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Outline
Todays presentation Recent trends in capital flows to emerging countries The nature of capital flows Benefits and drawbacks of capital flows Capital flows and exchange rates Capital flows and exchange-rate regimes Dealing with capital flows Summary
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Negative:
output sensitivity of emerging market countries to growth slowdowns in advanced economies; correlation in risk premia across markets; and international finance multiplier: redemption calls, margin calls, funding of positions
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Negative:
historical reputation; trend volatility in fundamentals; fiscal procyclicality; and fragility of external funding mechanism: foreigncurrency debt
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Portfolio equity
No risk sharing
Short-term debt
Transitory
Permanent
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Remittances (1)
Definition and nature of remittances Remittances are defined as transfers from international migrants to family members in their country of origin Remittances tend to be a stable, and often countercyclical, source of foreign-exchange earnings But at a macroeconomic level large and sustained remittance flows may lead to (equilibrium) real exchange rate appreciation, with adverse consequences for exports
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Remittances (2)
Scale of remittances
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Remittances (3)
Macroeconomic consequences of remittances Given the large size of aggregate remittance flows, they can be expected to have significant macroeconomic effects on the economies that receive them The empirical evidence suggests that:
remittances are positively correlated with real (equilibrium) exchange rate appreciation (hence, there is some evidence of Dutch disease effects (on long-run growth) in remittancereceiving countries (Chami et al. (2008))
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Sudden stops
Large reversals in capital flows
Mexico, 1993-95 Korea, 1996-97 Mexico, 1981-83 Thailand, 1996-97 Venezuela, 1987-90 Turkey, 1993-94 Venezuela, 1992-94 Argentina, 1988-89 Malaysia, 1986-89 Indonesia, 1984-85 Argentina, 1982-83 0 15% of GDP 11% of GDP 6% of GDP 10% of GDP 7% of GDP 10% of GDP 5% of GDP 4% of GDP 10 20 30 40 50 60 9% of GDP 18% of GDP 12% of GDP
USD billion
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Large capital inflows are of particular concern to countries with substantial current account deficits and to countries with inflexible exchange rate regimes (IMF (2007))
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US
Hong Kong
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Other considerations include the stage of the business cycle, the fiscal policy situation and the quality of domestic financial markets
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Policy instruments
Assessing the effectiveness of policy instruments Policy instruments differ in their effectiveness An effective instrument must fulfil two properties:
it must be macro-relevant; and it must be independent
In general, the more macro-relevant a policy instrument is, the more difficult it is to use it to target specific economic problems
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Public outflows:
SWFs; and diversification of public pension portfolio
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Final thoughts
Capital flows and exchange-rate regimes Insufficiently flexible exchange-rate regimes have the potential to alter the pattern of capital flows and the price of financial assets The fact that official purchases of financial assets are determined by different factors than those influencing private investors suggests that we would probably see a somewhat different combination of capital flows, exchange rates and interest rates in the absence of official intervention
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Summary (1)
The magnitude and gyrations of capital flows, rather than the trade deficit and economic growth, are becoming the primary determinant of exchange-rate movements on a day-to-day basis Identification of the causes of inflows is generally more important than analysis of its type, as it helps to determine the appropriate policy response
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Summary (2)
Capital flows are endogenous to economic development: once capital barriers are removed, a capital flow represents a change in expectations or relative returns available in the domestic economy compared with abroad In general, capital controls are found to have little impact on the total volume of capital inflows and thus on currency appreciation Controls on inflows, however, may alter the maturity structure and composition of inflows
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Summary (3)
There is no one-size-fits-all way to deal with the impact of potentially destabilising short-term capital inflows but for both macroeconomic and macroprudential reasons, there may be circumstances in which capital controls are a legitimate component of the policy response to surges in capital inflows But supplementary (macroprudential) tools should not be seen as a substitute for sound macroeconomic policies, which are essential in limiting the consequences of volatile capital inflows
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