Learn to Deal with Heavy Capital Flows
May 28, 2011
Learn to dealcope with Heavy Capital Flows
That is largely good news, said economists and officials at a conference on capital flows held by the IMF and Brazils finance ministry. Hot economies such as Brazil and Indonesia may see less fallout than some fear when the US Federal Reserve eventually raises interest rates, tightening the tap on cheap funds that flooded into Latin America and Asia in search of higher returns.
But they will need to keep adjusting their policy mixes to distinguish between good flows that 
We have to be open to exploration here, he told reporters at a beach-side hotel in Rio de Janeiro, which is experiencing many of the symptoms of Brazils boom, like soaring real estate prices and strong credit growth.
We are not at the stage at which we can tell this is exactly the way we can do it we still dont exactly know what the optimal package is.
In Latin America alone, capital inflows have skyrocketed to nearly US$270 billion (RM810 billion) in 2010 from an average of about US$40 billion between 200! 0 and 20 05, according to data from the Inter-American Development Bank.
Emerging countries have adopted a broad range of measures to regulate inflows and stem currency rises, increasingly resorting to capital controls and so-called macro-prudential measures such as credit curbs.
In recognition of the alarm about huge inflows that are stoking growth and also inflation rates, the IMF last month endorsed the use of capital controls, once considered anathema to its free-market philosophy. Advanced countries want to establish a framework to monitor their use, an approach opposed by emerging markets.
Blanchard and other IMF officials said it was unclear whether such a system was needed because there was so far little evidence that capital controls had a negative, beggar-thy-neighbour effect on other countries.
There was a broad consensus that the surge in flows was more than a temporary phenomenon driven by loose liquidity in struggling developed economies. Rather, it is being driven by a fundamental re-rating of global risk, said Joyce Chang, global head of emerging markets and credit research at JP Morgan.
This is not a temporary state of affairs. This is what the new normal has become. It could be a cycle but it could be a 25- to 50-year cycle, she said.
From a capital markets perspective many of us think that capital controls are likely here to stay. Investors will continue to allocate more to emerging market assets given the better fundamentals and higher returns.
Developed world investors are still vastly under-exposed to emerging markets, suggesting that emerging markets need to be prepared for decades of strong inflows. She said US defined-contribution pension plans only have 2.1 per cent of their funds allocated to developing economies, which make up nearly 50 per cent of global GDP.
Flows to countries such as Brazil, which has tripled the tax it charges foreigners to buy local bonds, have remained strong, suggesting that governments have yet to exhaust their po! licy opt ions, participants said.
These measures are small. Given the profit opportunities, money is still going to come in, Jonathan Ostry, deputy director of the IMFs research department, told Reuters.
Kristin Forbes (left), an economics professor at the Massachusetts Institute of Technology, said countries should also consider the role of domestic investors since they are increasingly influential in determining net inflows.
In the hierarchy of when you should use capital controls, a key question you should ask before even talking about them is: what is driving the surge in net inflows? If its largely foreigners then there may be a role for capital controls, she said. Reuters
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