Transcript Policy advice on capital controls

MANAGING CAPITAL INFLOWS:
WHAT TOOLS TO USE?
Jonathan D. Ostry*
Research Department, IMF
United Nations Conference on Capital Flows
Rio 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.
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
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
Capital Controls: Not Just An EME Phenomenon
Capital Account Restrictiveness in Selected Advanced Economies
1960-2006
Capital Account Restrictiveness in Advanced Economies: Some Examples
1960-2006
1.0
1.0
0.8
0.8
0.6
0.6
0.4
0.4
0.2
Canada: Interest payments on inward
financial credits, and inter-bank loans and
deposits subject to a withholding tax
France: "Devise-titre” system: residents could
only reinvest the proceeds of sales of
previously held foreign securities; could not
increase their foreign asset holdings
0.2
0.0
1960-1969
1970-1979
Canada
1980-1989
France
Germany
1990-1999
UK
US
Note: Capital account restrictiveness index (0=highly restrictive; 1=fully liberalized).
Source: Quinn and Toyoda (2008).
2000-2006
Germany: Ban on non-resident purchases of
German bonds introduced in 1972 (and lifted in
1974). Discriminatory reserve requirements
employed
UK: Purchases of foreign securities by UK
residents required foreign exchange bought at a
premium
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
0.0
1960
1965
Canada
1970
France
1975
1980
Germany
1985
1990
1995
United Kingdom
2000
2005
United States
Note: Capital account restrictiveness index (0=highly restrictive; 1=fully liberalized).
Source: Quinn and Toyoda (2008), and OECD (1982).
2
Context
3
3
Capital Inflows: Recovery or Historic Surge?
Net Quarterly Capital Flows into EMEs,
2006Q1-11Q1 (billions of US dollars)
Net Annual Capital Flows into EMEs,
2001-2016 (billions of US dollars)
250
600
500
150
400
50
300
200
-50
100
-150
0
Emerging Europe
Latin America
Net Capital Flows
Source: International Financial Statistics.
Emerging Asia
Other
Emerging Europe
Latin America
Net Capital Flows
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
-100
2001
2011Q1
2010Q4
2010Q3
2010Q2
2010Q1
2009Q4
2009Q3
2009Q2
2009Q1
2008Q4
2008Q3
2008Q2
2008Q1
2007Q4
2007Q3
2007Q2
2007Q1
2006Q4
2006Q3
2006Q2
2006Q1
-250
Emerging Asia Excl. China
Other
WEO Projections
4
4
Strong Fundamentals in EMEs
Annual Real GDP Growth (in percent)
10
Public Debt to GDP (in percent)
135
Projection
BRICS
EMEs
G7
Projection
8
115
6
95
4
2
75
0
BRICS
EMEs
G7
-2
55
-4
35
2005
2007
2009
2011
Source: IMF’s WEO database.
Note: Average year-on-year growth (in percent).
2013
2015
2005
2007
2009
2011
2013
2015
Source: IMF’s WEO database.
Note: Average gross general government debt to GDP ratio (in percent).
5
The Search for Yield…
Interest Rate Differential (in basis points)
1300
Brazil
Returns on Assets (in percent)
Gold
136.4
GBI-EM Global div
54.6
1100
US High Grade
900
South Africa
Mexico
700
42.5
US High Yield
40.2
EMBIG
40.0
CEMBI Broad
500
36.0
Korea
ELMI+
300
China
EM equities
Commodities
Jan-07
Mar-07
May-07
Jul-07
Sep-07
Nov-07
Jan-08
Mar-08
May-08
Jul-08
Sep-08
Nov-08
Jan-09
Mar-09
May-09
Jul-09
Sep-09
Nov-09
Jan-10
Mar-10
May-10
Jul-10
Sep-10
Nov-10
Jan-11
Mar-11
May-11
100
-100
30.1
UST
10.2
9.9
1.7
S&P 500 -10.5
-300
Source: Bloomberg.
Note: 10-year government bond yield minus 3-month US T-bill rate in basis points.
Source: J.P. Morgan.
Note: Returns as of June 29, 2007 to May 31, 2011 (in percent).
6
Improved Sovereign Credit Ratings
Sovereign Rating Upgrades & Downgrades
EMBI Global Average Credit Rating
BBB/Baa2
EMBIG Rating
Developed Up
Developed Down
Emerging Up
Emerging Down
35
BBB-/Baa3
28
28
28
BB+/Ba1
BB/Ba2
BB-/Ba3
19
EMBIG Moody’s
14
EMBIG S&P
14
11
10
EMBIG Avg
7
6
5
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
1
0
4
0
2007
Source: Chang (2011).
Note: EM fixed income indices are now investment grade. (> BBB-).
12
0
2008
0
2009
0
2010
2011YTD
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.
7
Is it Push or Pull Factors?


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)
8
Inflation and Credit Growth: Selected Cases
9
Are New Bubbles Emerging in EMs?
Real Credit to the Private Sector
Real House Prices
130
20
Top Quartile (China,
Columbia, Hong Kong,
Israel, Malaysia )
120
Top Quartile (Argentina, Bolivia,
Brazil, China, Hong Kong,
Indonesia, Sri Lanka, Turkey)
15
110
10
100
Other Emerging
Economies
90
5
80
Other Emerging
Economies
Central Eastern
European Countries
0
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.
2011Q1
2010Q4
2010Q3
2010Q2
2010Q1
2009Q4
2009Q3
2009Q2
2009Q1
2008Q4
2008Q3
2008Q2
2008Q1
2007Q4
2007Q3
2007Q2
2007Q1
2006Q4
2006Q3
-5
2006Q2
2010Q4
2010Q2
2010Q3
2009Q4
2010Q1
2009Q3
2009Q1
2009Q2
2008Q4
2008Q2
2008Q3
2008Q1
2007Q3
2007Q4
2007Q2
2006Q4
2007Q1
2006Q3
2006Q1
60
2006Q2
70
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.
10
Source: IMF IFS.
Policy Responses to Capital Inflows
Currency
Appreciation
Reserve
1
Increase
2
Policy Rate3
Fiscal
Tightening
4
Prudential 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.
/ Cumulative percentage change in NEER from 2009Q1 to 2011Q1.
1
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 fiscal stance betw een 2009 and 2010.
*South Africa has liberalized capital controls on outflow s in response to the surge in capital inflow s.
11
Capital Controls, Macroeconomic and
Prudential Risks
12
When are Capital Controls Appropriate?

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
13
Key Questions to be Addressed
Ostry et al. (2011) examine:




How macroeconomic and prudential rationales for capital controls
fit together?
What are the main elements of the policy toolkit (once macropolicy space is exhausted)?
What combination of prudential measures and controls should be
deployed to address inflow-induced risks?
How should capital controls be designed?
14
How do Macro and Prudential Concerns Fit Together?
Capital inflow
surge
Macroeconomic
concerns
Financial-stability risks
Primary responses
Macro policies:
exchange rate appreciation,
reserves accumulation, fiscal and
monetary policy mix
Prudential policies:
Strengthen/introduce
prudential measures
Macro policy options
exhausted? Residual
risks?
Impose/intensify capital controls (or measures
that act like them) subject to multilateral
considerations and macro tests
15
How do Macro and Prudential Concerns Fit Together?

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
16
The Policy Toolkit
17
What’s in the Toolbox?



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
18
How Common are the Measures?
19
Recent Examples of Measures
FX-related measures
Other prudential
measures
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)
•
•
•
•
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)
• Tax on equity and bond inflows (Brazil)
• Fee on NR purchases of central bank paper (Peru)
• Reserve requirements on NR deposits (Peru)
20
Issues in Classifying Instruments


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)
21
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
22
Matching Risks and Tools
23
23
Choice of Instruments: Flows Intermediated through the
Financial Sector
Flows to domestic banks
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
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?
Concerns about
access to finance/
distortions?
FX-related
prudential
Capital controls
FX-related prudential/
Capital controls1/
24
1/ Once macro policy space exhausted, and taking due account of multilateral considerations.
Choice of Instruments: Flows Not Intermediated through the
Financial Sector
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 controls1/
Capital controls1/
Capital controls to discourage
debt instruments
Capital controls to discourage
FX borrowing by unhedged
entities
Broad-based capital controls
Legal or other
impediments to
capital controls?
Borrower-based FXmeasures
25
1/ Once macro policy space exhausted, and taking due account of multilateral considerations
Exceptions to Flow Chart
 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)
26
Policy Measures and Financial Stability Risks: Some
Suggestive Evidence
27
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 FXregulation 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 regressors
28
External Liability Structure: Cross-Sectional Evidence*
Debt Liabilities
60
Below mean index
Above mean index
Debt liabilities in total external
liabiliities (in percent)
50
40
***
**
*
30
20
Capital controls and FX-related
prudential measures associated
with smaller proportion
of debt in external liabilities …
10
0
Economy
wide capital
controls
Forex
Macroprudential
Financial
sector capital regulations measures
controls
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.
29
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
30
FX Lending: Cross-Sectional Evidence*
Forex credit
Forex credit to GDP (in percent)
25
Below mean index
Above mean index
20
15
*
10
***
***
5
0
Capital controls and FX-related
prudential measures associated
with lower foreign currency denominated
lending by domestic banks
Forex
Macroprudential
Economy wide Financial sector
measures
capital controls capital controls regulations
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.
31
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
32
regressors
Credit Booms: Cross-Sectional Evidence*
Other prudential measures
associated with lower lending
booms by domestic banks
Change in private credit to GDP
(in percentage points)
Domestic private credit boom
17
15
Below mean index
Above mean index
13
11
9
7
5
3
1
-1
**
Macroprudential
Economy wide Financial sector
Forex
measures
capital controls capital controls regulations
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.
33
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 200307, 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
34
Crisis Resilience: Recent Crisis*
Crisis Resilience
Capital controls, FX-related and
other prudential measures
associated with greater crisis resilience
Crisis growth decline
(in percentage points)
0.0
Economy wide Financial sector
Forex
Macropudential
capital controls capital controls regulations
measures
-0.5
-1.0
-1.5
**
*
-2.0
*
-2.5
-3.0
-3.5
-4.0
Below mean index
Above mean index
-4.5
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.
35
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 strengthened
36
Designing Capital Control Instruments
37
Designing Capital Controls: Some Considerations
 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
38
Conclusions
39
Key Takeaways

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
40