Bilge Erten and José Antonio Ocampo, Guest Bloggers

The ongoing financial volatility in emerging economies is fueling debate about whether the so-called “Fragile Five” – Brazil, India, Indonesia, South Africa, and Turkey – should be viewed as victims of advanced countries’ monetary policies or victims of their own excessive integration into global financial markets. To answer that question requires examining their different policy responses to monetary expansion – and the different levels of risk that these responses have created.

Although all of the Fragile Five – identified based on their twin fiscal and current-account deficits, which make them particularly vulnerable to capital-flow volatility – have adopted some macroprudential measures since the global financial crisis, the mix of such policies, and their outcomes, has varied substantially. Whereas Brazil, India, and Indonesia have responded to surging inflows with new capital-account regulations, South Africa and Turkey have allowed capital to flow freely across their borders.

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Jayati Ghosh

So now we have witnessed yet another sell-off of emerging market assets in global financial markets in the last week of January, which has caused currencies to depreciate from Argentina to Indonesia and many countries in between. For those who had seen it coming,  it was one more reminder of the extreme fragility generated by global financial integration, and the problems that such exposure can create for developing countries whether or not they also have specifically domestic economic concerns. Essentially, these markets are now so peculiarly integrated into the global financial system that they are part of the collateral damage whenever U.S. monetary or fiscal policy changes.

Indeed, the first round of such capital flight in the middle of 2013 did not even require any actual policy change in the United States. Rather it was generated simply by talk, when U.S. Federal Reserve Chairman Ben Bernanke announced the likely possibility of tapering down the massive monetary stimulus that had been feeding capital markets with huge amounts of liquidity since 2009. Suddenly, “taper” entered the financial lexicon of developing countries with an extremely adverse connotation, as the fear of capital inflows to emerging markets reducing or even reversing in the wake of such a move caused anticipatory movements, often by residents of the countries themselves rather than only external investors.

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Cross-posted from The Star (Malaysia)

AT the end of last week, several developing countries saw sharp falls in their currency as well as stock market values, prompting the question of whether it is the start of a wider economic crisis.

The sell-off in emerging economies also spilled over to the American and European stock markets, thus causing global turmoil.

Malaysia was not among the most badly affected, but the ringgit also declined in line with the trend by 1.1% against the US dollar last week; it has fallen 1.7% so far this year.

An American market analyst termed it an “emerging market flu”, and several global media reports tend to focus on weaknesses in individual developing countries.

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From the editors: This piece by Triple Crisis blogger Kevin Gallagher appeared previously on the Institute for New Economic Thinking blog.

Kevin Gallagher

World leaders who are gathering for the APEC summit next week had hoped to be signing the Trans-Pacific Partnership Agreement (TPP). The pact would bring together key Pacific-rim countries into a trading bloc that the United States hopes could counter China’s growing influence in the region.

But talks remain stalled. Among other sticking points, the U.S. is insisting that its TPP trading partners dismantle regulations for cross-border finance. Many TPP nations will have none of it, and for good reason. The U.S. stands on the wrong side of experience, economic theory, and guidelines issued by the International Monetary Fund.

Indeed, it’s the U.S. that could learn a few lessons from the TPP countries when it comes to overseeing cross-border finance.

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Kevin Gallagher

In the immediate aftermath of the global financial crisis, the world economy was characterized as experiencing a “two-speed” recovery.  Industrialized nations, where the crisis occurred, saw slow growth whereas many emerging market and developing countries grew significantly.  These growth differentials, coupled with significant interest rate differentials across the globe, triggered significant flows of financial capital to the emerging market and developing countries.  As a result, many countries experienced sharp appreciations of their currencies and associated concerns about the development of asset bubbles.

Two of these countries were South Korea and South Africa.  Between 2009 and 2011 currency appreciation in each country was from close to 20 and 40 percent respectively and stock prices doubled.  This triggered significant political debates in each country over what to do.  Interest groups lined up along predictable lines.  In South Korea and South Africa the financial sector was dead set against any intervention by the government, as they perceived themselves to be “winners” of the cheap credit and cross-border finance entering and leaving these nations at will.  In South Korea, exporters were split.  Some were in lock-step with the financial sector, especially the shipping industry that was using the carry trade to not only hedge currency risk but also to speculate for more profit.  Others, such as US auto firms operating in South Korea, were quite concerned about the impact of exchange rate volatility on their competitiveness and asked the government to take action.  However, the financial authorities in South Korea still had the 1990s and global financial crisis in their memory and overpowered interest groups to create a set of traditional and innovative measures from taxes on inflows to limits on the speculative positions of foreign exchange derivatives.

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Ilene Grabel

There’s a political cartoon that I’ve had in mind these days when I think about recent changes in the international political economy of capital controls.  Picture a sailboat in stiff winds on rough seas. The wind in the sails is labeled something like “Cyprus, Iceland, Brazil, China, or the Global South.” The boat is labeled “S.S. Capital Controls.” The International Monetary Fund’s (IMF) Managing Director Christine Lagarde is at the tiller, and she barks at her worry-stricken shipmate—“No, don’t trim the sails!” But we also see that the ship is trailing its anchor, which is labeled  “Neoliberalism.”

I begin with this image because I think it captures well the conflicted processes surrounding capital controls during the current global financial crisis.  Many extraordinary things have happened during the crisis. One is that we’ve come to learn an awful lot about countries like Iceland and Cyprus, countries that we could safely say weren’t even at the periphery of any discussions of the global financial system until 2008.  Another is that capital controls (so long anathema to neo-liberals) have been successfully “re-branded” as a tool of prudential financial management, even within the corridors of the IMF.  In a recent paper, I examine the myriad factors that have enabled this re-branding.  As with most rebranding exercises there is uncertainty about whether the framing will prove sufficiently sticky, especially in the context of tensions and countervailing impulses at the IMF and elsewhere.

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Sunanda Sen, Guest Blogger

Concerns have been rising, in recent months, over the current state of China’s external balance and the future of the RMB. Apprehensions relate to the negative balances, which have been visible in China’s financial balance since the last quarter of 2011. The negative sums were respectively (-) $ 3.02 and  (-)$ 4.21 billion during the second and third quarters of 2012, preceded by an even larger sum at (-)$ 29.0 billion in Q4 2011. Such deficits contrast with the surpluses in the financial account usually maintained, which were as much as $13.20 billion during Q4 of 2010.  These changes have been matched by tendencies for its official reserves to slide downwards. For instance, there was a $ 6 trillion drop in official reserves between March and June 2012. Pressures on the RMB rate even led to its depreciation, from 6.30 per dollar in April 2012 to 6.41 by August 2012. The currency, however, reverted to its earlier phase of appreciation, with the rate moving up from RMB 6.38 to RMB 6.31 between 24th July 2012 and 18th January 2013.

Differences relating to the exchange rate have continued to prevail across officials and think tanks in China and the US, with the latter holding China’s exchange rate management responsible for the continuing global account imbalances between the two countries. With pressures on China to appreciate the currency, the US Treasury even came to the point on in April 2010 of deciding whether China can be treated as a currency manipulator. The on-going dynamics of China’s foreign exchange transactions can be better understood by tracking the following major breaks in China’s exchange rate policy:

First, an end to the prevailing fixed RMB-dollar rate in 2005, which came largely with pressures from the US. Despite the twin surpluses between the current and the capital account, China was maintaining, since 1997, a fixed exchange rate at around 8.27 RMB per dollar. The change to managed floating, still supported by direct purchases of foreign currency which were flowing in abundance with the twin surpluses, led the RMB to rise immediately to 8.11 per dollar, with gradual appreciations since then. With appreciations continuing, the change to a floating RMB did not, however, lead to currency speculation till the third quarter of 2011.

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Yilmaz Akyuz

As the crisis in advanced economies (AEs) has laid bare the deficiencies of unfettered financial markets and developing countries (DCs) have started exploring ways and means of counteracting destabilizing capital inflows triggered by quantitative easing and historically low interest rates in major AEs through various measures, the IMF has been compelled to reconsider its position on capital account liberalization. After two years of pondering it has now come up with an Institutional View, discussed in its Executive Board and endorsed by most Directors. It is meant to guide Fund advice to members and Fund assessments in the context of surveillance, while it is also reiterated that members have no capital account obligations under the Articles of Agreement.

This new view brings no fundamental change in the long-held position of the Fund regarding the benefits of free capital movements. It is now recognized that there may be circumstances when capital movements may need to be restricted by Capital Flow Management Measures (CFMs), but such measures need to be deployed only as a last resort (even though the new text avoids using the term) and on a temporary basis. Countries with long-standing and extensive CFMs are advised to liberalize in order to benefit from capital movements. The Fund goes even further and encourages premature liberalization: “a country could make progress towards greater capital flow liberalization before reaching all the necessary thresholds for financial and institutional development, and indeed doing so may spur progress in these dimensions.”

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Daniela Gabor, guest blogger

In 2010, the development community sighed in collective relief as the IMF reconsidered its long-standing rejection of capital controls. Development agendas, it was hoped, would hence be pursued without the well-known disruptions caused by large and volatile capital inflows. And since foreign crises now come through capital rather than trade flows, developing countries could draw on the IMF’s expertise to avoid global financial volatility and contain sudden-stops.

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Ilene Grabel

Through much of 2010 and 2011 many of us watched the unfolding “currency war.” The currency war construct came into vogue after Brazil’s Finance Minister Guido Mantega began to complain openly in 2010 about the pressures placed on his economy and currency (and that of other rapidly-growing developing countries) by the cheap credit made available by the US Federal Reserve and other wealthy country central banks. Brazil’s President, Dilma Rousseff, joined the rhetorical fray later in 2012 by calling US President Obama and European leaders on the carpet for what she termed the “monetary tsunami” of hot money coming from rich countries.

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