capital flows

Claire Jones

A familiar consequence of crises is a flight to quality. This crisis is no exception, with gold soaring to nominal highs and the Swiss franc appreciating against pretty much every other currency on the planet.

However, owing to two decades’ worth of financial globalisation, a trend more pronounced during this crisis than any other was that this shift to safe-haven assets was coupled with a flight of capital across borders. As European Central Bank research, out on Wednesday, notes, investors were not only risk averse, but also fearful of uncertainty. And this so-called “uncertainty aversion” fed home bias.

The capital flight threatened financial stability and hindered economic growth. So what to do? For the ECB, there are two things: better analysis and more regulation.  

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 argument

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. 

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. 

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. 

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.” 

Turkey’s central bank has just cut their benchmark rate 25 basis points, building upon moves last month that cut the same rate 50bp and raised reserve requirements. The two-pronged move was intended to weaken the lira, make exports more attractive and thus reduce the current account deficit – a blight on an otherwise booming economy.

The particular problem with Turkey’s bank reserves is their maturity profile, which is quite short-term, making the country vulnerable to external shocks. Rather than focusing on inflation and growth, a great deal of attention in Ankara must be focused on securing the next slice of funding. Encouraging longer-term maturities is a smart move; financial stability increases in proportion to the average maturity of deposits. 

*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 

Research from the Bank of Japan argues that we are seeing a multiplier effect in capital flows between emerging markets and the US, and its reversal could cause a very sudden upward correction in US government bond prices.

The argument runs along these lines: investors seeking high returns have caused large capital inflows into emerging markets, causing forex intervention and leaving governments with stockpiles of US dollars. Those dollars are then invested in US treasuries, reducing the yield and making it cheaper for US investors to borrow – and to seek high returns in emerging markets. Repeat.

While no direct mention is made of the Fed’s recent $600bn stimulus, 

Chile has held rates at 3.25 per cent, following its pledge to buy $12bn in the forex market to weaken the peso. Pundits had been split roughly equally between a rate hold and a small rate rise. The central bank has typically been raising rates regularly but by small increments of late (see chart, right).

Inflation in Chile is running at 3 per cent, exactly on target (which allows for one per cent either side of this) – but it is rising quickly. Chile recently pointed to the effect of the Fed’s $600bn stimulus programme on its currency – i.e. causing appreciation – and in doing so, joined a chorus of opposition from emerging markets trying to cope with an influx of “hot money”.