- International Monetary Fund. Monetary and Capital Markets Department
- Published Date:
- October 2015
During January 1, 2014–July 31, 2015, liberalization of foreign exchange transactions continued unabatedly accompanied by measures to advance the financial sector regulatory agenda against the backdrop of still weak and uneven global recovery, volatility of capital flows and commodity prices, and recurring pressures in financial markets. The growth divergence across major economies has also been reflected in exchange rate movements, both in the appreciation of the U.S. dollar and the weakening of many emerging market currencies, particularly those of commodity exporters. These movements triggered various policy responses, including intensified foreign exchange interventions in some cases and adjustments in monetary policy in others, although many emerging market economies have relied on exchange rate flexibility in the absence of significant market disruptions.
Emerging market economies generally experienced tighter external financing conditions and some weakening in capital inflows in the second half of the reporting period. Many of these economies came under renewed pressure in early 2014; equities fell, risk premiums rose, and currencies depreciated. While pressures were felt widely, economies with relatively high inflation and external deficits were among the most affected. Following strong capital inflows and an increase in asset prices in the second quarter of 2014, emerging market portfolio flows weakened beginning in September 2014 and became outflows toward the end of the reporting period, including in China, and emerging market asset prices fell.
The volatility in capital flows and related pressures in emerging market financial markets reflect a variety of factors, including shifts in markets’ expectation of the Federal Reserve’s interest rate liftoff, changes in the perception of easy external financing conditions related to the European Central Bank’s June 2014 announcement of a new round of credit easing, weaker emerging market growth, and lower commodity prices (particularly of oil). These conditions also underscore the challenges emerging market economies face as a result of shifting sentiment. Sensitivity to movements in U.S. and euro area interest rates, geopolitical developments, and continued divergence in U.S. economic activity strength vis-à-vis the rest of the world are at play. Domestic vulnerabilities may compound risks for some economies with these increasingly differentiated market pressures.
Despite generally volatile market conditions, IMF member countries moved to more stable exchange rate regimes and for the most part continued to ease controls on current and capital transactions. The reform of the financial sector regulatory framework also continued by phasing in stronger regulatory standards for the global banking system, particularly in the euro area.
The 2015 AREAER documents the following major trends and significant developments:
Exchange rate arrangements shifted markedly toward more stable managed arrangements. The use of other managed arrangements (the residual category of de facto exchange rate arrangements) has gradually diminished with improving global financial conditions, while the number of countries using a soft peg increased. The shift toward more managed arrangements may indicate recurring pressure on emerging market currencies as a result of capital flow volatility.
The role of the exchange rate as the anchor for monetary policy continued to decline, with more countries moving to inflation targeting. The U.S. dollar remained the dominant exchange rate anchor, although the number of countries anchoring to it continued to decrease.
Exchange rate interventions increased, as the volatility of major currencies picked up and currencies of emerging markets were heavily affected by capital flow volatility, geopolitical tensions, and in some cases domestic conditions during the reporting period. Members relied more on the use of foreign exchange auctions as a tool for managing foreign reserves and as a vehicle for foreign exchange interventions.
The modernization of foreign exchange market structures continued as foreign exchange markets developed and market-based arrangements spread. However, the number of countries with central bank auctions also increased, reflecting volatile global and internal market conditions. Countries overwhelmingly eased conditions for foreign exchange forward and swap operations to deepen the foreign exchange market, facilitate businesses’ risk management, and manage liquidity.
The number of IMF member countries accepting the obligations of Article VIII, Sections 2(a), 3, and 4, remained at 168, with no new acceptances. Twenty IMF members avail themselves of the transitional arrangement under Article XIV.
The previous trend toward liberalization with respect to payments for invisible transactions continued, but conditions for other current transactions were generally tightened. In addition, the overall number of restrictive measures on current payments and transfers increased considerably, in part due to improved reporting but also reflecting more restrictive regulatory conditions in response to balance of payments pressures.
Members continued to liberalize capital transactions. Measures mostly eased conditions for both inflows and outflows, as in the previous reporting period. The transactions that recorded the largest number of changes were related to capital and money market instruments, followed by foreign direct investment, and in both cases easing measures predominated over tightening measures. This trend may be driven by the greater share of portfolio flows in total capital flows to emerging market economies and may suggest their further globalization and financial deepening. Tightening measures were mainly introduced in the context of balance of payments crises or pressures on the domestic foreign exchange market.
Developments in the financial sector indicate progress with the implementation of the global regulatory reform agenda and continued liberalization of controls on capital flows. Prudential frameworks were generally tightened both for commercial banks and institutional investors to bolster financial stability. The continued easing of capital controls reflects implementation of broader capital flow liberalization plans and in some cases, tighter external financing conditions and weaker capital inflows. Reserve requirements were used extensively to implement monetary policy and reduce dollarization, and as a regulatory response to capital flow volatility.
The remainder of this Overview highlights the major developments covered in the individual country chapters that are part of this report. (These are on the CD that accompanies the printed version of the Overview and are available through AREAER Online.)