IMF favours capital controls to arrest fund inflows

Warning that the global financial system is vulnerable to further shocks, the International Monetary Fund (IMF) has cautioned emerging market economies that increased capital inflows could complicate the efforts of a tight monetary policy, an advisory that may not be true for India at this juncture.

The multilateral agency, in fact, has favoured capital controls in some cases to arrest the huge flow of overseas funds into emerging economies.

“Emerging markets are receiving an increased flow of foreign capital at a time when their output gaps are closing and inflation rates are rising. These capital inflows are complicating efforts to manage local demand through tighter monetary policy and are straining the absorptive capacity of some local financial markets,” IMF said.

In its Global Financial Stability report, IMF said the main challenge for emerging economies was to combat overheating and the accumulation of financial imbalances in order to maintain financial stability and avoid future crises.

The report said emerging economies needed to rebalance their policy mix by relying more on economic policies, for example, tighter monetary policies in a number of countries, with a judicious use of macro-prudential policies. These policies may include, in some cases, capital controls that can play a supportive role in managing capital flows and their effects.

In India, Reserve Bank of India (RBI) is widely expected to increase short-term lending and borrowing rates — repo and reverse repo — by 25 basis points in its annual monetary policy for 2011-12, slated for May 3. If that happens, RBI will be doing so for the ninth time after monetary tightening started in early 2010, when the impact of global financial crisis abated.

Capital inflows, particularly of portfolio variety, has not increased substantially into India this calendar year so far. The country has received $3,452.10 million in 2011 so far, against $10,228 million in the corresponding period last year.

At the time of heightened inflows last year, the government had ruled out putting capital controls to arrest portfolio investment.

However, market regulator Securities and Exchange Board of India (Sebi), had in 2007, imposed various curbs on participatory notes, through which unregistered overseas entities in India invest in capital markets through Foreign Institutional Investors (FIIs).

Though the market regulator had claimed that time the reasons behind the curbs were to have transparency in participatory notes, it was widely argued that heavy inflow of funds into capital markets led to the restrictions.

It was the drying up of fund sources abroad at a time of global financial crisis that the market regulator had to lift those curbs in 2008.