IMF warns against capital controls

The International Monetary Fund, drawing on lessons from the Asian financial crisis a decade ago, warned developing countries from buying and selling their own currencies or erecting barriers to curb surging capital inflows.

Many developing economies have "intervened heavily in foreign exchange markets to resist currency appreciation," a strategy that "is likely to be ineffective", the IMF said in its annual World Economic Outlook, chapters of which were published in Washington today. Imposing capital controls also doesn't "appear to deliver better outcomes", the fund said.

Emerging markets are contending with one of "two great waves" of international investment, following the 1990s inflows that ended in collapse, according to the fund.

Without naming any nation specifically, the report offers a critique of East Asian countries with rising trade surpluses, such as China, that suppress the value of their currencies.

US and European officials, seeking to temper deepening trade imbalances, have urged the fund to pressure China to let the yuan appreciate. They will gather in Washington along with counterparts from around the world for the IMF and World Bank annual meetings on October 20-22.

The IMF will release its latest economic forecasts in the full World Economic Outlook report, scheduled for October 17. A European government official today said the fund had lowered its 2008 projections for the US and euro region.

Asian Missteps
The fund's handling of the Asian crisis raised hackles in the region. In return for aid, the IMF forced governments from Indonesia to South Korea to adopt policies that included spending cuts, interest-rate increases and sales of state-owned companies.

Critics including former World Bank chief economist Joseph Stiglitz, a Nobel laureate, contend that IMF policies needlessly deepened the region's recession.

The IMF's Independent Evaluation Office conceded in 2003 that its economic forecasts had been overly optimistic "leading to the design of macroeconomic policies that turned out to be too tight", in Indonesia and Korea.

Malaysia's former prime minister Mahathir Mohamad ignored the IMF's advice and introduced capital controls in September 1998 and pegged the ringgit at 3.8 to the US dollar to stem its slide.

The IMF, which called the ringgit peg a "retrograde step" at the time, later acknowledged it was a "stability anchor" that helped the economy recover.

Capital Inflows
Now policy makers in countries including Brazil and India are concerned that soaring capital inflows are pushing up exchange rates, hurting exporters and increasing swings in financial markets.

"The recent wave has been building since 2002, but has accelerated markedly recently, with flows in the first half of this year already far exceeding the total for 2006," the report said.

Private capital flowing to emerging markets this year will probably rise to $545 billion, almost double the $233 billion in 2003, according to estimates in May by the Institute for International Finance.

Forty-three per cent of the total will go to emerging European countries and 41 per cent is destined for Asia, according to the IIF, a Washington-based group of the world's largest commercial and investment banks.

The IMF said the best policy response to foreign inflows is to restrain government spending. That helps lower interest rates, reducing the incentive for further investment from abroad, according to the report.

Sound fiscal policies also give governments greater scope to ramp up spending in the event that a sudden reversal of capital flows causes growth to weaken, the report said.

Important Lesson
"An important lesson" from the 1997-98 financial crisis "is that the policy choices made in response to the arrival of capital inflows may have an important bearing on macroeconomic outcomes," the IMF report said.

In a separate chapter of its World Economic Outlook, the IMF concluded that the increase of inequality in most regions over the past 20 years was mainly due to the spread of technology, which places a premium on skilled labor.

The fund also said that increased trade helped reduce inequality. Opening trade tends to make agricultural producers more productive and frees up underemployed farm workers for the manufacturing or service industries, fund economists said.

Oxfam Counterpoint
By contrast, Elizabeth Stuart, senior policy adviser at the aid group Oxfam International in Washington, said that globalization of trade contributed to inequality.

"Much of the benefit has gone to big agro-businesses and smaller producers have had less access," she said. "Many countries have been pressured into giving up control of their trade policies."

In another chapter, the IMF said swings in economic growth have moderated in recent decades thanks in part to better monetary and budget policies.

The share of time that developed economies spent in recession halved to just 8 per cent over the past two decades compared with the period between 1947 and 1982, the IMF said. Improvements in monetary policy accounted for about one-third of the stabilization of output, the fund said.