India, which has received a record number of foreign direct investment in recent years despite the Covid-19 crisis, has a number of hedging measures to reduce risks from capital flows, the International Monetary Fund said on Wednesday.
“Capital flows have several benefits. They finance the necessary investments. They help insure against certain types of risks. There are many benefits to the country from having capital flows in India and also benefits from receiving such capital flows,” said Gita Gopinath, IMF First Deputy Managing Director. , to reporters here.
The IMF on Wednesday released a working paper on the Institutional Perspective Review (IV) on Liberalization and Capital Flow Management. IV was adopted in 2012 and provides a basis for the Fund’s consistent advice on policies related to capital flows.
IV aims to help the country reap the benefits of capital flows while managing the associated risks in a way that preserves macroeconomic and financial stability and does not generate significant negative outflows. The review introduces important changes that expand the tool kit for policymakers, such as allowing the early application of capital flow measures over inflows if financial weaknesses exist.
In response to the question, Gopinath noted that there are other types of financial risks associated with having large amounts of capital inflows.
“In the case of India, there are a large number of existing capital restrictions. The Indian government uses these restrictions proactively in dealing with when the external environment changes. So, by placing restrictions on the amount of external borrowing that corporations can make, that is the instrument they use. And they use it in response to changes in external conditions.
“So, there is little protection available to the Indian economy in terms of capital flows. But of course, it is still in the process of liberalizing its capital accounts. And as the financial market deepens, the financial institution deepens, it can move in more direction, allowing for more forms of capital flow, ”Gopinath said.
The IMF’s top official, an American Indian, said the capital flow was justified as it could bring huge benefits to the recipient country. But it can also result in macro-economic challenges and financial stability risks, he said.
“The dramatic capital outflows we witnessed at the start of the global pandemic, and the recent turmoil and capital flows into several emerging markets following the war in Ukraine are a clear reminder of how volatile capital flows are and their impact on the economy,” Gopinath said. .
After the great financial crisis, where interest rates were low for a long time in advanced economies, capital flows to emerging markets in search of high returns, he said. In some countries, this has led to a gradual increase in their external debt in foreign currency, which is not offset by foreign currency assets or hedges, he said.
“Then when a tantrum hit and there was a sudden loss of appetite for emerging market debt, it led to severe financial stress in some markets. Now the lesson learned from such episodes and from large groups of research is that in some cases, countries should have the option to curb debt inflows early on to protect macro-economic and financial stability, ”Gopinath said.
Accordingly, a major update to the policy tool kit issued by the IMF is the addition of capital flow management measures and macro -prudential policies that can be applied preemptively.
“But when used appropriately, these measures reduce the likelihood of a financial crisis in the event of a sudden reversal of capital input. These changes are built on an integrated policy framework, research efforts by the IMF to build a systematic framework for analyzing policy options and exchanges in response to country -specific shocks, ”he said.
The latest IMF report, he said, highlights the risks to financial stability that could arise from gradual external debt liabilities, especially when this generates currency mismatch, and the narrow and unusual case of foreign debt in local currency.
“Advance capital flow management measures and macro -prudential policies to curb inflows can reduce the risk of external debt. Yet it should not be used in a way that leads to excessive distortion, nor should it replace the macro-economic policies or views and structures needed to maintain an overly weak currency, ”Gopinath said.
“Another update to our advice is to give special treatment to certain categories of capital flow measures that are regulated by certain other international frameworks for security considerations. It also provides practical guidance for policy advice on capital flow measures, including how to identify spikes in capital inflows and how to decide whether it is too early to liberalize capital flows, ”he said.