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International Monetary Fund and Swiss National Bank, ^Ecole Polytechnique and SciencesPo. The views expressed are the authors’ only and do not necessarily represent those of the SNB or the IMF. For their helpful comments, we would like to thank Chikako Baba, Reza Baqir, Enrico Giovanni Berkes, Varapat Chensavasdijai, Marcin Grela, Beata Jajko, Werner Keller, Kamila Kuziemska, Ricardo Llaudes, Marcel Peter, Mahvash Qureshi, René Weber, Katarzyna Zajdel-Kurowska and seminar participants at the IMF.
In accordance with the descriptions in the IMF’s sixth edition of the Balance of Payments and International Investment Position Manual, the term capital flows is defined as “cross-border financial transactions recorded in economies’ external financial accounts”.
As noted by the IMF (2011a) discrimination is considered to occur when “(i) a measure explicitly differentiates on the basis of residency (of either the parties or assets involved), (ii) this differentiation treats non-resident transactions less favorably, and (iii) the less favorable treatment is not justified by relevant inherent differences in the non-resident transactions. The criterion in (iii) is a narrow concept that provides flexibility to differentiate between resident and non-resident transactions only where this is necessary to put the two sets of transactions on an equal footing.”
Prudential measures can be further classified as macro- or micro-prudential, where micro-prudential policies are those that focus on ameliorating institutions’ resilience to risks or reducing systemic risk. Macro-prudential policies, often based on the micro toolkit, will be exclusively aimed at lessening systemic risk.
Empirical evidence on the magnitude and direction of multilateral effects of CFMs is inconclusive thus far. The results of a recent study by the IMF (2011f) indicate that CFMs can increase or decrease flows to neighboring countries. In several instances, the results suggest that CFMs did divert flows to other countries, while in other cases the evidence is consistent with investor perception that CFMs could be adopted more widely, reflected in a reduction in flows and equity prices even in neighboring countries.
While this paper focuses on the framework for managing inflows, the IMF (2012) recently suggested a policy framework for managing capital outflows. Ostry et al. (2010) note that relaxing controls on outflows may also have an impact on aggregate net inflows, and hence on the exchange rate and other macroeconomic variables. The direction of that impact, however, remains unclear. On the one hand, liberalizing capital outflows can reduce net inflows as some of the inflows are offset by outflows. On the other hand, Ostry et al. (2010) argue that greater assurance concerning the repatriation of capital may make the country an even more attractive destination for foreign investors.
CGER (the Consultative Group on Exchange Rate Issues) is a methodology for assessing the consistency of exchange rates with medium-term fundamentals, within a multilaterally consistent setup and is comprised of three complementary approaches. The macroeconomic balance approach calculates the difference between the current account balance projected over the medium-term at prevailing exchange rates and an estimated equilibrium current account balance; the equilibrium real exchange rate approach estimates an equilibrium real exchange rate for each country as a function of medium-term fundamentals; and the external sustainability approach calculates the difference between the actual current account balance and the balance that would stabilize the net foreign asset position of the country at some benchmark level (see IMF, 2006).
In the presence of inflationary concerns, the resulting increase in the money supply stemming from the accumulation of reserves could be sterilized.
The IMF staff’s call for targeted macro-prudential measures as a response to substantial capital inflows indicates that even if macroeconomic considerations do not warrant the imposition of prudential measures, financial-stability concerns might. A main concern from the financial stability perspective is that large capital inflows may lead to excessive borrowing and foreign currency exposure, possibly fueling domestic credit booms and asset bubbles (see Ostry et al., 2010).
In an effort to counteract foreign currency risks, the Financial Supervisory Authority planned important regulatory amendments, including introducing a 50 percent limit for the share of exposures open to FX risk in the entire bank’s portfolio of retail credit exposures financing real estate; recommending to limit the borrower’s exposure to FX risk by ensuring conformity of the currency of exposure with the currency of income used for repayment; introducing the obligation to identify reliable sources of financing long-term credit exposures, that finance the real estate, adequately to the currency of the exposure (NBP, 2010).
The IMF’s Executive Board approved a 24-month SDR 3,090.6 million Stand-By Arrangement in March 2011. The authorities are treating the arrangement as precautionary.
Between May 2009 and May 2010 the central bank reduced its policy rate by 325 basis points from 9.5 percent to 6.25 percent. Further reductions of a total of 50 basis points in the policy rate occurred after the cutoff date of our analysis in November 2011 and January 2012.
Foreign direct investment, in billions of Euros, is projected to increase from 4.1 in 2011 to 5.1 by 2013. In the mean time, net portfolio inflows are expected to decline moderately but remain positive during this time period. The currently negative balance on other investments is expected to turn positive in 2012 and increase further to Euros 6.0 billion in 2013.