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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.”

Much can be said and written about the position of the Fund Secretariat on the costs and benefits of free capital movements and capital control measures. Here I will make short remarks on two issues: the countercyclical use of CFMs and possible practical consequences of this Institutional View for policy making in DCs.

According to the Fund, in managing capital flows “a key role needs to be played by macroeconomic policies, including monetary, fiscal and exchange rate management… In certain circumstances, capital flow management measures can be useful.” However, this position is not justified. There is no practical or theoretical reason for any economy with policies judiciously designed to attain stability, growth, debt and balance-of-payments sustainability to alter the mix and stance of its macroeconomic policies when faced with an externally generated surge in capital flows. For such an economy, capital controls are the first best measures to insulate domestic conditions from externally generated destabilizing pressures.

This may also be true for an economy where pull factors play some role in the surge in capital flows. Suppose a relatively high-inflation country is following the IMF advice of inflation targeting, pursuing a policy of high interest rates and setting its fiscal stance to ensure debt sustainability – very much like Brazil or Turkey in recent years. In such economies high interest rates can attract large amounts of arbitrage capital. Lowering interest rates would conflict with domestic policy objectives. Sterilized interventions would be costly because of high interest rates. The most sensible response would again be restrictions on capital inflows, a kind of interest equalization tax designed to eliminate the arbitrage margin.

Be that as it may, the Fund’s Institutional View cannot have much impact on countercyclical capital account policies in DCs receiving large inflows because such countries are unlikely to come under the Fund’s oversight as borrowers and because the Fund has little leverage over non-borrowing members. By contrast, capital inflows could help them exit Fund programmes. This is, for instance, the case of Turkey which is not only paying fully its debt to the Fund but also offering some $5 billion from such inflows to boost IMF resources. Thus, Article IV assessments would have little practical consequences for such countries.

However, for its borrowers the policy advice given by the IMF in Article IV consultations often provide the framework for the conditionality to be attached to any future Fund program. Therefore, if a developing country finds itself in trouble as a result of a sudden stop and reversal of capital flows and ends up on the doorstep of the IMF, then it may come under the Fund’s pressure to eliminate CFMs that go beyond the Institutional View and open up its capital markets. This is not without precedent. During the 1997 crisis, under an IMF programme, Korea was forced to abolish the limits on foreign ownership of shares in Korean companies and even to allow hostile takeovers.

How the Fund’s Institutional View is to be made operational is yet to be clarified in a guidance note to staff, and the Executive Board has asked to be consulted before the finalization of that note. It is important for DCs to ensure that it does not become an instrument for opening up their capital markets – a concern apparently voiced during the discussions at the Executive Board. For, this initiative can cause problems for DCs not so much by restricting capital account policies at times of surges in inflows as by opening a new route for the Fund to push for further liberalization with the support of its major shareholders.

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