March 24, 2013
Abstract: Views on capital flow management measures (CFMMs) have evolved from being always “bad” to becoming more nuanced. Even the IMF acknowledged that CFMMs are appropriate under certain circumstances. This view surfaced when central banks of developed countries infused massive liquidity causing potentially destabilizing inflows and currency appreciation in emerging market economies (EMEs) in 2010. Theoretically, CFMMs are not necessary to prevent appreciation as EMEs can potentially purchase unlimited amounts of foreign currencies with their own currency. But this can have many adverse macroeconomic consequences; so CFMMs have to remain as part of their toolkit.
After August 2011, capital flows into EMEs reversed sharply. This caused dissimilar outcomes within EMEs. Currencies of EMEs with large current account deficits experienced more downward pressure compared to those with surplus. Preventing depreciation requires sufficient reserves together with some form of CFMMs. There is however a risk that market participants may see capital controls as a reversal of policy commitment. Overall, a right balance between sequencing, pace, timing and risk mitigation of the capital account is required.
Keywords: capital account; current account; IMF; emerging markets; exchange rates; capital inflow; capital outflow; capital flow management measures