The International Monetary Fund has developed a comprehensive, flexible, and balanced view on the management of global capital flows to help give countries clear and consistent policy advice.
Global capital flows have increased dramatically in the last decade, from an average of less than 5% of global GDP during 1980-1999 to a peak of about 20% by 2007. In the past, countries’ capital accounts have ranged from almost completely closed to completely open and, while most countries have moved in the direction of greater openness, wide differences remain. The issue of when and how much to liberalize capital flows has been one of the most contentious in the global economic policy debate for decades.
The financial account in a country’s balance of payments covers a variety of financial flows—mainly foreign direct investment (FDI), portfolio flows (including investment in bonds and equities), and bank borrowing—which have in common the acquisition of assets in one country by residents of another. Capital account liberalization, in broad terms, refers to easing limitations or fees and taxes on capital flows across a country’s borders. This can result in a higher degree of financial integration with the global economy through higher volumes of capital inflows and outflows.
The free flow of capital across the globe can have important benefits for countries and for the global economy. For example, capital flows can help a country’s financial sector to become more competitive and sophisticated. At the global level, they can achieve a better allocation of capital that fosters higher growth, and help smooth the adjustment of economic imbalances between countries.
Capital flows can also pose important risks however. They are volatile and can be large relative to the size of a country’s financial markets or economy. This can lead to booms and busts in credit or asset prices, and makes countries more vulnerable to contagion from global instability.
The global crisis is the latest in a series of events that have shown that policymakers need to be vigilant to the risks, while maximizing the benefits of capital flows.
The new institutional view is the culmination of work begun two years ago to develop a pragmatic, experience-based approach to help countries cope with capital flows.
The IMF has published several studies on capital flows that underpin this institutional view, and on December 3 issued a synthesis of its work that the IMF Executive Board endorsed.
The goal is to help countries reap the benefits of capital flows, while managing their risks.
“We need to be in a position to provide clear and consistent advice with respect to capital flows and the policies related to them,” said David Lipton, the IMF First Deputy Managing Director.
“This work clarifies the trade-offs between policy options for dealing with the risks related to capital flows, harnessing the benefits of capital mobility, and addressing the implications of capital flow management for global economic and financial stability.”
Key features of the institutional view are as follows:
• Capital flows can have substantial benefits for countries. At the same time, they also carry risks, even for countries that have long been open and drawn benefits from them.
• Capital flow liberalization is generally more beneficial and less risky if countries have reached certain levels or “thresholds” of financial and institutional development.
• Liberalization needs to be well planned, timed, and sequenced in order to ensure that its benefits outweigh the costs.
• Countries with extensive and long-standing measures to limit capital flows are likely to benefit from further liberalization in an orderly manner. There is, however, no presumption that full liberalization is an appropriate goal for all countries at all times.
• Rapid capital inflow surges or disruptive outflows can create policy challenges. Appropriate policy responses involve both countries that are recipients of capital flows and those from which flows originate.
• For countries that have to manage the risks associated with inflow surges or disruptive outflows, a key role needs to be played by macroeconomic policies, as well as by sound financial supervision and regulation, and strong institutions. In certain circumstances, capital flow management measures can be useful. They should not, however, substitute for warranted macroeconomic adjustment.
• Policymakers in all countries, including countries that generate large capital flows, should take into account how their policies may affect global economic and financial stability. Cross-border coordination of policies would help to mitigate the riskiness of capital flows.
This institutional view reflects a very broad consensus of the IMF's membership. It will guide the institution’s advice to its member countries, without prejudice to the need to take into account country circumstances. It does not alter members’ rights and obligations.
The IMF plans to develop operational guidance to integrate this view in its work. Over time, the view will evolve to incorporate new lessons from country experiences, analytical work, and feedback from country authorities and other interlocutors.