Damming Capital

The Capital Flow Conundrum

Capital flows and remittances

The portion of capital inflows that is not re exported represents net capital inflows.

Private sector capital flows now dwarf traditional public sector aid flows.

One of them is a reserve requirement on cross border flows successfully implemented in Chile, Colombia, and elsewhere or, even better, on cross border liabilities. Taxes on inflows can play a similar role, as can minimum stay periods for capital inflows.

Brazil has been aggressive in terms of capital restrictions, twice increasing its tax on financial inflows.

The first is the flood of short term capital heading their way.

Prudential controls on capital flows make a lot of sense.

The lack of effective global economic governance has important implications for capital flows.

Another global financial crisis could disrupt short term capital inflows.

Private capital, which accounts for more than 90 of capital flows to developing economies, will remain the dominant source of long term financing.

The IMF also prefers CFMs to be temporary.

Net private capital flows, particularly to developing economies, have become more volatile.

But it left cross border capital flows entirely off the agenda, as if they were not a part of finance.

But that is wrong. Inflation fell as a result of the crisis, which reversed the direction of capital flows.

Clearly, we need to get a better handle on what is driving these capital inflows.

Capital controls, whatever their benefits in terms of mitigating the risks associated with volatile capital flows, are costly in a variety of ways.

But the rise would most likely be offset by capital outflows, as looser capital controls would enable savers to escape the financial crisis.

But why should Latin American countries care about these capital flows and the revaluation of their currencies? After all, capital inflows traditionally have been regarded as a positive transfer of savings from rich industrial countries to capital scarce emerging markets.

The fall in the capital inflow would therefore bring with it a fall in the trade deficit.

Rapidly growing catch up economies are paddling furiously to avoid being dragged down by a torrent of capital inflows.

Given that international capital flows had restarted, they did not fear immediate external constraints.

But it is inducing massive capital flows to emerging markets, where they are generating asset price bubbles.

Private capital flows have exploded since, dwarfing trade in goods and services.

Reform is not just a plan it is already happening.

And we can hope that these capital flows will carry with them the institutions and managerial expertise that have made the core so wealthy.

The propaganda was successful. Even in 2008, the US was able to attract net capital inflows of 808 billion.

True, private capital flows have surged in the wake of global liberalization and these countries privatization schemes.

They are resisting appreciation through foreign exchange intervention and capital controls.

In a currency union, however, central bank credit may play this role if private capital flows are insufficient.

Growth that relies on capital inflows or commodity booms tends to be short lived.

Strauss Kahn s response that taxes on capital flows are costly and ineffective is therefore unfortunate.

Witness the surge in capital flows to emerging markets as investors chase higher financial returns.

The same can be said of capital inflows and the upward pressure that they place on the real exchange rate.

Table 2. FDI outflows as a percentage of gross fixed capital formation in selected economies, 2001 2003a

Private capital flows have an important role in complementing developing countries' domestic resources, the transfer of technology, employment generation and entrepreneurship building.

Even the International Monetary Fund, long the embodiment of the Washington Consensus, has acknowledged that capital controls are a legitimate part of the toolkit to manage capital flows in certain circumstances.

And, to address volatile capital flows, countries should increase exchange rate flexibility, maintain adequate international reserves, and implement carefully designed capital controls.

Pick any indicator trade relative to global GDP, capital flows relative to the global capital stock, and so forth all are rising.

Direct interventions, restrictions on short term capital inflows, capital gains taxes, and stabilizing prudential banking regulations will all have to be considered.

The taboo that has attached to capital controls has discouraged practical, policy oriented work that would help governments to manage capital flows directly.

Moreover, there is good reason to see inflows into emerging markets as an opportunity to strengthen domestic capital markets, rather than primarily as a threat to financial stability.

The consequences sharp capital flow reversals that are now hitting all risky emerging market assets have not been pretty.

Massive capital inflows caused real estate and stock market bubbles in the US and parts of Europe.