capital controls

Chris Giles

Although the IMF is super-orthodox and Anglo Saxon, when it comes to advanced economy monetary policy, even with a French managing director and chief economist, there are some signs of a softer IMF this spring.

Capital controls
Most attention has focused on capital controls, on which the Fund has issued its first ever guidelines on their use. This is seen as the IMF giving ground to countries, such as China, seeking to build foreign exchange reserves for currency management rather than expose itself to volatile capital inflows. This is a misreading of the IMF’s intentions.

The Fund could not have been clearer that capital controls are only a valid part of the macroeconomic toolkit if a country’s currency is not undervalued, it has sufficient foreign exchange reserves and it is unable to use monetary or fiscal policy. Only one  - foreign exchange reserves – of these three criteria apply to China.

In contrast, in the World Economic Outlook, the Fund complains repeatedly about China’s exchange rate 

The International Monetary Fund has proposed its first ever guidelines for using controls on flows of speculative capital, legitimising a controversial tool that it once campaigned against.

The guidelines – which are not yet official Fund policy – say that countries can control capital inflows when their currency is not undervalued, when they already have enough foreign exchange reserves, and when they are unable to use monetary or fiscal policy instead. 

Iceland’s central bank has just cut its interest rates by 25bp, leaving the key current account rate at 3.25 per cent. The Bank hasn’t stopped cutting since the financial crisis, though this is the smallest cut since 2002. Previous cuts have been monthly, and mostly half a percentage point (see chart).

The tiny island-state’s economy appears in relatively good shape. Inflation has fallen below the target of 2.5 per cent, and inflation expectations, which were nearing double digits, have fallen below 5 per cent. Indeed, with inflation at just 1.8 per cent, one might wonder why rates have been cut at all. According to the Bank, temporary factors were at play in pushing down January’s inflation:

One-off factors added to the seasonal drop in January. Favourable exchange rate developments over the past year, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation.

 

Iceland’s central bank is still cutting rates – and further cuts lie ahead if inflation continues to fall. Sedlabanki said: “The appreciation of the króna, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation… there may yet be some scope for further monetary easing.” November’s year-on-year inflation fell to 2.6 per cent – close to the 2.5 per cent target – down from 10.7 per cent in March.

With inflation expected to fall further, Iceland’s central bank will be wanting to head off any prospect of deflation. Lower rates will encourage debt-fuelled spending, which should drive prices up. The rate cuts – some 50bp, some 1pp, some 1.5pp – will also narrow the interest rate corridor to 2pp. This should help to reduce volatility in short-term interest rates. New rates are: 

Declining inflation expectations and a strengthening currency have prompted another substantial 75bp cut to Iceland’s key rates. The country has not stopped cutting since the financial crisis (see chart). No doubt the decision was supported by expectations of Fed easing, and the lower dollar that will likely follow.

Key rates are left as follows:

  • deposit rate (current account rate) will be 4 per cent
  • maximum bid rate for 28-day certificates of deposit (CDs) will be 5.25 per cent
  • seven-day collateralised lending rate will be 5.5 per cent
  • overnight lending rate will be 7 per cent.

Iceland’s central bank has also announced a revision to its strategy to lift capital controls. 

Taiwan just expanded its armoury against hot money: its financial regulator has apparently accepted a proposal from the central bank to accept only US dollars as cash collateral for bond borrowing. The move is intended to bar the use of bond borrowing as a means of speculating on Taiwan’s currency. There is no official confirmation (in English, at least) on the Financial Supervisory Commission or central bank websites but the news is widely reported from local sources. While addressing the Legislative Yuan’s Finance Committee, FSC chairman Chen Yuh-chang also voiced reservations about a more direct ‘hot money’ tax, saying it could dramatically affect domestic equities.

First it was Indonesia, then South Korea. Inspired by the strength of an Asian recovery that has left the western developed world standing, regional central bankers are challenging old Western orthodoxies, and are embracing once dreaded capital controls.

Is Thailand about to become the latest country to join them?  No. But that hasn’t stopped the new central bank governor from talking about it.

Tarisa Watanagase, the governor of Bank of Thailand, said yesterday that while the bank had no imminent plans to introduce capital controls, many were questioning the conventional thinking on the subject matter.

Capital controls were previously dismissed as something old fashioned, something that interferes with the market mechanism and should not be an acceptable tool of a central bank and I think that idea has changed.

 

For emerging markets, at least.

Adair Turner is such a trend-setter. He backed a Tobin tax, and the world laughed. Then the world paused and considered. And now there is a great deal of support for the idea. 

The Russian central bank isn’t discussing any kind of capital controls, Sergei Shvetsov, head of financial operations at Bank Rossii, said in Moscow today. With Russian inflation falling year-on-year and static month-to-month (data from Q3), this is unsurprising. The rouble is also falling against most developed and emerging currencies (see chart).

The Bank of Thailand has ended restrictions on the amount Thai firms can invest abroad, raised the foreign investment limit for Thai mutual funds to $50bn from $30bn and cleared the way for wealthy Thais to spend more in overseas property markets, deputy governor Bandid Nijathaworn told a news conference.

The changes will reverse the effects of capital controls imposed in 2006 during a political crisis. The Thai stock exchange announced yesterday that it too would soften regulations, to encourage the listing of companies worth Bt100bn ($3bn).