Capital controls have a role, just not lasting-IMF

NEW YORK, April 13 Tue Apr 13, 2010 11:04am EDT

NEW YORK, April 13 (Reuters) - Capital controls have a place, albeit a limited one, in helping emerging markets protect themselves from the cash flood of developed market economic stimulus, the IMF said in a study on Tuesday.

In the International Monetary Fund's global financial stability report, capital controls were deemed a complementary policy in a government's toolkit for dealing with surges of capital that can disrupt exchange rates or asset prices.

While the IMF has given credence to the use of capital controls in the recent past, they caution sovereign governments not to rely on them to be a long-term solution for limiting big swings in cash either into or out of their markets.

Rather than using a myriad different controls, the IMF put a flexible exchange rate policy at the top of a list of measures nations should use to limit financial market risks.

"When these policy measures are not sufficient and capital inflow surges are likely to be temporary, capital controls may have a role in complementing the policy toolkit," it said.

In an effort to protect their domestic markets and export businesses, a tax, higher reserve requirements, or outright limits on capital movement were used in countries such as Brazil, Colombia, South Korea, Thailand and Turkey.

The debate over capital controls came to a head as a result of the current financial crisis when developed rather than emerging nations pumped massive amounts of cash into their financial markets in order to stave off economic collapse.

Emerging markets ended up on the receiving end of a significant portion of the money that sloshed around the global financial system as investors sought solid returns.

These countries by and large had shorter and less severe economic downturns, offering better economic prospects and higher interest rates compared to their more mature peers.

Their economic growth attracted excessive capital flows, swelling demand and outstripping supply, thereby bloating asset prices and the value of national currencies.

The IMF's study found mixed results on using capital controls. In some cases they "lengthen the maturity of inflows and create some room for monetary independence."

However, even if the controls provided relief, the IMF said the effect was typically temporary, and often the impact on cash flows proved statistically insignificant.

"Controls tend to lose effectiveness over time, as market participants find ways to circumvent them," the IMF said, citing the conclusions of recent economic research that was broadly consistent with earlier findings.

The controls can also prove to be an economic crutch.

"A widespread reliance on capital controls may delay necessary macroeconomic adjustments in individual countries and, in the current environment, prevent the global rebalancing of demand and thus hinder the recovery of global growth," the report said.

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