On March 21, 2022, the Executive Board of the International Monetary Fund (IMF) concluded the review of the Institutional View on the Liberalization and Management of Capital Flows (IV).
The IV was adopted in 2012 and provides the basis for consistent Fund advice on policies related to capital flows. The IV aims to help countries reap the benefits of capital flows while managing the associated risks in a way that preserves macroeconomic and financial stability and does not generate significant negative outward spillovers.
The review aims to bring the IV up to date with advances in theoretical and empirical research and policy experiences. Notably, it was informed by the work on the Integrated Policy Framework (IPF), the findings of the Independent Evaluation Office (IEO)’s 2020 evaluation on IMF Advice on Capital Flows, and IMF staff’s experience with the implementation of the IV. The review preserves the core principles of the IV, i.e., the overall presumption that capital flows can bring substantial benefits for countries and that capital flow management measures (CFMs), while useful in certain circumstances, should not substitute for warranted macroeconomic adjustment.
The paper introduces two changes to the existing policies under the IV. First, based on the insights from the IPF, it recognizes that the use of CFMs that are also macroprudential measures (CFM/MPMs) on debt inflows in a preemptive manner (i.e., in the absence of a capital inflow surge) may be appropriate in the presence of stock vulnerabilities in certain circumstances, most notably where elevated currency mismatches make countries vulnerable to systemic financial risks in the event of capital flow reversals. Second, it establishes a special treatment for certain categories of CFMs, which because of their special nature, should not be subject to the appropriateness assessments applicable to other CFMs under the IV.
The IV’s policy advice on managing capital inflow surges, disruptive outflows, and capital flow liberalization remains unchanged. However, the paper offers additional guidance to make assessments that play an important role in the implementation of capital flow policies, such as the assessment of macro-criticality, and the identification of capital inflow surges, imminent crises, and premature liberalization.
Executive Board Assessment [1]
Executive Directors welcomed the opportunity to discuss the review of the Institutional View (IV) on the Liberalization and Management of Capital Flows. They noted that, at the time of its adoption, it was envisaged that the IV would evolve in the light of research and lessons from its implementation. Directors highlighted the useful contributions from the work on the Integrated Policy Framework (IPF) and the Independent Evaluation Office’s evaluation on IMF Advice on Capital Flows in informing the review.
Directors underlined that the core principles of the IV remain valid, namely the overall presumption that capital flows are desirable and can bring substantial benefits for countries. The IV should continue to aim to help countries reap those benefits while managing the risks to macroeconomic and financial stability of large and volatile capital flows. CFMs can be useful in certain circumstances, but should not substitute for warranted macroeconomic adjustments. It is also important to ensure that the Fund’s policy framework on capital flows also guards against unintended effects or possible inappropriate use of CFMs. A number of Directors emphasized that strong macroeconomic frameworks and sound financial regulation and supervision, as well as structural reforms and market development to reduce underlying market imperfections, are the first line of defense to protect against excessive capital volatility. A number of Directors noted that policies in both source and recipient countries have a role in mitigating the multilateral risks associated with capital flows.
Directors supported the proposal on the use of measures that are both capital flow management measures and macroprudential policy measures (CFM/MPMs) on debt inflows in a preemptive manner (i.e., in the absence of a capital inflow surge) in some circumstances. They agreed that such measures may be warranted when systemic financial risks from stock vulnerabilities, notably currency mismatches, cannot be addressed effectively and efficiently with conventional policy instruments. Directors also generally concurred that, in narrow and exceptional circumstances, preemptive CFM/MPMs may also be warranted to address vulnerabilities from local currency-denominated external debt stocks. A few Directors emphasized that the appropriate conditions for use of preemptive CFM/MPMs should be sufficiently forward-looking to allow a timely and effective response to systemic risks.
Directors stressed that the appropriateness of preemptive CFM/MPMs should be subject to a comprehensive evaluation process and periodic reviews to ensure that they do not substitute for necessary macroeconomic adjustments, undermine market development, or maintain or exacerbate external imbalances. Their adoption may also complement needed macroeconomic policy adjustments. CFM/MPMs should be targeted, temporary, and transparent. A number of Directors highlighted the importance of the Fund’s capacity development assistance to address capacity constraints and underlying vulnerabilities. A number of Directors also emphasized the importance of staff judgment and flexibility in evaluating CFM/MPMs and to be mindful of the limitations of the Fund’s external sector assessment frameworks. Directors noted that if preemptive CFM/MPMs produce adverse spillovers that may significantly influence the effective operation of the international monetary system, in line with the Integrated Surveillance Decision, staff should examine whether alternative policy actions could achieve the same domestic policy objectives while minimizing the negative outward spillovers. They encouraged staff to transparently assess when CFM/MPMs are no longer appropriate and to discuss alternative policies. Directors stressed the need for staff guidance to ensure evenhanded and careful implementation of the evaluation process, as well as giving appropriate weight to the views of the authorities.
Directors broadly agreed with the proposal to accord a special treatment to certain categories of CFMs, including those introduced solely for national or international security reasons, adopted pursuant to certain internationally-agreed prudential frameworks (including reciprocity agreements), implemented in line with FATF standards to combat money laundering and the financing of terrorism, and CFMs arising from certain international cooperation standards against the avoidance or evasion of taxes. They concurred that the IV is not the right framework to assess the appropriateness of such measures, while noting that they should still be categorized as CFMs if those measures qualify as such under the definition of CFMs in the IV, and discussed in surveillance if they are macro-critical or may generate significant spillovers, consistently with the Integrated Surveillance Decision. Many Directors cautioned that measures introduced for national or international security reasons should be used sparingly and avoid misuse.
Directors noted that the IV’s advice for managing capital inflow surges, responding to disruptive outflows, and undertaking capital flow liberalization remains unchanged. They welcomed the additional guidance provided to conduct assessments of macro-criticality and identify capital flow surges, imminent crises, and premature liberalization, noting that such assessments play an important role in formulating policy advice under the IV. Some Directors sought further clarification of some aspects. Directors called for a careful balance of staff judgment and evenhandedness, as well as transparency, when implementing the IV and assessing CFMs. Directors also welcomed the clarifications provided on certain operational issues, such as the treatment of measures that are both CFMs and exchange restrictions or multiple currency practices.
Directors noted that certain topics, including the use of CFMs for social or political objectives, the distributional effects of capital flow liberalization, the use of outflow CFMs outside of (imminent) crisis circumstances, and in particular the effects of digitalization and climate change on capital flows, need further research and could not be addressed in this review. Directors encouraged staff to continue research on these topics and consider their policy implications in a timely manner in a future review of the IV.
Directors urged careful and balanced external communication to stakeholders on the changes to the IV while emphasizing that the fundamental principles of the framework are preserved.
[1] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing ups can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm .
