- International capital flows and economic development - Rationale for the capital flows management (CFM) - Impacts of the COVID-19 crisis on capital flows in emerging countries - Some lessons from the CFM during the COVID-19 crisis

1. CAPITAL FLOWS MANAGEMENT IN EMERGING
COUNTRIES: SOME LESSONS FROM THE RECENT
COVID-19 CRISIS
MAHMOUD SAMI NABI
LEGI-ECOLE POLYTECHNIQUE DE TUNISIE & FSEGN
msaminabi@ept.ucar.tn
23 Octobre 2021
COVID 19, CHAINES DE VALEUR MONDIALES,FLUX FINANCIERS ET MIGRATOIRES : VERS QUELLES PERSPECTIVES?

2. 2
OUTLINE
1. International capital flows and economic development
2. Rationale for the capital flows management (CFM)
3. Impacts of the COVID-19 crisis on capital flows in emerging
countries
4. Some lessons from the CFM during the COVID-19 crisis
1

3. 2
1. International capital flows and economic development
– International capital flows : A dilemma that has long posed challenges for
policymakers in many open economies : benefits for economic development /
source-amplifier of shocks.
– In the early 1990s: IMF advised the “big-bang” approach of capital account
liberalization (CAL) while recognizing the necessity of a prior domestic financial
liberalization.
– By 1999: and following the financial crises that hit many developing countries due
to rapid CAL, the IMF’s dominant thinking about CAL had become more focused on
caution.
– IMF (2012) : “for countries that have to manage the risks associated with inflow
surges or disruptive outflows, a key role needs to be played by macroeconomic
policies, as well as by sound financial supervision and regulation, and strong
institutions. In certain circumstances, CFMs can be useful. They should not, however,
substitute for warranted macroeconomic adjustment”.

4. 3
1. International capital flows and economic development
– Adrian et al. (2020) : “Our analysis suggests that there is no “one-size-fits-all”
response to capital flow volatility: Optimal policies depend on the nature of shocks
and country characteristics. For instance, the appropriate policy response in a country
with less developed financial markets and large foreign currency debts may differ
from that of a country that does not have foreign currency mismatches on their
balance sheets, or those that can rely on more sophisticated (deep and liquid)
markets.”
– The advocates of the gradual approach: CAL is not an end in itself and should be
implemented in parallel or after building up the economic institutions and
strengthening the financial markets. However, a gradual approach may be
inappropriate if it could create resistance from vested interests or if the existing
economic system is so complex that a piecemeal reform generates significant
distortions (Prasad, 2009).

5. 4
1. International capital flows and economic development
– Sequencing of the CAL:
1) liberalization of FDI inflows;
2) liberalization of portfolio equity inflows taking into account the development
level of the domestic financial market (management of the risks arising from
increased volatility of interest rates and/or exchange rates; sufficiently deep
bond market particularly for government securities to enable sterilization of the
financial flows);
3) liberalization of debt flows (long-term debt flows followed by short-maturity
flows);
4) liberalization of capital outflows successively for corporate entities, institutional
investors and individuals.
(Nabi, 2019)

6. 5
1. International capital flows and economic development
‒ BIS (2021) : The main drivers of capital flows :
 Push factors : global economic and financial conditions affecting the availability of
funds: global liquidity, international investors’ risk appetite, global economic
growth...
 Pull factors: country characteristics determining its risk-return profile relatively to
foreign investors : cyclical factors (eg economic growth, fiscal deficits, foreign debt
ratios, yields on domestic assets) and structural factors (eg institutional quality,
financial market development, public debt, trade openness, exchange rate regime,
foreign reserves).
 Pipes : banks, institutional investors, investment funds, rating agencies, that can
contribute to spillovers and contagion.

7. 6
1. International capital flows and economic development
‒ BIS (2021) : Following the financial crisis of 2007–09: large flows of capital to
emerging market equity and bond markets and their banking sectors (catalyzed by
the fintech). Shift in the composition of borrowers: shifted away from banks towards
corporates and public sector entities (sub-national governments, the central bank,
state-owned banks and enterprises). On average, over the 2009–19 period, 38%
of total capital inflows to EMEs and more than half of portfolio inflows is attributed
to the public sector.
 Push factors : abundance of global liquidity, fueled international investors’ pursuit
of yield. Favorable interest rate differentials due to the unconventional monetary
policies in developed economies.
 Pull factors: improvements in EMEs’ macroeconomic fundamentals and institutional
frameworks.

8. 7
2. Rationale for capital flows management (CFM)
– Academic research : CFMs is a second-best welfare improving policy response to
the surge or flight of capital when conventional macroeconomic or financial
stabilization policies are ineffective namely due to economic distortions (price
inertia and downward nominal wage rigidity > large gains in real wages during
capital inflows / employment losses during capital outflows; inadequate financial
sector regulation).
– The use of CFMs increased in countries where financial markets were undeveloped,
ineffectiveness of the exchange rate as a shock absorber. Das and ugacheva
(2020): 40 countries adjusted restrictions on their capital account policies in the
face of capital inflows/outflows over 2008-2019.

9. 8
2. Rationale for capital flows management (CFM)
– The use of CFMs is motivated by the following main objectives:
Macroeconomic Stabilization: it encompasses the broader objective of achieving
monetary or exchange rate autonomy when faced with inconsistent objectives
under trilemma considerations (in order to cope with domestic overheating, loss of
competitiveness and threats to the export sector; balance of payment pressures)
Capital Flow Management: targeting the volume of foreign capital flows, and/or
its composition, maturity structure. This is mainly the case when the domestic
financial sector is enable to absorb the foreign capital without creating significant
financial imbalances, and especially when the exchange rate is rigid, and
asymmetric information problems might trigger herding behavior.
Financial stability goals : A third objective is the use of CFMs to limit the buildup
of risks to the financial sector from large and/or volatile capital flows,
particularly those targeted to the banking and financial sector.

10. 9
3. Impacts of the COVID-19 crisis on capital flows in emerging countries
– Following the triggering of the COVID-19 pandemic :
sudden capital outflows from EMEs mainly in the form
of sales of portfolio assets by foreign investors (in
particular, investment funds). It is estimated that
around USD 103 billion were drawn from EMEs
between mid-January and mid-May 2020.
– Massive outflows (scale and speed) of portfolio
investments followed by debt flows, from EMEs
especially those having entered the crisis with
relatively weak fundamentals (Brazil, India, Korea,
Malaysia, Philippines, Turkey and South Africa)
compared to other EMEs (China, Mexico, and some oil
exporters after the OPEC+ agreement) .
 The exchange rates of key emerging market
economies (EMEs) depreciated substantially (Brazilian
real (BRL), Mexican peso (MXN), Russian rouble (RUB),
South African rand (ZAR), Indonesian rupiah (IDR)
Turkish lira (TRY)).
Source: BIS (2021)
BIS (2021) :

11. 10
3. Impacts of the COVID-19 crisis on capital flows in emerging countries
‒ Starting in April 2020: Inflows to EMEs began to
recover, following the monetary policy easing in
advanced economies.
‒ The degree of economic vulnerabilities and the control
of the pandemic determined the countries that
regained the confidence of the investors firstly (e.g.
China, Vietnam, Hong Kong, South Korea, Taiwan and
eastern Europe).
‒ Debt inflows recovered faster than that in equity
inflows mainly in hard currency, given the fears about
weak EME currencies, future fiscal space and monetary
policy.
‒ By the last quarter of 2020: net asset values of EME
bond funds (hard and local currency) reached their
pre-crisis levels.
Source: BIS (2021)
BIS (2021) :

12. 11
3. Impacts of the COVID-19 crisis on capital flows in emerging countries
– Alba et al. (2021) : examines the dynamic impact on debt flows of different shocks using
VAR models for 2009-2020. Among the main results : i) global risk is an important
determinant of debt portfolio outflows to EMEs during the COVID-19 pandemic. In face of
greater global uncertainty, investors sought refuge in lower-risk assets (e.g. US government
securities). ii) an increase in the spread between the domestic and foreign interest rates
seems to have a positive effect on debt flows in Mexico, Brazil and South Africa.
– Beirne et al (2021) : examines the reaction of global financial markets across 38 economies
(14 EMEs) to the COVID-19 crisis, using daily data over 4/01/2010 to 30/04/2020 and
controlling for a host of domestic and global macroeconomic and financial factors.
Two main results : i) the most substantial effects happened in European and Asian EMEs,
ii) EME equity and bond outflows are directly linked to investor risk aversion and flight to
safety.
– De Crescenzio and Lepers (2021) : the important cross-country heterogeneity in capital flow
dynamics during COVID-19 crisis could be explained by country specific factors (Pull
factors) : number of COVID deaths per capita, the stringency of health-related restrictions,
domestic macroeconomic variables, the extension of swap lines, and pre-COVID financial
vulnerabilities.

13. 12
4. Lessons from the capital management during the COVID-19 crisis
Source: Adrian et al. (2020)
‒ Beirne et al (2021) and BIS (2021) : Central banks
played a major role in stabilizing financial
markets globally during the COVID-19 crisis
through : i) interest rate reductions, ii) QE (asset
purchases), iii) injecting USD liquidity through
international swap lines, iv) providing credit
guarantees, v) relaxing prudential policies and
engaging regulatory forbearance.
‒ The monetary policy measures (coupled with fiscal
stimulus packages) by the central banks of many
Asian EMEs (QE for the first time) have been
effective in i) supporting stock prices; and
ii) stabilizing capital flows.
‒ BIS (2021): i) Macroprudential measures,
occasional foreign exchange intervention and
liquidity provision mechanisms, can help mitigate
capital flow-related risks; ii) critical role of the
global financial safety net.

14. 13
‒ Examples (BIS, 2021)
 FX intervention : Brazil - In order to support the BRL, which depreciated by 15% since mid-
February 2020, the central bank intervened with USD 23 billion (6.4% of the gross
reserves), as of April 2020. Korea: relaxed the cap on FX forward positions for local banks,
from the current 40% to 50% of their equity capital, and for foreign banks from the current
200% to 250%. The measure aims at boosting short-term debt and forward contracts
denominated in FX.
 Central banks swaps : During March 2020 : the Fed announced a temporary USD liquidity
arrangements with many central banks among which those of Brazil and Mexico. The Bank of
Japan and the Bank of Thailand have also agreed on a bilateral swap. In April, The ECB
agreed on swap lines with the central banks of Croatia and Bulgaria.
 Capital management measures : Many EMEs have relaxed CFMs, mainly on inflows by
making regulations less stringent. China : removed restrictions on the investment quota of
foreign institutional investors. India : i) raised the limit for foreign portfolio investors’
investment in corporate bonds, ii) increased limits on short-term investments by foreign
portfolio investors, iii) removed the ceilings on selected categories of government securities
to non-resident investors, iv) extended the repatriating period of export proceeds, taking in
account the difficulties of the trading partners affected by the COVID-19 lockdown. Peru :
reduced its reserve requirements for short-term FX liabilities to non-residents from 50% to
9%, to boost liquidity.
4. Lessons from the capital management during the COVID-19 crisis

15. 14
4. Lessons from the capital management during the COVID-19 crisis
‒ Adrian et al. (2020) : “When a country has certain vulnerabilities, such as shallow
markets, dollarization, or poorly anchored inflation expectations, while flexible
exchange rates continue to provide significant benefits, other tools can play a
useful role as well.
In particular, macroprudential measures, foreign exchange intervention, and
capital flow management measures can enhance monetary policy autonomy so
monetary policy can adequately focus on containing inflation and promoting
stable economic growth.”
‒ Bergant et al. (2020) : sound macroprudential regulatory framework (adequate
bank capital and liquidity and prevents excessive risk taking in credit provision )
strengthens the resilience of EMEs against global financial shocks. Imposing
capital controls to limit cross-border financial transactions is not a valid substitute
to adopting a solid macroprudential framework.

16. Merci
msaminabi@ept.ucar.tn