“There are some safeguards that the Indian economy has in relation to capital flows.”
“There are some safeguards that the Indian economy has in relation to capital flows.”
India, which has received a record number of foreign direct investments in recent years despite the COVID-19 crisis, has some safeguards in place to mitigate risks from capital flows, the International Monetary Fund said on Wednesday.
“Capital flows have several benefits. They finance necessary investments. They help to insure against some types of risks. There are many benefits for countries in having capital flows to India, as well as benefits in receiving those capital flows,” IMF First Deputy Managing Director Gita Gopinath told reporters here.
The IMF on Wednesday released a paper reviewing the Institutional View (IV) on capital flow liberalization and management. Adopted in 2012, the IV 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 avoids significant negative external spillovers. The review introduces important changes that expand the toolbox for policymakers, e.g. B. the possibility of pre-emptively applying cash flow measurements to inflows when financial vulnerabilities exist.
In response to a question, Ms. Gopinath noted that there are other types of financial risk associated with large capital inflows.
“In the case of India, there are already a large number of capital restrictions. The Indian government uses these restrictions quite proactively in dealing with changes in the external environment. By limiting the amount of external borrowing companies can borrow, this is one tool they use. And they use it in response to changing external circumstances.”
“So there are some safeguards that the Indian economy has in relation to capital flows. But of course it’s still in the process of liberalizing its capital accounts. And as its financial markets deepen, its financial institutions deepen, it could move towards more and allow for more forms of capital flows,” Ms. Gopinath said.
The senior IMF official said capital flows are desirable because they could bring significant benefits to recipient countries. But they can also lead to macroeconomic challenges and risks to financial stability, she said.
“The dramatic capital outflows we witnessed at the start of the global pandemic and the recent turmoil and capital flows to some emerging markets following the war in Ukraine are stark reminders of how volatile capital flows can be and the impact this can have on economies. said Mrs. Gopinath.
After the Great Financial Crisis, when interest rates in advanced economies were long low, capital flowed to emerging markets in search of high yields, she said. In some countries, this led to a gradual build-up of their foreign currency external debt that was not offset by foreign currency investments or hedging, she noted.
“Then, when the taper tantrum struck and EM debt suddenly lost interest, it led to serious financial difficulties in some markets. The lessons we have learned from such episodes and from a variety of research is that countries should have the ability to pre-emptively contain debt inflows in certain circumstances to ensure macroeconomic and financial stability,” Ms. Gopinath said.
Accordingly, the main update to the policy toolkit released by the IMF is the addition of capital flow management measures and macroprudential measures that can be applied pre-emptively.
“But if used correctly, these measures reduce the likelihood of a financial crisis in the event of a sudden reversal in capital deployment. This change builds on the Integrated Policy Framework, an IMF research effort to build a systematic framework to analyze policy options and trade-offs in response to shocks given country-specific characteristics,” she said.
The latest IMF report, she said, highlights the risks to financial stability that can arise from a gradual build-up of external debt, particularly when it leads to currency mismatches, and narrow and exceptional instances of external debt denominated in local currencies.
“Preventive capital flow management measures and macroprudential policies to limit inflows can mitigate external debt risks. However, they should not be used in a way that leads to undue distortions, nor should they replace the necessary macroeconomic and structural policies or views to keep currencies unduly weak,” Ms. Gopinath said.
“Another update to our recommendation is to give separate treatment to some categories of cash flow measurements that are subject to certain other international frameworks for security considerations. It also provides practical guidance for policy advice related to capital flow measures, including how to identify capital inflows and decide whether it is premature to liberalize capital flows,” she added.
