Surge In Capital Inflows Research Articles

Managing Large-Scale Capital Inflows: The Case of the Czech Republic, Poland and Romania

Many emerging market economies have in the recent past experienced a surge in capital inflows that may threaten their economic and financial stability. The IMF in early 2011 proposed a framework intended to guide Fund advice to policymakers on how to best respond to such inflows, including both macroeconomic instruments and so-called capital flow management measures (CFMs). The paper applies this framework to three countries that have experienced elevated capital inflows after the onset of the 2008 global financial crisis - the Czech Republic, Poland, and Romania. It finds that the evaluation of the macroeconomic criteria as prescribed by the framework does not support the use of CFMs, but instead advocates macroeconomic policies as the first line of defense against large-scale capital inflows. This finding is by and large consistent with the IMF’s policy advice given to country authorities in the context of surveillance missions.

The Effectiveness of Monetary Policy Transmission Under Capital Inflows: Evidence from Asia

The effectiveness of the monetary policy transmission mechanism in open economies could be impaired if interest rates are driven primarily by global factors, especially during periods of large capital inflows. The main objective of this paper is to assess whether this is true for emerging Asia's economies. Using a dynamic factor model and a structural vector auto-regression model, we show that long-term interest rates in Asia are indeed predominantly driven by global factors. However, monetary policy transmission mechanism remains effective in the region, as it operates predominantly through short-term interest rates. Nevertheless, the monetary transmission mechanism, though effective, is somewhat weaker in Asia during the periods of surges in capital inflows.

The Effectiveness of Monetary Policy Transmission Under Capital Inflows: Evidence from Asia

The effectiveness of the monetary policy transmission mechanism in open economies could be impaired if interest rates are driven primarily by global factors, especially during periods of large capital inflows. The main objective of this paper is to assess whether this is true for emerging Asia’s economies. Using a dynamic factor model and a structural vector auto-regression model, we show that long-term interest rates in Asia are indeed predominantly driven by global factors. However, monetary policy transmission mechanism remains effective in the region, as it operates predominantly through short-term interest rates. Nevertheless, the monetary transmission mechanism, though effective, is somewhat weaker in Asia during the periods of surges in capital inflows.

ABS Inflows to the United States and the Global Financial Crisis

The 'global saving glut' (GSG) hypothesis argues that the surge in capital inflows from emerging market economies to the United States led to significant declines in long-term interest rates in the United States and other industrial economies. In turn, these lower interest rates, when combined with both innovations and deficiencies of the U.S. credit market, are believed to have contributed to the U.S. housing bubble and to the buildup in financial vulnerabilities that led to the financial crisis. Because the GSG countries for the most part restricted their U.S. purchases to Treasuries and Agency debt, their provision of savings to ultimately risky subprime mortgage borrowers was necessarily indirect, pushing down yields on safe assets and increasing the appetite for alternative investments on the part of other investors. We present a more complete picture of how capital flows contributed to the crisis, drawing attention to the sizable inflows from European investors into U.S. private-label asset-backed securities (ABS), including mortgage-backed securities and other structured investment products. By adding to domestic demand for private-label ABS, substantial foreign acquisitions of these securities contributed to the decline in their spreads over Treasury yields. Through a combination of empirical estimation and model simulation, we verify that both GSG inflows into Treasuries and Agencies, as well as European acquisitions of ABS, played a role in contributing to downward pressures on U.S. interest rates.

Capital Controls: When and Why?

How should emerging market countries handle surges in capital inflows that may pose both prudential and macroeconomic policy challenges? We review the arguments on the appropriate management of inflow surges and discuss the conditions under which controls on capital inflows may be appropriate. We argue that if the economy is operating near potential, if reserves are adequate, if the exchange rate is not undervalued, and if the flows are likely to be transitory, then controls on capital inflows—together with macroeconomic policy adjustment and prudential measures—may usefully form part of the policy toolkit.

Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework

Emerging markets (EMs) are experiencing a surge in capital inflows, lifting asset prices and growth prospects. While inflows are typically beneficial for receiving countries, inflow surges can carry macroeconomic and financial stability risks. This paper reviews the recent experience of EMs in dealing with capital inflows and suggests a possible framework for IMF policy advice on the spectrum of measures available to policymakers to manage inflows, including macroeconomic policies, prudential measures and capital controls. Illustrative applications of this framework suggest that it may be appropriate for several countries, based on their current circumstances, to consider prudential measures or capital controls in response to capital inflows. The suggested framework is intended to inform staff policy advice to all Fund members with open capital accounts. It forms part of a broader effort to sharpen Fund surveillance, preserve evenhandedness, and foster greater global policy coordination. As indicated in the Supplement to this paper, this broader effort includes the development of “global rules of the game” on macroprudential policies, capital account liberalization, and reserve adequacy, and the preparation of spillover reports assessing spillovers from the five systemic economies—all of which will inform the current and broader framework being developed.

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Macro-economic management of the Indian economy: capital flows, interest rates, and inflation1

This paper addresses the issue of surge in capital inflows into a relatively open emerging economy. One of the constraints in dealing with surges is that much of the theoretical analysis is motivated by developed economies with well developed capital and money markets, while emerging economies are characterised by missing market segments and incomplete integration of such markets. It tries to use the existing literature and empirical information on the concerned economy to derive practical policy suggestions for meeting and balancing the objectives of inflation control and sustained growth. One of the noteworthy recommendations is the introduction of an auctioning mechanism for the right to incur foreign debt. This is designed to correct or compensate for the negative externalities arising from such cross-border debt, given the possibility of sharp reversals arising from global external developments and global shocks. The auction of rights to borrow can act as a variable tax that taxes short term flows at a higher rate and adjusts to changing environment. A limited version of such auctions has been tried sucessfully under the supervision of the Securities and Exchange Board of India. The global environment that gave rise to this issue in India has changed dramatically the US financial crisis and global recession. The analysis however, stands and may be useful when the global situation returns to normal and another emerging economy is faced with a similar situation.

Surges and Sudden Stops of Capital Flows to Emerging Markets

A characteristic of many of the recent emerging market currency crises is a preceding surge in capital inflows and their reversals or ‘sudden stops’ during the crises. The empirical investigation of 38 emerging market economies between 1990 and 2003 reveals that a surge in capital inflows significantly increases the probability of a sudden stop. In addition, a surge accompanied by a high current account deficit or an appreciated real exchange rate is more likely to be associated with a sudden stop. The paper also finds that a surge that is dominated by private loans and portfolio flows rather than direct investment has a higher probability to end with a sudden stop.

Surges and Sudden Stops of Capital Flows to Emerging Markets

A characteristic of many of the recent emerging market currency crises is a preceding surge in capital inflows and their reversals or 'sudden stops' during the crises. The empirical investigation of 38 emerging market economies between 1990 and 2003 reveals that a surge in capital inflows significantly increases the probability of a sudden stop. In addition, a surge accompanied by a high current account deficit or an appreciated real exchange rate is more likely to be associated with a sudden stop. The paper also finds that a surge that is dominated by private loans and portfolio flows rather than direct investment has a higher probability to end with a sudden stop.

Challenges to Monetary Policy From Financial Globalization: The Case of India

The question of how India should adapt monetary policy to ongoing financial globalization has gained prominence with the recent surge in capital inflows. This paper documents the degree to which India has become financially globalized, both in absolute terms and relative to emerging and developed countries. We find that despite a relatively low degree of openness, India's domestic monetary conditions are highly influenced by global factors. We then review the experiences of countries that have adapted to financial globalization, drawing lessons for India. While we find no strong relationship between the degree of stability in monetary conditions and the broad monetary policy regime, our findings suggest that improvements in monetary operations and communication?sometimes prompted by a shift to an IT regime?have helped stabilize broader monetary conditions. In addition, the experience of countries which used non-standard instruments suggests that room to regulate capital flows effectively through capital controls diminishes as financial integration increases.

Challenges to Monetary Policy from Financial Globalization: The Case of India

The question of how India should adapt monetary policy to ongoing financial globalization has gained prominence with the recent surge in capital inflows. This paper documents the degree to which India has become financially globalized, both in absolute terms and relative to emerging and developed countries. We find that despite a relatively low degree of openness, India's domestic monetary conditions are highly influenced by global factors. We then review the experiences of countries that have adapted to financial globalization, drawing lessons for India. While we find no strong relationship between the degree of stability in monetary conditions and the broad monetary policy regime, our findings suggest that improvements in monetary operations and communication - sometimes prompted by a shift to an IT regime - have helped stabilize broader monetary conditions. In addition, the experience of countries which used non-standard instruments suggests that room to regulate capital flows effectively through capital controls diminishes as financial integration increases.

Welfare Implications of Capital Account Liberalization

In recent decades, capital account liberalization in emerging economies has often been followed by a surge in capital inflows, despite the presence of severe informational asymmetries for foreign lenders. Empirical studies have shown that in emerging economies financial liberalization has led to an increase in consumption volatility (also relative to output). I use a small open economy model where foreign lending to households is constrained by an endogenous borrowing limit. Borrowing is secured by collateral in the form of durable investment whose accumulation is subject to adjustment costs. This economy is able to replicate the aforementioned stylized fact in response to various shocks (productivity, foreign demand and government expenditure). I find that financial liberalization reduces welfare since it increases the volatility of consumption and employment.

Foreign Exchange Reserves, Exchange Rate Regimes, and Monetary Policy: Issues in Asia

This paper seeks to outline issues arising from rapid foreign exchange reserve accumulations in Asia. Attention is paid to People’s Republic of China and India for the significance of the accumulation fed by surges in capital inflows. The paper finds that sterilization interventions by the two economies appear to be effective in curbing credit growth, but the impacts appear limited and short-lived. In this regard, adjustments of exchange rate policies are called for to have more freedom in policy options, though incentives to live with exchange rate fluctuations are still limited, and in fact the currencies have been managed more tightly than before. Therefore, the paper argues that, while maintaining the current exchange rate practices with capital controls in place, domestic reforms should be pushed further to be ready for capital account convertibility and more exchange rate flexibility in the long term.

An Empirical Assessment Of Monetary Policy Responses To Capital Inflows In Asia Before The Financial Crisis

This paper highlights monetary policy implemented by monetary authorities in response to a surge of capital inflows in Asia during the period 1985–1996. It statistically assesses the effectiveness of monetary policy responses. Regression results show that Asian countries as a group took the operation of a high rate of sterilization and the foreign exchange market intervention which yielded a small change in the exchange rate. Consequently, they succeeded in keeping nominal exchange rates at desired levels and in limiting increases in monetary growth, despite a surge in capital inflows. The adoption of floating exchange rates, it is concluded, could have avoided the occurrence of financial crisis in Asia. [F32, F41]

Do capital controls and macroeconomic policies influence the volume and composition of capital flows? Evidence from the 1990s

In the early 1990s capital inflows to Asia were primarily foreign direct investment (FDI). Latin America was attracting little FDI and much more `hot money'. This fed the view that Latin America was more vulnerable to reversals of capital flows than Asia. Yet, regional differences were eroding—the 1997 crises revealed Asia's exposure to short-term capital. We present evidence that capital controls influence the composition of flows, not their volume while sterilized intervention influences volume and composition, skewing flows to short maturities. We conclude that Asia's increasing reliance on `hot money' was largely due to the policy response to the surge in capital inflows.

Financial Reverberations: The Latin American Banking System During the Mid-1990s

The early 1990s witnessed a broad liberalization of the banking sector across Latin America. Consequently, there was a surge in capital inflows. The new banking institutions, however, were frail and supervision was weak. Therefore, the sector was vulnerable to endogenous and exogenous shocks. The shocks started arriving in 1993 and peaked during the first quarter of 1995, as the reverberations from the Mexican devaluation spread to most of the Latin American economies. This paper examines the different policy responses across the four major countries in Latin America . The paper argues that governments that led pro-market policy responses registered the lowest fiscal and macroeconomic costs. While those that pursued non-market responses registered the highest costs.

Are Capital Inflows in the Czech Republic Inflationary?

Capital inflows in the Czech Republic, as measured by the surplus in the capital account of the balance of payments (BoP), amounted to 8.5 percent of GDP in 1993 and 5.8 percent of GDP in 1994. In recent years, several countries have experienced surges in capital inflows; for example, Chile in 1990, 10.6 percent of GDP; Mexico in 1992, 7.6 percent of GDP; Thailand in 1991, 12.6 percent of GDP; Spain in 1987, 3.8 percent of GDP (see Schadler et al. 1993). As in these countries, in the Czech Republic the magnitude of capital inflows raises concerns about their destabilizing effects. While, in principle, capital inflows can finance economic growth and investment, they are often associated with an increase in domestic demand and consumption, putting pressure on prices. Credit expansion afforded by foreign capital causes increases in monetary aggregates, making monetary policy

Personal Financial Planning, 7th Edition

In this paper, we aim to investigate (a) the dynamic adjustment of investment-to-GDP ratio and bank credit-to-GDP ratio following banking crisis episodes; (b) whether the adjustment of investment and bank credit ratios varies with several country and crisis characteristics. Based on a sample of 79 developed and emerging countries over the 1973–2010 period, our results suggest that in the aftermath of banking crises, investment ratio declines but swiftly recovers to its pre-crisis level within two to three years. Bank credit declines significantly and remains stagnated even in the medium run. In terms of country characteristics, we find that investment and bank credit ratios decline significantly more in advanced countries and countries with higher level of capital openness. In addition, investment ratio declines significantly more in countries with higher level of financial development. Finally, we split the banking crises episodes into two categories: those preceded by a domestic credit boom or a surge in net capital inflows, and those that were not preceded by such booms. We find that dynamic adjustment of investment and bank credit ratios differs substantially across the two groups. Existence of a credit boom or a surge in capital inflow in the run-up to the crisis intensifies the length and depth of the decline in investment and bank credit ratios. In fact, we find no statistically significant decline in investment following banking crises that were not preceded by a credit boom or a surge in capital inflows. These results imply that deleveraging is costly to the economy.

Implications of a Surge in Capital Inflows: Available tools and Consequences for the Conduct of Monetary Policy

"Volume 1996 (1996): Issue 053 (May 1996): Implications of a Surge in Capital Inflows: Available tools and Consequences for the Conduct of Monetary Policy" published on 01 May 1996 by International Monetary Fund.