The IMF supertanker may be changing course

Policymakers seem to be warming to capital controls to avoid stagnation spreading

Steve Johnson

Debt levels are rising around the world, leading to fears that any crunch could be particularly felt in emerging markets
The IMF is rethinking its once rigidly 'neoliberal' advice © FT montage

Advanced economies have delivered a decade of woeful economic growth since the global financial crisis. The last thing the world needs is for emerging economies to be dragged down, too.

Such thinking is taking hold in some parts of Washington, where the IMF is rethinking the once rigidly “neoliberal” advice — stressing open markets and free-floating currencies — that it doles out to economies great and small.

David Lipton, first deputy managing director of the IMF, says one of its primary concerns is that low inflation in the developed world may, through capital flows, be “spreading in an undesirable way to emerging countries and causing them to stagnate”.

“Many of these countries are concerned about how spillovers from advanced world policies cause them to lose some degree of control over their domestic economies.” He questioned whether policies such as currency intervention could be used to “offset this transmission mechanism”.

Only last month Fitch Ratings warned it had a negative view on emerging market banks, in part because low interest rates were putting pressure on their margins.

Mr Lipton says the IMF began early this year to have a discussion on this topic with both advanced and emerging economies using different policy combinations, though it had not yet come to “firm conclusions”, adding: “We haven’t changed our approach, but we will incorporate what we are learning from our case studies as we go.”

His comments build on a gradual shift in thinking at the IMF, as it edges away from the Washington Consensus worldview of freely floating exchange rates and opposition to capital controls that dominated its thinking for decades.

In the aftermath of the global financial crisis, when many EMs were dealing with a deluge of capital inflows, the fund said that “in certain circumstances, capital flow management measures can be useful”. The IMF’s latest thinking appears to go further.

Gita Gopinath, its chief economist, outlined some of her thoughts at the annual Jackson Hole central bankers’ shindig in August, making the case for an integrated policy framework.

Developing countries run the risk of becoming overindebted as a result of capital inflows reducing borrowing costs. For some such countries, she said, the IMF’s preliminary modelling suggested “capital controls are the appropriate instrument to tackle this overborrowing problem, and they should be imposed as prudential policy in normal times before debt limit shocks strike”.

The use of the phrase “in normal times” suggests that, for some countries at least, the IMF is moving towards endorsing capital controls on a semi-permanent basis, not just in an emergency.

Ms Gopinath also referred to circumstances in which “FX intervention may become a desirable part of the policy mix in stressed times”, diluting the fund’s once full-blooded support for freely floating rates.

Other ideas once anathema are also swirling around Washington, with growing support for macroprudential measures, such as leverage and liquidity limits for both banks and non-bank lenders, and questioning whether inflation targeting by central banks needs to be as rigorously insisted upon as it once was.

Ms Gopinath’s thinking appears to be influenced by “dominant currency paradigm” theory, which applies when, as is increasingly the case, the bulk of a country’s exports are priced in dollars or euros, rather than its own currency.

Under this scenario, currency depreciation can lose its power to stimulate growth as it no longer increases export competitiveness, as hinted at by previous FT research. However, depreciation still retains its negative effects, such as raising the cost of servicing foreign currency debt.

The IMF is likely to tread carefully. It is wary of providing ammunition to critics of those EM governments and central banks, typically commodity exporting and importing countries, that do currently practise economic orthodoxy.

One EM economist at a leading bank, who backs the rethink but asked for anonymity given the sensitivity around the subject, said that for decades the IMF “has been guilty of capital account fundamentalism”.

He sees Southeast Asian states such as Thailand, Indonesia, Vietnam and Malaysia, all of which use capital controls and FX intervention, as being the catalysts for change.

“These governments said to the IMF, ‘You have been saying for 30 years to keep capital accounts open, but it’s not working is it? We are the ones growing and we are not doing that’,” he said.

The approach brings to mind China rather than the US. “The Washington consensus gave the US intellectual influence,” the economist added. “How close are we to China doing the same? This integrated policy framework makes me think we are close to it.”

The implication of such a shift is that the pricing of EM assets might be determined less by fundamentals and more by macroeconomic and political considerations.

Moreover, if currency intervention were to become normalised, the chances of an unhappy US president one day following suit have to be elevated. Given the preponderance of the dollar in global trade, dominant currency theory points to one country that could gain more than any other from a weaker currency — the US.

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