Bare Talk
The IMF gets a timely nudge on capital controls as a useful tack
- The arena for carry-trade will be well set, and this is expected to be the preferred sport for investors, corporate borrowers and sovereigns in the developing world
Amidst all the talk about per capita income in dollar terms prompted by the International Monetary Fund’s October update of its World Economic Outlook, came an unheralded report by its Independent Evaluation Office (IEO), on the advice that the Fund offers member countries advice on capital flows management (CFM). It is authored by IMF veteran Prakash Loungani and his team of young researchers, which includes Sriram Balasubramanian, whose father and I shared a workspace more than three decades ago in Chennai. The report could not have been better timed, given the likely need for CFM measures by emerging economies in the years ahead.
America’s fiscal deficit ratio had slowly declined from 9.8% of gross domestic product (GDP) in 2009 to 2.4% in 2015, and then Trump’s tax cut in 2017 caused it to widen to 4.6% of GDP in 2019. According to the Fund, it will be 18.7% of GDP in 2020, declining to 6.5% of GDP in 2022. With the yield on the 10-year Treasury bond of the US government below 1.0%, market appetite for open-ended borrowing by the US administration is unlikely to be strong. America will go the Japan way, with its Federal Reserve ending up both as the market maker and sole market participant in US government debt. Too many dollars will be sloshing around the world in the coming years, regardless of who occupies the White House and which party dominates the US Congress from 2021 on.
The arena for carry-trade (dollar borrowings seeking higher returns in emerging markets) will be well set, and this is expected to be the preferred sport for investors, corporate borrowers and sovereigns in the developing world. There is enough experience to foretell what it would do to domestic credit aggregates and investment. Imbalances will rise and developing-country central banks will have their task cut out. In such an environment, having the imprimatur of the Fund on CFM policies will help enhance credibility. The Fund has not legitimized these so far, or has been a reluctant supporter at best. That might or should change. If it does, much credit will go to the IEO report, which has not pulled too many punches.
The Rules of the Game: International Money in Historical Perspective by the late professor Ron McKinnon, first published in the Journal of Economic Literature in 1993, is a classic. It describes the evolution of the global monetary regime from the Gold Standard of the late 19th century to the 1990s. He has neat boxes to capture the rules that applied to each monetary regime that prevailed over the century-plus period he covers. One of the rules (Rule Box 2) that was a feature of the Bretton Woods agreement was that currencies would be convertible on the current account but countries were free to use capital control measures to dampen currency speculation.
John Maynard Keynes was nothing if not consistent. He was resolutely against the Gold Standard because it constricted policy space for sovereigns. He was against international capital mobility for the same reason. It’s known that unrestricted capital flows leave policymakers powerless. Students will recall the “Impossible Trinity”. That is, only two of three specific policies—a stable exchange rate, an autonomous monetary policy and an open capital account—are possible at any given time.
To Hélène Rey should go the credit of drawing our attention to the “Impossible Duality” that it became in practice. That is, regardless of the exchange rate regime that the country follows—fixed or floating—capital flows make it impossible for central banks to autonomously pursue policies that are appropriate for their economic circumstances. The problem is going to become far bigger this decade. For India, it already has. The Fund sees the spillover effects of advanced-country monetary policies on emerging economies as small. That is neither believable nor likely to hold up as the future unfolds.
The Fund’s official position on CFM first showed signs of changing in 2012. It began to acknowledge the need for temporary and short-term capital controls. The IEO report prods the Fund to accept the need for even a pre-emptive and longer-lasting application of CFM measures in certain situations. It shows how CFM measures could be useful in dealing with social issues such as housing affordability. Capital account liberalization has played a big part in financializing many asset markets, including the housing market. In turn, financialisation has played a part in fomenting social discontent and polarization.
The Fund believes that capital account liberalization in the long-term is desirable. But, there is nothing inherently desirable about an open capital account. It is an option to be exercised by a sovereign state, depending on the context. After the Asian crisis, Jagdish Bhagwati condemned the deliberate conflation of the virtues of trade liberalization (even that is questionable) with capital account liberalization favoured by the Wall Street-Treasury complex (‘The Capital Myth: The Difference between Trade in Widgets and Dollars’, Foreign Affairs, May/June 1998). What is good for Wall Street is seldom desirable for Main Street. The IEO nudge is good. But a push may be necessary. These are the author’s personal views.
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First Published:19 Oct 2020, 08:44 PM IST
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