Emerging markets saw worst drop in capital inflows: IMF

Emerging markets have so far weathered the worst slowdown in capital inflows in decades, thanks to flexible exchange rates and foreign-currency reserves, the International Monetary Fund said.

Net capital inflows to 45 emerging-market economies declined $1.1 trillion from 2010 to late 2015, an amount equivalent to 4.9 per cent of gross domestic product, the Washington-based fund said in a report released on Wednesday.

The analysis is part of the IMF's World Economic Outlook, whose updated global growth forecasts will be released next week.

Much of the drop in capital inflows can be explained by the narrowing gap between the growth prospects of emerging markets, once considered the engine of the global economy, and advanced economies, the IMF said.

The recent decline is actually steeper in relative terms than the drop-off faced by emerging markets during the Asian financial crisis of the late 1990s and the Latin American debt crisis of the 1980s, according to IMF figures.

However, several shock absorbers have helped cushion the blow, including higher levels of foreign-currency reserves, the fund said. Exchange rates among emerging markets are more flexible than they were in past episodes, and domestic prices "seem better anchored," perhaps partly due to the inflation-targeting regimes of central banks, the IMF said.

"Crucially, more flexible exchange rate regimes have facilitated orderly currency depreciations that have mitigated the effects of the global capital flow cycle on many emerging market economies," the fund said.

Despite the historically muted impact of the capital downturn, emerging markets need to upgrade their policies to ensure an orderly adjustment, the IMF said. Emerging economies should keep fiscal policy prudent, exchange rates flexible and foreign currency reserves adequately stocked, it said.

In a separate chapter released on Wednesday, the IMF analysed the impact of reforms such as industrial deregulation and changes to labour-market policies. The fund said product-market reforms can deliver short-term gains, while labour-market actions depend on the policy and on the state of the economy. Giving workers more take-home pay by cutting labour taxes has larger effects during periods of economic slack because it is akin to fiscal stimulus, the IMF said. The IMF said new research shows that structural changes to labour makets and some more heavily regulated business sectors could help lift potential output over the medium term while also helping to strengthen consumer confidence in the near term. It recommended deregulation of the retail and professional services sectors and network-based sectors such as air, rail and road transportation, electricity and gas distribution, telecoms and postal services, particularly in the euro zone and Japan.

"There is a role for complementing structural reform with macroeconomic policy support. That includes fiscal stimulus wherever space is available," said IMF researcher Romain Duval, a lead author of the report.

Duval and co-author Davide Furceri said that product market deregulation can start to pay growth dividends immediately regardless of the economic environment so they should be forcefully implemented. Economic growth can increase by one percentage point by the third year of the reforms, their research showed.

Another analytical chapter released by the IMF shows that emerging markets are coping better with recent capital outflows due to stronger reserve buffers, less foreign currency debt and more flexible exchange rates.

Those with more prudent fiscal policies, less public debt, stronger financial oversight, and foreign exchage flexibility are avoiding the abrupt currency shocks that characterized previous major emerging market outflows in the late 198