capital flows

To discourage volatile short-term capital flows, the Bank of Indonesia will extend the minimum holding period of its bank certificates, SBIs, from one month to six months, effective May 13. This means traders holding the notes will not be able to sell them in the secondary market until they have held them for six months.

The unexpected news builds upon previous measures aimed at slowing down investment in very short-term debt. For example, the Bank of Indonesia has already all but stopped issuing 3- and 6-month SBIs. A key risk for countries receiving increased capital inflows is that they might reverse, which could have sudden and unpredictable consequences, as the Bank of Japan has pointed out. The Bank of Israel’s Stanley Fischer has made the same argumentRead more

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 Read more

Nobody knows how much of Mrs Watanabe’s foreign stash she intends to bring home. But the choices made by this mythical Japanese housewife – astute, and hunting for a better return than she can find at home – could help to explain the rapidly strengthening yen.

It makes sense that the average Japanese investor would want to repatriate their money at the moment. The average Japanese investor, after all, lives in Tokyo. Many have lost homes and possessions, with 430,000 estimated to be living in temporary accommodation (and it is winter). Others will be trying to move away from the Fukushima atomic power station. Still more are facing food shortages or rationing. In all these cases, cash is king. Read more

Robin Harding

Data from the Treasury International Capital system have always got a lot of stick. The system is meant to show foreign holdings of US assets broken down by country (and vice versa) but has a big problem with ‘custodial bias’: it struggles to track funds beyond the financial centre where they are held, e.g. the UK, Switzerland, the Channel Islands, various dodgy Caribbean destinations etc.

Recent sanctions on Libya have created a fascinating natural experiment on just how big that ‘custodial bias’ actually is. Does the amount of Libyan assets in the US reported to TIC match up with the amount of Libyan assets frozen in the US? Answer: a resounding ‘No’. Read more

Robin Harding

The arguments in the speech and research paper that Ben Bernanke presented in Paris today will be fairly familiar if you’ve come across the influential 2009 AER paper by Ricardo Caballero and Arvind Krishnamurthy (indeed Mr Bernanke cites it specifically).

The basic point is that large capital inflows into the US in 2003-2007 were mainly in search of safe assets: and the US financial system responded by manufacturing them in the form of AAA-rated CDOs and similar moneytraps. Read more

Foreign investors’ hunger for safe US assets helped to cause the 2007-2009 crisis by encouraging banks to turn risky mortgages into AAA rated bonds, Ben Bernanke, US Federal Reserve chairman, argued in Paris on Friday.

“The preference by so many investors for perceived safety created strong incentives for US financial engineers to develop investment products that ‘transformed’ risky loans into highly rated securities,” said Mr Bernanke, presenting a new research paper that he co-wrote with other Fed economists. Read more

There are international rules to govern global trade, but none to oversee foreign exchange markets or capital movements, Israel’s central bank governor has observed.

Stanley Fischer said standards for capital movements were needed, even though it was not possible to govern how much central banks could intervene in markets. Reuters news wire reports: “It is important that the IMF is now trying to develop such rules, to figure out what works and what doesn’t work when the exchange rate starts to appreciate and … what measures they can take that are acceptable from the viewpoint of managing the international economy,” he told a conference. “Those are rules we have to develop just as we developed rules gradually in the years since the 1950s that produced a global trading system,” he added.

Many countries grappling with “hot money” blame the US openly and directly, but Professor Fischer did not join them. “I believe the US is doing what needs to be done for growth. Read more

Israeli foreign currency reserves rose to $73.4bn by the end of January as the country’s central bank bought foreign currency to dampen the shekel. The Bank bought $2.09bn and benefitted from an upward revaluation of its reserves by $628m, reports Bloomberg news wire.

Since the start of the year, the shekel weakened against the dollar, from 3.51421 to 3.712 per dollar, which explains the upward revision. Last time there was a net weakening in the currency over the month, it was followed by a net reserve reduction the month after (October-November last year). By that logic we could expect Israel’s foreign exchange purchases to fall during February. Read more

Israel’s foreign currency reserves stood at $70.9bn at the end of December, according to Bloomberg – but they may well be needed.

Central bank governor Stanley Fischer has warned that capital inflows could reverse sharply, leading the Bank to sell its reserves to try to slow any sudden weakening of the shekel. “One of the things that does concern us is that we have a lot of money coming in,” Mr Fischer told Bloomberg Radio in Davos. “If opinions change quickly money goes right back out and it could go out very fast.” Read more

Malaysia might be the next in a long series of central banks turning to reserve requirements. The central bank held the overnight policy rate today at 2.75 per cent for the third meeting, as expected. Inflation ran at just 2.2 per cent in the year to December.

Bank Negara Malaysia signalled, however, that it would consider tools other than rate rises to mop up excess liquidity. “Large and volatile shifts in global liquidity are leading to a build up of liquidity in the domestic financial system,” said the Bank, continuing: Read more

Turkey’s rate cut yesterday will be followed by another raise in reserve requirements in the coming days, continuing the central bank’s plan to discourage short-duration capital flows. Bloomberg news wire reports:

The Turkish central bank’s decision to reduce the benchmark interest rate was unanimous, Turalay Kenc, a member of the Monetary Policy Committee told Bloomberg HT television. Read more

*Updated 1509GMT

Interest rates will be a quarter of a point higher from tomorrow in Poland, after the MPC voted to increase them. The key refi rate will be 3.75 per cent. The move was expected, after bullish signals in December followed by strong hints from council members in the new year. Those comments suggested this would be the start of a rate normalisation policy, rather than a one-off reactive decision. All else equal, expect further rate rises ahead.

Headline inflation rose to 3.1 per cent in December, driven by higher energy prices. Initial estimates suggest core inflation rose, too. “The inflation rise,” said the Bank, “was accompanied by a rise in inflation expectations.”  This was given as the main reason for the rate rise in today’s news conference.

Governor Marek Belka has also said in recent months that he saw a decreased risk of strong capital inflows into Poland. Inflationary “hot money” inflows are encouraged by rate rises, which increase the return to investors. If those inflows are subsiding, Poland would be liberated to raise interest rates without fear of undue inflation.

Effective tomorrow, the 25bp rate rise will be the first Read more

Money Supply - Click for interactive interest rate graphicCentral bankers in Seoul have raised the base rate by 25bp, taking it to 2.75 per cent. While the move was unexpected, it is not surprising. The Bank of Korea has taken numerous measures to combat inflation in recent weeks, even doubling the availability of staple food sources to help contain food price inflation. In December, the country announced plans for a bank levy on foreign-currency debt; the bill, yet to be finalised, could become law in the second half of this year.

In a statement issued with the decision, the Bank’s tone was generally upbeat, but concerns persist around asset prices: Read more

Peru’s central bank caught economists by surprise on Thursday night when it raised its benchmark lending rate from 3 to 3.25 per cent on inflation concerns arising from “international” price rises.

Amid strong inflows of “hot money” that have pushed the Nuevo Sol to a two-year high of about 2.8 per dollar, the seven-member bank board had been holding rates at 3 per cent for the past three months.

The bank said the increase of 25 basis points was now warranted as “a preventive measure” against “the dynamism of domestic demand in an environment of international increases in food and energy prices”. While inflation stood at 2.08 per cent this month, well within the Bank’s target range of 1 per cent to 3 per cent, Peruvians are understandably touchy on the subject, having lived through hyperinflation in the mid-80s.

 Read more

Chile’s Finance Minister says the Fed’s second round of quantitative easing put upward pressure on the peso, as he welcomed central bank plans to weaken the currency.

The peso has fallen very sharply on news that the Banco Central de Chile plans to buy $12bn in the foreign exchange markets. On the shopping list is $50m per day from January 5 to Feburary 9.

Thereafter, the central bank aims to offset the liquidity effects and “soften the impact on the prices of debt market instruments” by selling $10bn-worth of peso-denominated bonds plus $2bn-worth of short-term maturities. Read more

Officials from Taiwan’s central bank have rejected the implication of currency undervaluation in a chart used by Ben Bernanke. The offending graph – to the right – shows changes in the real effective exchange rate on its vertical (y) axis. Taiwan’s currency weakened by 2.8 per cent in real terms between September 2009 and 2010, according to this Fed chart. Taiwan says it fell by just 0.2 per cent, and argues that REER is not a good measure of undervaluation anyway.

At stake is responsibility for volatile capital flows that add to inflation in emerging markets and threaten to destabilise recovery. Emerging markets point to the Fed’s stimulus programme. But Mr Bernanke argued in his speech that the Fed’s $600bn stimulus programme was good for the world economy, refusing to accept responsibility for the extra inflationary pressure flowing through to emerging markets. In spite of former chair Alan Greenspan’s comments to the contrary, the Fed also continues to deny any attempt deliberately to weaken the dollar.

Indeed, Mr Bernanke accused emerging market economies of spending their reserves to slow the appreciation of their currencies. Hot money, he argued, was flowing into emerging markets regardless of Fed actions, because investors expected currencies they were buying to strengthen further. Since – by this chart – Taiwan’s currency has strengthened the least (indeed, has weakened), the implication is that Taiwan is one of the worst ‘offenders’. Read more

Former Fed chair Alan Greenspan has an article in today’s FT. It’s quite blunt about China and the US. “Both may be right about each other,” he says. “America is pursuing a policy of currency weakening,” while China’s reserve accumulation has caused exchange rate suppression for “competitive export advantage”. China and the US aren’t just hurting each other: the joint effect of their policies is to strengthen other currencies, placing those countries at a disadvantage.

Unlike most pundits hand-wringing over the current state of play, Mr Greenspan proposes a solution. It is quite radical. The G20, he says, can propose a new rule through the IMF that “limits the accumulation of reserve assets and sterilisation of capital flows”. “It would be easier to maintain and control than a stability and growth pact,” he says, referring to the “failed” eurozone agreement.

Well, yes, it would be easier. But the fact he has considered a stability and growth pact for sovereign states with separate currencies is staggering. The monetary proposal is also radical. Read more

A deputy governor at the People’s Bank of China has indirectly criticised the Fed’s $600bn stimulus plan, saying emerging market economies will have to stay alert for inflation and bubbles as a result of the scheme. Ma Delun also said the stimulus might also increase global imbalances, though it might help the US economy “to some extent”.

Similar comments – which amount to indirect accusations of selfish irresponsibility – were levelled by the Brazilian central bank governor on Friday. Henrique Meirelles said: “excess liquidity in the US is creating problems in other countries” and that this should be addressed at G20 meetings in South Korea. Read more

China’s central bank has signalled a shift toward rate normalisation, following its recent rate rise. The People’s Bank said it will “gradually guide monetary conditions back to the normal state while continuing the comparative loose monetary,” according to Xinhua. The remarks were made in the Bank’s third quarter Monetary Policy Implementation report released before the Fed meeting and not yet available in English.

China’s change in tone may usher in a new period of tightening, as inflationary pressures mount. The Fed’s decision to pump $600bn into the US economy will push down the dollar. Since the renminbi closely tracks the dollar, the Chinese currency will not be allowed to strengthen proportionately, and the extra money in the system will increase the supply of renminbi, adding to inflationary pressure. Read more

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.