Opinion

IMF likes India’s ‘masala’ for capital flows

Lokeshwarri SK | Updated on October 21, 2020 Published on October 21, 2020

The agency is more accepting now of India’s blending of various policies to maintain financial stability

The Independent Evaluation Office (IEO) of the IMF recently released its evaluation of the IMF Advice on Capital Flows. The report assesses the IMF’s advice on managing capital flows and capital account liberalisation, focussing on the period since the approval of the IMF’s Institutional View (IV) on this set of issues in 2012. In an email interaction, Prakash Loungani, Assistant Director, IMF IEO, who led this evaluation, talks about how countries such as India have accepted IMF’s advice and how it needs to keep evolving based on country-specific experiences.

What is the primary objective behind the IMF’s Institutional View on the Liberalization and Management of Capital Flows?

It is to improve the quality of IMF’s advice on policies to help countries benefit better from surges of foreign capital and cope with sudden stops of foreign capital. In 2012, the IMF adopted an official position on when and how capital controls could be used in the policy toolkit to deal with volatility.

Have countries seen a change in IMF advice since the adoption of this new policy in 2012?

Countries have seen an improvement in the quality of IMF’s advice and a change in attitude. In the 1990s, the IMF was perceived by some, particularly in Asia, as being ideologically driven in pushing countries to open up to foreign capital. The IMF was also thought to be too dismissive of the need for capital controls and other tools such as foreign exchange intervention to manage volatility. That is no longer the general perception. Many countries have felt that the IMF has been supportive of their use of a heterodox toolkit to manage volatility and is no longer pushing for opening up the capital account regardless of country circumstances.

How have Indian officials regarded the IMF’s advice to India in managing capital flow volatility?

Current and former Indian officials have also noticed an improvement, according to confidential interviews conducted for our report by Ila Patnaik. There has been greater acceptance by the IMF of the blending of various policies by Indian policymakers to maintain financial stability in the face of foreign capital surges. This ‘masala’ approach was not always very palatable to the IMF in the past but it has become more to their taste. That said, some officials felt the IMF did not provide prompt support to India when it adopted some capital controls — as part of a broader package — to deal with the sudden stop in foreign capital during the so-called ‘taper tantrum’ episode in 2013.

Has the IMF considered further capital account liberalisation advisable for India?

The IMF has been fairly cautious, indeed too cautious in the view of some Indian officials. Under this view, the IMF has not given sufficient weight to the likely benefits to growth from further opening to foreign capital or to costs of maintaining controls in hindering longer-term market development. Other officials feel that the IMF’s caution is justified given the financial crises that have accompanied liberalisation in many countries. It appears that the IMF is trying to reach an evidence-based assessment of benefits and costs of further liberalisation; even officials who do not agree with the IMF’s assessment give it credit for this reasonable approach.

How about other countries? What tools have they used to manage their capital account and have they received IMF support?

Country practices vary widely based on the circumstances they face. The use of capital controls is not widespread, but many countries value the flexibility they can provide on occasion and hence would like to see them included in the toolkit. Korea for instance has used reserve requirements on foreign currency deposits quite actively. Peru has used a judicious mix of policies to cope. These are two of many examples that have received IMF support. Australia and Singapore received IMF support for policies to manage the flow of foreign capital into their real estate sectors to curb house price inflation and keep houses affordable for their citizens.

Has there been a disparity between the manner in which advanced economies and emerging markets regard the IMF’s new policy? Are emerging markets more partial to capital controls and foreign exchange intervention?

By and large, policymakers around the world today share the view that there are benefits to being open to foreign capital if the risks to financial stability can be managed. It is true that advanced economies, by virtue of deeper financial markets, are better positioned to deal with volatility through standard policy tools like monetary policy and exchange rate adjustment. But some advanced economies have used capital controls or other non-standard tools. In addition to the Australia and Singapore examples mentioned, Canada, Hong Kong and New Zealand have used capital controls on inflows to their real estate sectors. Iceland used controls in 2016 in the face of surges to prevent a recurrence of its financial crisis. Many emerging markets do not as yet have deep enough financial markets or face circumstances (such as currency mismatches on corporate balance sheets) that make reliance solely on exchange rate adjustment not advisable. Hence they are more inclined toward retaining capital controls and foreign exchange rate intervention in their current arsenal.

Will the IMF’s advice on capital flows change in the post-Covid-19 world where global central banks are willing to continue monetary easing as long as it takes? Does this stance of central banks reduce the prospects of sudden capital outflows from EMDEs?

It is true that the pressures from sudden capital outflows from emerging markets in March this year were contained quite successfully, due partly to the actions you mention. Foreign capital has returned, though there have again been periods of stress. It would be inadvisable to take the challenges of surges and sudden stops of foreign capital as a thing of the past. When the IMF sits down next year to review its policy position on capital controls, it should learn from the experience since 2012 and make the necessary revisions to ensure that it continues to have state-of-art framework to provide good advice over the coming decade.

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Published on October 21, 2020
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