regulations included
Moving from 25th to 75th percentile of prudential regulations lowers credit growth (03-07) by 1.5 percent per year
Panel data (1995-2008) Results similar to those above Region and time dummies, per capita income, political stability index,
stock market capitalization, exchange rate regime and credit bureaus included as additional regressors
33
-1
1
3
5
7
9
11
13
15
17 Below mean indexAbove mean index
Economy wide capital controls
Financial sector capital controls
Forexregulations
Macroprudential measures
Domestic private credit boom
Ch
ange
in p
rivat
e cr
edit
to G
DP
(in
per
cent
age
poi
nts)
**
Other prudential measures associated with lower lendingbooms by domestic banks
34
Credit Booms: Cross-Sectional Evidence*
Source: Authors’ estimates.*Sample: 28 EMEs over 2003-07. Private credit boom is the residual (including constant) obtained after regressing change in private credit to GDP over 2003-07 on private credit to GDP in 2003.
Empirical Evidence: Crisis Resilience
If policy measures reduce vulnerabilities through previous channels, then downturn in event of crisis should be smaller
Cross-section (change in growth 2008-09 relative to average 2003-07, 41 countries)
Economy-wide capital controls, FX and domestic prudential regulations associated with smaller decline (controlling for growth in trading partners, change in terms of trade)
Both economy-wide capital controls and domestic prudential regulations retain significance when included together
But economy-wide capital controls dominate when included with FX regulations
Moving from 25th to 75th percentile of economy-wide controls or FX regulations lowers growth decline by 3.5 and 2.5 ppt, respectively
Past Crises(1995-2008) Capital controls associated with smaller growth decline in past crises
35
Capital controls, FX-related andother prudential measuresassociated with greater crisis resilience
-4.5
-4.0
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
Below mean indexAbove mean index
Cris
is g
row
thde
clin
e (in
per
cent
age
poin
ts)
**
**
Economy wide capital controls
Financial sector capital controls
Forex regulations
Macropudentialmeasures
Crisis Resilience
Crisis Resilience: Recent Crisis*
36
Source: Authors’ estimates.*Sample: 41 EMEs over 2003-07. Crisis resilience is the residual (including constant) obtained after regressing the difference between real GDP growth rates averaged over 2008-09 and 2003-07 on trading partner growth and terms of trade change.
Robustness
Numerous robustness tests Additional regressors to capture political stability,
financial market development, and overall regulatory quality
Alternative indices (use first principal component of sub-indices instead of averages)
Endogeneity—use bilateral investment treaty with US (which generally prohibit use of capital controls) as instrument for capital control
Key results are unaffected or strengthened37
38
Designing Capital Control Instruments
38
Designing Capital Controls: Some Considerations
39
Broad principles Effective: achieve intended aim; not easily circumvented
Efficient: minimize distortions and scope for non-transparent/arbitrary enforcement
But a number of questions… Permanent or temporary inflow?− Macroeconomic concerns: Controls for temporary, not permanent inflows− Prudential concerns: Controls could be imposed for persistent flows Broad-based or targeted controls?− Macroeconomic concerns: Broad based possibly with limited exemptions− Prudential concerns: Targeted but taking account of circumvention possibilities Price or quantity-based controls?− Macro concerns: Price-based measures easier to adjust cyclically, and simpler to administer− Prudential concerns: Quantitative measures more appropriate when authorities face
information asymmetries/uncertainty about private sector’s response Other considerations: Administrative and institutional capacity 39
40
Conclusions
40
Key Takeaways
41
Macro and prudential policies can go a long way to deal with inflow surges Use and strengthen orthodox toolkit before resorting to capital controls
There is strength in numbers—no measure is likely to work perfectly, so diversify and use more than one
Capital controls and prudential measures should target specific risks Prudential measures main instrument when flows are intermediated through the
banking sector Capital controls main instrument when flows by-pass the banking sector
In designing capital controls, Macro concerns imply broad and price-based controls for temporary surges Prudential concerns imply targeted on specific risks and possibly administrative
capital-control measures, even in case of persistent inflows Design should reflect administrative inheritance/apparatus 41