The International Monetary Fund (IMF) said Wednesday that India, which has attracted a record number of foreign direct investments in recent years despite the COVID-19 problem, has a variety of protections in place to limit the risks from capital flows.
“Capital flows have a number of advantages. Investments were required by the finance. They aid in the prevention of certain dangers. “There are many benefits to countries from having capital movements in India, as well as benefits from receiving those capital flows,” said Gita Gopinath, the IMF’s First Deputy Managing Director.
The IMF published a document on the Review of the Institutional View (IV) on Capital Flow Liberalization and Management on Wednesday. The IV was approved in 2012 and serves as the foundation for consistent Fund advice on capital flow policies.
The IV strives to assist countries in reaping the advantages of capital flows while also managing the risks associated with them in a way that maintains the macroeconomic and financial stability and avoids major negative outward spillovers. The Review makes significant modifications to policymakers’ toolset, such as allowing for the use of capital flow measures on inflows ahead of time if financial vulnerabilities exist.
Ms. Gopinath responded to a question by stating that there are other types of financial hazards linked with huge capital inflows. “In the case of India, there is already a slew of capital controls in place. When the external environment changes, the Indian government takes advantage of these limits. So, limiting the amount of external borrowing that corporations can undertake is an instrument that they employ. And they deploy it in response to shifting external conditions.”
“There are a number of controls in place for capital movements in the Indian economy.” Of course, it is still working on liberalizing its capital accounts. And as the country’s financial markets and financial institutions develop, it may be able to move toward more, allowing for more types of capital flows,” Ms. Gopinath explained.
Capital flows are desirable, according to a top IMF official, because they can benefit recipient nations significantly. They can, however, cause macroeconomic problems and financial stability threats, according to her.
The global pandemic resulted in dramatic capital outflows
“The dramatic capital outflows we saw at the start of the global pandemic, as well as the recent turbulence and capital, flows to some emerging markets following the war in Ukraine,” Ms. Gopinath said, “are stark reminders of how volatile capital flows can be and the impact this can have on economies.”
Following the Great Financial Crisis, when interest rates in industrialized nations remained low for a long period, capital flocked to emerging markets in pursuit of higher yields, she explained. According to her, this resulted in the progressive accumulation of foreign currency external debt in some nations, which was not countered by foreign currency assets or hedges.
“Then came the taper tantrum, which resulted in a sharp drop in demand for developing market debt, causing serious financial turmoil in several economies.” “Now, based on the lessons learned from past episodes and a substantial body of research, countries should have the option of preemptively reducing loan inflows to protect macroeconomic and financial stability in specific scenarios,” Ms. Gopinath said.
As a result, the IMF’s policy toolkit has been updated to include capital flow management measures and macroprudential policies that can be implemented ahead of time.
“However, when employed correctly, these safeguards lessen the risk of a financial catastrophe in the event of an abrupt change in capital inputs.” “This change builds on the IMF’s integrated policy framework, which is a systematic framework for analyzing policy options and tradeoffs in response to shocks based on country-specific features,” she explained.
Lates study of IMF emphasizes Financial Stability
According to her, the latest IMF study emphasizes the risks to financial stability that can result from the steady accumulation of external debt liabilities, particularly when these cause currency mismatches and narrow and rare cases of foreign debt denominated in local currency.
“External debt risks can be mitigated through proactive capital flow management strategies and macroprudential policy that restricts inflows.” However, they should not be employed in a way that causes undue distortions, nor should they be used to replace necessary macroeconomic and structural policies or viewpoints in order to maintain currencies unduly weak, according to Ms. Gopinath.
“Another addition to our recommendation is to regard some types of money flow measures authorized by other international frameworks differently for security reasons.” “It also gives practical assistance for policy advice on capital flow measures, such as how to identify capital inflow surges and when it is appropriate to liberalize capital flows,” she noted.