*No single solution for countries facing capital inflows
*Strong flows to emerging markets seen here to stay
*Technical expertise needed to frame right policies
By Stuart Grudgings
RIO DE JANEIRO, May 27 Policy-makers in
emerging markets need to keep reaching for a broad mix of tools
to cope with the heavy capital flows that have caused
strong-currency headaches and led to fears of asset bubbles --
because such flows are here to stay.
That is largely good news, said economists and officials at
a conference on capital flows held by the IMF and Brazil's
finance ministry. Hot economies such as Brazil and Indonesia
may see less fallout than some fear when the U.S. Federal
Reserve eventually raises interest rates, tightening the tap on
cheap funds that flooded into Latin America and Asia in search
of higher returns.
But they will need to keep adjusting their policy mixes to
distinguish between "good flows" that help economic growth and
"bad" short-term flows that can cause volatility, said IMF
Chief Economist Olivier Blanchard. While countries should
adjust fiscal and monetary policies before moving to capital
controls, there is no one-size-fits-all response, he said.
"We have to be open to exploration here," he told reporters
at a beach-side hotel in Rio de Janeiro, which is experiencing
many of the symptoms of Brazil's boom, like soaring real estate
prices and strong credit growth.
"We are not at the stage at which we can tell this is
exactly the way we can do it ... we still don't exactly know
what the optimal package is."
In Latin America alone, capital inflows have skyrocketed to
nearly $270 billion in 2010 from an average of about $40
billion between 2000 and 2005, according to data from the
Inter-American Development Bank.
Emerging countries have adopted a broad range of measures
to regulate inflows and stem currency rises, increasingly
resorting to capital controls and so-called macro-prudential
measures such as credit curbs.
In recognition of the alarm about huge inflows that are
stoking growth and also inflation rates, the IMF last month
endorsed the use of capital controls, once considered anathema
to its free-market philosophy. Advanced countries want to
establish a framework to monitor their use, an approach opposed
by emerging markets.
Blanchard and other IMF officials said it was unclear
whether such a system was needed because there was so far
little evidence that capital controls had a negative,
beggar-thy-neighbor effect on other countries.
HERE TO STAY
There was a broad consensus that the surge in flows was
more than a temporary phenomenon driven by loose liquidity in
struggling developed economies. Rather, it is being driven by a
fundamental re-rating of global risk, said Joyce Chang, global
head of emerging markets and credit research at JP Morgan.
"This is not a temporary state of affairs. This is what the
new normal has become. It could be a cycle but it could be a
25- to 50-year cycle," she said.
"From a capital markets perspective many of us think that
capital controls are likely here to stay. Investors will
continue to allocate more to emerging market assets given the
better fundamentals and higher returns."
Developed world investors are still vastly under-exposed to
emerging markets, suggesting that emerging markets need to be
prepared for decades of strong inflows. She said U.S.
defined-contribution pension plans only have 2.1 percent of
their funds allocated to developing economies, which make up
nearly 50 percent of global GDP.
Flows to countries such as Brazil, which has tripled the
tax it charges foreigners to buy local bonds, have remained
strong, suggesting that governments have yet to exhaust their
policy options, participants said.
"These measures are small. Given the profit opportunities,
money is still going to come in," Jonathan Ostry, deputy
director of the IMF's research department, told Reuters.
The key to a successful balance of policies may be
technical expertise and detailed tweaking of rules to direct
inflows to the "right" places. India last year raised the
ceiling on foreign investment in long-term bonds, for example,
aiming to attract funds for long-term projects such as
Kristin Forbes, an economics professor at the Massachusetts
Institute of Technology, said countries should also consider
the role of domestic investors since they are increasingly
influential in determining net inflows.
"In the hierarchy of when you should use capital controls,
a key question you should ask before even talking about them
is: what is driving the surge in net inflows? If it's largely
foreigners then there may be a role for capital controls," she
(Editing by Todd Benson and Chizu Nomiyama)