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.

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

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

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

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

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.

Investment and private flows

The region s economies are now cooling and incomes are flattening, and low cost capital inflows will no longer encourage public and private sector consumption.

Private capital flows have come to play the dominant role in development finance, eclipsing both official bilateral and multilateral flows.

The sale of sovereign bonds under the fixed exchange rate regime put direct upward pressure on their yields, while sales of private securities by foreigners had a similar effect, but through indirect channels. Monetary tightening was forestalled only to the extent that another source of foreign capital (either private or ECB) could replace the outflow.

Mutual and other private sector funds require minimum terms for investments, and such mandatory lock up periods should be applied to capital inflows as well.

Encouraging private capital flows and remittances

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

Prudential controls on capital flows make a lot of sense.

These factors considerably limit those countries' ability to attract foreign direct investment and other international private capital flows.

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.

What national and international efforts can be made to increase the stability of private capital flows to developing countries and to maximize their development impact?

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

Another global financial crisis could disrupt short term capital inflows.

The IMF also prefers CFMs to be temporary.

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.

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.

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.

Sub theme 2 Trade, investment and private flows

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.

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.

20. Notes the importance of an orderly, gradual and well sequenced liberalization of capital accounts to strengthen the ability of countries to sustain its consequences so as to mitigate the adverse impact of the volatility of short term capital flows

When dealing with surges of potentially destabilizing capital inflows, capital controls are a no no, but something called prudential regulation is quite okay.

The latter course risks the worst of all worlds all of the costs of capital controls and all of the domestic policy complications from volatile capital flows, but few of the potential benefits of foreign capital.

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