WSJ: IMF urges developing nations to consider capital controls
NepaliEconomy
WSJ, 19-Feb-2010
By BOB DAVIS
International Monetary Fund economists, reversing the fund's past
opposition to capital controls, urged developing nations to consider
using taxes and regulation to moderate vast inflows of capital so they
don't produce asset bubbles and other financial calamities. It said
emerging markets with controls in place had fared better than others
in the global downturn.
The recommendation is the IMF's firmest embrace of capital controls
and a reversal of advice it gave developing nations just three years
ago. The IMF has long championed the free flow of capital, as a
corollary to the free flow of trade, to help developing countries
prosper. But the global financial crisis has prompted the fund to
rethink long-held beliefs. It recently suggested the world might be
better off with a higher level of inflation than central bankers now
are targeting.
"We have tried to look at the evidence and tried to learn something
from the current crisis," said Jonathan Ostry, the IMF's deputy
director of research, who wrote "Capital Inflows: The Role of
Controls" with five other IMF economists.
The IMF examined capital restrictions tried by Brazil, Chile, Malaysia
and other countries, such as explicit taxes on capital inflows,
requirements that a portion of foreign capital be held interest-free
at the central bank, and various regulations to reduce foreign
lending. The fund recommends that countries first look at whether
traditional policies, such as allowing currencies to appreciate, will
work to moderate capital inflows. Countries whose currencies are
appropriately valued and that are wary of lowering interest rates to
ward off inflows should look at "unconventional" measures, Mr. Ostry
said.
Money is flooding into emerging markets, producing fears that asset
bubbles are forming in China, South Korea, Taiwan, Singapore and
elsewhere, particularly in real-estate markets. This year, about $722
billion in private capital is expected to flow to developing nations,
a 66% increase over 2009 but far below the $1.28 trillion that flowed
to emerging markets in 2007 before the financial crisis, according to
the Institute of International Finance, a banking trade association.
Private investment generally helps growth, the IMF says, but a too-
rapid increase can lead to a boom and then a bust. About six months
ago, IMF economists started examining the ability of capital controls
to limit financial damage. Countries that had controls in place before
the global recession, they found, were much less likely to have
suffered a sharp economic downturn. "The less risky financial
structure meant you were less likely to undergo a credit boom-credit
bust cycle," said Mr. Ostry.
The IMF says capital restrictions have tended to make it harder for
investors to pull money from a country quickly, thus reducing
financial fragility. It isn't clear whether the measures also reduce
total capital entering the country, it said.
Before the crisis, a very different IMF gave very different advice. In
a July 2007 speech in Bangkok, the IMF's managing director at the
time, Rodrigo de Rato, advised nations that capital controls "rapidly
become ineffective" and are easily circumvented.
The IMF now says that finding a way around restrictions increases
costs for investors and acts as "sand in the wheels" of international
capital. Columbia University economist Jagdish Bhagwati, who
criticized IMF opposition to capital controls during the Asia crisis
in the late 1990s, applauded the change. "Better late than never," he
said. "This is so clearly an area where letting markets rip isn't a
good idea."
Deploying restrictions to maintain undervalued currencies, the authors
warned, would be undesirable:In that circumstance, money would flow to
other countries, pushing up their currencies and making their exports
less competitive internationally. The authors didn't mention any
country in particular, but it is clear they were warning China. The
IMF has labeled the yuan as undervalued, joining the U.S. and Europe
in pressing China to let its currency rise.