Motivation: This is the fourth in a series of Board papers developing a comprehensive Fund view on capital flows and the policies that affect them. A first paper in December 2010 dealt with the Fund’s overall role in this area, both historically and prospectively. The second paper in March 2011 developed a framework for policy advice on managing capital inflows broadly endorsed by the Board, which constitutes a first round articulation of the Fund’s institutional views on managing capital inflows. The third paper in November 2011 examined the multilateral aspects of policies affecting capital flows, and focused mainly on source country policies. This paper covers liberalizing capital flows and the management of outflows.

Objective and coverage: The objective of the present paper is to equip the Fund with an up-to-date and operational framework for policy advice on liberalizing capital flows and on the management of capital outflows. First, it proposes an “integrated approach” to the liberalization of capital flows. Second, in this context, it discusses the implications of liberalization by systemically important emerging market economies (EMEs) that extensively control capital flows (China and India). Third, it considers the use of capital flow management measures (CFMs) on outflows in preventing and managing crises. In addressing these questions, the paper takes account of lessons from the ongoing crisis. The frameworks as set forth in this paper are intended to inform policy discussions with and advice to Fund members, but are not intended to provide guidance on members’ obligations under the Articles of Agreement.

Main messages: While the understanding of the issues discussed in the paper has advanced over the past decade, it remains far from complete. What is now known is consistent with the following conclusions. First, the appropriate degree of liberalization for a country would depend on its specific circumstances, notably on whether it has reached certain thresholds with respect to financial development. The crisis has underscored the financial stability risks associated with capital flows. Managing these risks requires stronger policies and cooperation across countries. CFMs may need to be temporarily reimposed under certain conditions without compromising the overall process of liberalization. Second, in China and India, further liberalization would be beneficial based on implementation of the authorities’ liberalization plans and more rapid progress on supporting reforms, particularly in the financial sector. Liberalization needs to be well planned and sequenced, as it could have potentially significant domestic and multilateral effects. Third, the reimposition of CFMs on outflows can be useful mainly in crisis or near crisis conditions, but only as a supplement to more fundamental policy adjustment.

Next steps: A subsequent paper, responding to the call by the International Monetary and Financial Committee (IMFC), will integrate all of the elements covered in the series of papers thus far into a comprehensive, flexible, and balanced, approach for the management of capital flows, drawing on country experiences.