Emerging markets can better resist capital flow volatility by taking measures to encourage their residents to invest abroad in good times and repatriate the funds when needed, according to a study by the International Monetary Fund.
Countries where a surge of capital inflows was offset by domestic residents’ purchase of foreign assets fared better during the global financial crisis as international investors pulled out, the IMF said in a chapter of its World Economic Outlook released Monday. That showed policy makers have other options than capital controls or currency interventions, it said.
The fund’s advice comes as countries from India to Indonesia brace for weaker capital flows once the U.S. Federal Reserve phases out its monetary stimulus. The Fed’s surprise decision earlier this month not to pare its $85 billion in monthly asset buying for now is leaving these nations time to address domestic economic fragilities.
During the 2008 turmoil “while some countries experienced the classical boom-and-bust cycle in response to volatile international capital flows, many did not,” the IMF wrote in the study called “The Yin and Yang of Capital Flow Management: Balancing Capital Inflows with Capital Outflows.”
“Rather, as international capital flows dried up, domestic residents stepped in to replace them by drawing down their own foreign assets,” according to the IMF.
Monday’s report focused on Chile, Malaysia and the Czech Republic, showing how they learned from past crises to adopt new policies enabling what the report called “stabilizing financial adjustment.”
In Chile, private pension funds, which hold about 40 of their assets abroad, repatriated some during the global turmoil, helping offset the reduction in foreign investors’ inflows, according to the report. In Malaysia, bond markets remained stable thanks to purchases by well-capitalized institutional investors, it said.
Common features of resilient countries include credible fiscal and monetary policies and financial regulation that limits excessive risk taking, according to the report.
An open capital account enabling residents to move money in and out of the country and a flexible exchange rate regime also play a positive role, it said. (Bloomberg)
