Controls on Capital Part of the Policy Mix, Says IMF Staff

But some countries facing sudden and temporary spikes in different forms of foreign capital flows are worried about the possible problems this can cause for economic management or the health of the financial system.

Controls on foreign capital into emerging economies can be part of the policy options available to governments to counter the potential negative economic and financial effects of sudden surges in capital, the IMF staff said.

In a new Staff Position Paper "Capital Inflows: The Role of Controls," issued on February 19, IMF staff discusses the circumstances under which controls on capital inflows to emerging market economies can usefully form part of the policy toolkit to address the economic or financial concerns surrounding sudden surges in capital. The paper is part of work under way by the staff of the 186-member international institution that reassesses the macroeconomic and financial policy framework in the wake of the devastating global financial crisis.

Controls part of a policy package

There are a number of policy choices governments can make when faced with a short-term or sudden surge in foreign capital, IMF staff said. These include

- Allowing the currency to appreciate

- Accumulating more reserves

- Changing fiscal and monetary policy

- Strengthening rules to prevent excessive risk in the financial system, and

- Capital controls.

In some circumstances, capital controls may complement the use of economic or prudential remedies to more effectively address the problem.

"There may be circumstances in which capital controls are a legitimate component of the policy response to surges in capital inflows," the paper says, while noting controls would normally be temporary, as a means to counter surges. In particular, the paper notes: "If the economy is operating near potential, if the level of reserves is adequate, if the exchange rate is not undervalued, and if the flows are likely to be transitory, then use of capital controls is justified as one element of the policy toolkit to manage inflows."

Nevertheless, evidence to date on the relative effectiveness of capital controls is ambiguous, according to the paper. Controls appear to work better in countries with existing restrictions, or with strong administrative capacity. Evidence also suggests that controls have more effect on the composition of capital flows...

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