Summary of WP/92/62
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The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.

Abstract

The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.

Summary of WP/92/62

“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors” by Guillermo A. Calvo. Leonardo Leiderman. and Carmen M. Reinhart

During the past two years, Latin America has received sizable international capital flows, amounting to $24 billion in 1990 and $40 billion in 1991. In most cases, they have been accompanied by a marked accumulation in international reserves, significant appreciations in real exchange rates, booming stock markets, faster economic growth, and wider current account deficits. Although the restoration of voluntary access to international capital markets after nearly a decade has been heralded as a positive development, the resurgence in capital inflows has also been a source of concern to policymakers in the region, who fear, in particular, that the accompanying real exchange rate appreciation will adversely affect the export sector. In addition, given that the previous capital inflow episode was followed by the debt crisis of the 1980s, there are fears that some of the capital inflows are of the “hot money” variety. These highly speculative flows could be reversed on short notice and, possibly, spark a domestic financial crisis.

This paper focuses on two aspects of the present capital inflow phenomenon. First, in an effort to determine how vulnerable these economies are to an unexpected reversal in capital flows, it assesses quantitatively to what extent the recent increase is due to external forces. Second, it discusses the form and timing of the appropriate policy response, examining the pros and cons of a menu of policy measures, including taxes on capital imports, trade policy, fiscal tightening, central bank sterilized and nonsterilized intervention, and banking regulations.

The empirical analysis indicates that capital is returning to most Latin American countries despite considerable differences in domestic policies and macroeconomic conditions. External forces, particularly developments in the United States, have played an important role in inducing capital flows into Latin America. The sharp decline in U.S. interest rates, the continuing recession, and capital account developments in the United States have encouraged a portfolio shift toward Latin American assets. The policy analysis suggests that, although external factors may be reversed in the future, it is difficult to advocate sterilized intervention, given the fiscal burdens it entails, unless countries adopt a strong fiscal stance and capital inflows are expected to be short-lived. A more comprehensive policy intervention mix--including raising marginal reserve requirements on short-term bank deposit, imposing taxes on short-term capital imports, or a combination of these measures--is a viable policy alternative to deal with the possible detrimental effects of substantial capital inflows.

Working Paper Summaries (WP/92/49 - WP/92/112)
Author: International Monetary Fund