• Net capital inflows declined $1.1 trillion in past five years
  • Flexible currencies and foreign reserves providing cushion

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 percent of gross domestic product, the Washington-based fund said in a report released 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 dropoff 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.

Policy Upgrade

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 Wednesday, the IMF analyzed the impact of reforms such as industrial deregulation and changes to labor-market policies. The fund said product-market reforms can deliver short-term gains, while labor-market actions depend on the policy and on the state of the economy.

Giving workers more take-home pay by cutting labor taxes has larger effects during periods of economic slack because it’s akin to fiscal stimulus, the IMF said.

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