International Monetary Fund Managing Director Christine Lagarde will likely outline the lender’s reversal of its decades-old opposition to capital controls on a five-day tour of Latin American this week, even as Brazil says the new position doesn’t go far enough.
In a Dec. 3 report, the IMF said targeted and temporary controls can be effective in preventing asset bubbles and currency rallies. Policy makers in Brazil, the largest economy in the region and the most aggressive in erecting such barriers, said the fund still shows a bias against controls, places too much emphasis on the benefits of capital flows and doesn’t hold rich nations accountable for fueling sudden liquidity surges.
Still, the IMF’s shift can give cover to countries that might consider enacting such controls, said Claudio Loser, a former Western Hemisphere director at the Washington-based fund.
“Latin American countries probably would implement capital controls on their own, but they have felt uncomfortable because of the view by international authorities that it’s not the right thing to do,” said Loser, who now runs the Centennial Group research firm in Washington. “With this report, some countries will feel much more comfortable introducing controls.”
Lagarde is visiting Colombia and Chile, which haven’t enacted capital controls this year even as their currencies rank among the world’s five strongest against the U.S. dollar. She doesn’t plan to stop in Brazil after she visited the country in 2011 as part of her first trip to the region as IMF chief, which also included stops in Peru and Mexico.
While in Bogota today, Lagarde will meet with President Juan Manuel Santos and his economic team. Colombia is one of three countries, along with Poland and Mexico, that during the global financial crisis accessed the IMF’s new flexible credit line for countries with strong policy fundamentals. She heads tomorrow to Chile, the region’s most-open economy, where she’ll attend a meeting of Latin American and Caribbean finance ministers in the coastal city of Vina del Mar.
The IMF’s rethinking may tempt some policy makers in Vina del Mar into implementing capital controls after butting heads with the lender on the topic for years, said John Williamson, a senior fellow at the Washington-based Peterson Institute for International Economics. He didn’t specify which countries are most-likely to enact barriers, though Loser said Colombia and Chile are prime candidates because of their surging currencies.
“The IMF has got its position right at long last,” Williamson, a former World Bank economist who used to lecture at Rio de Janeiro’s Catholic University, said in a phone interview Dec. 6. “This was a big step for the IMF and shows they are flexible and amenable to argument.”
Global capital flows have increased dramatically in the last decade, from an average of less than 5 percent of global gross domestic product between 1980 and 1999 to a peak of about 20 percent by 2007, according to the IMF.
While the fund says the free movement of capital across borders can stimulate growth, in some cases sudden dollar surges can destabilize economies by leading to boom-and-bust cycles in asset prices, according to the report.
The IMF recommends capital flow management measures only in limited situations, when other policy tools such as lowering interest rates and allowing for some currency appreciation don’t fully mitigate risks. The report also calls on nations to avoid discriminating against investors based on residency, and calls on nations with long-standing controls to loosen restrictions.
Paulo Nogueira Batista, who represents Brazil and 10 other nations at the IMF’s executive board, criticized the report as soon as it was released. The report, he wrote in an e-mailed statement, downplays the responsibility of rich nations for destabilizing surges in capital flows.
His view is shared in Brasilia, where President Dilma Rousseff has accused the U.S. and Europe of provoking a “currency war” and “monetary tsunami” by keeping interest rates at record lows, which encourages yield-seeking investors to flood emerging markets with cash.
Starting in October 2010 the country tripled a tax on foreigner purchases of bonds, and also raised levies on offshore loans and bets against the dollar in the derivatives market. Since then the real has dropped 19 percent against the dollar, while the Chilean peso has appreciated 0.8 percent and Colombia’s currency has remained unchanged.
Brazil’s usage of capital controls probably doesn’t pass muster under the IMF’s new guidelines, said Loser.
“The Brazilians tend to be more aggressive and more long term on capital controls than the IMF would recommend,” he said.
Felipe Larrain has ruled out capital controls since becoming Chile’s finance minister in March 2010, saying his country had mixed results introducing such measures in the 1990s. Investors find ways to circumvent barriers, meaning assets remain at risk as developed countries and China try to keep their exchange rates artificially weak, he said Oct. 24.
Still, Chile’s central bank doesn’t completely reject their usage, though it sees them as a measure of last resort, bank Vice President Manuel Marfan said last year. Colombia also reserves the right to implement measures, though the cost of doing so currently outweigh the benefits, central bank chief Jose Dario Uribe has repeatedly said.
“The text issued by the IMF is very cautious,” European Central Bank Vice President Vitor Constancio told reporters Dec. 8 following a meeting of European and Latin American policy makers in Santiago. “Everyone around the table was in agreement that what is important are indeed the fundamental policies that have to do with macroeconomic stability that are relevant in addressing the impact of capital flows more than any measures that could only be relevant for very short-term flows.”
Countries are under less pressure now than they were previously to deter investment. While Brazil’s economy expanded 7.5 percent in 2010, its fastest pace in two decades, it is forecast to grow only 1.27 percent this year. Since reaching a 12-year high in July 2011, the real has fallen 26 percent and the Bovespa stock index’s 3 percent increase this year is less than half the gains of U.S. and European benchmark indexes.
As Brazil’s economy struggles to regain its footing, the government last week began unwinding several controls, reducing the maturity of foreign loans subject to a 6 percent tax.
Still, if Europe’s debt crisis stabilizes and the U.S. resolves its fiscal problems, investors may once again seek higher returns in emerging markets.
Net private capital inflows into Latin America will decline by an estimated $1 billion this year from $254 billion in 2011, according to the Institute of International Finance. Still, inflows will expand 8 percent in 2013, according to the Washington-based baking association.
“I don’t know if it will be discussed 10 percent of the time or 50 percent of the time, but controls will come up” in Lagarde’s talks with finance officials, Loser said. “It’s very relevant in Latin America.”
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