August 2, 2017
Versions in Español (Spanish)
Exchange rates board, Australian Securities Exchange: Emerging economies have several tools to manage capital flows. The most common are foreign exchange intervention and monetary policy (photo: wx-bradwang/iStock by Getty Images)
The global financial crisis and its aftermath saw boom-bust cycles in capital flows of unprecedented magnitude. Traditionally, emerging market economies were counselled not to impede capital flows. In recent years, however, there has been growing recognition that emerging market economies may benefit from more proactive management to avoid crisis when flows eventually recede. But do they adopt such a proactive approach in practice?
May 29, 2017
It seems likely that Brexit will alter the relationship that UK-based financial firms have with the European Union—even though negotiations are just beginning.
For an idea of how much is at stake for the United Kingdom’s financial services industry, take a look at our Chart of the Week, drawn from the IMF’s latest Global Financial Stability Report. The chart illustrates the linkages that might be affected by the country’s withdrawal from the EU. One example: of the over-the-counter trading in foreign exchange derivatives in the United Kingdom, Germany and France, the UK share comes to 89 percent. […]
(Version in Español)
With the expected move by the Federal Reserve to raise interest rates before the end of the year, many are asking about the effects on emerging market countries. Will outflows increase, and how will this affect economic activity in emerging markets? To answer that, we need to know if capital inflows are in general expansionary or contractionary.
One would think that the question was settled long ago. But, in fact, it is not. It is a case where theory suggests one thing and practice another. The workhorse model of international macro (the Mundell-Fleming model), for example, suggests that, for a given monetary policy rate, inflows lead to an appreciation, and thus to a contraction in net exports—and a decrease in output. Only if the policy rate is decreased sufficiently can capital inflows be expansionary. Symmetrically, using a model along these lines, Paul Krugman argued in his 2013 Mundell-Fleming lecture that capital outflows are expansionary.
Debt held by firms in emerging market economies in a currency other than their own poses extra complications these days. When the U.S. Fed does eventually raise interest rates, the accompanying further strengthening of the U.S. dollar will mean an emerging market’s own currency will depreciate against the higher value of the U.S. dollar, and would make it increasingly difficult for firms to service their foreign currency-denominated debts if they have not been properly hedged.
In the latest Global Financial Stability Report, we find that firms in emerging markets that have increased their debt-to-assets ratios have generally also increased their overall sensitivity to changes in the exchange rate—commonly called exchange-rate exposure.
By: John Simon
The winds may fell the massive oak, but bamboo, bent even to the ground, will spring upright after the passage of the storm.
– Japanese Proverb
Capital flows to emerging market economies are a source of particular and enduring concern to many policymakers. As seen in the 1997-98 Asian crisis, surging inflows can fuel excessive credit growth, expanded current account deficits, appreciated exchange rates and a loss of competitiveness—followed by painful adjustment when the inflows reverse. Countries often fight these buffeting winds with tight controls on exchange rates, capital flow management and aggressive interest rate movements. While these sometimes work, and are sometimes the best response to a crisis, all too often countries can find themselves felled by the wind like the massive oak.
In the most recent World Economic Outlook we discuss an approach to dealing with volatile international capital flows that emphasizes the soft and flexible response to capital flows rather than the hard and oak-like. Instead of trying to resist foreign inflows, countries can bend. We find that the countries that proved to […]