Governments should put in place a permanent infrastructure for capital controls aimed at curbing speculative fund flows so that they can be ready for use when needed, the International Monetary Fund’s chief economist said.
Rather than reacting at the last minute to harmful capital flows, those central banks and finance ministries that want to use capital controls should build a carefully calibrated legal and tax infrastructure for their use in advance.
“I think there has to be an infrastructure on a permanent basis,” said Olivier Blanchard, chief economist with the International Monetary Fund after a seminar in Rio de Janeiro on managing capital flows in emerging markets.
The International Monetary Fund has sought to foster increasing debate on capital controls after it legitimized their use for the first time earlier this year with the release of guidelines on the matter.
Brazil has become one of the leading proponents of the use of capital controls to ward off speculators after a 14 per cent gain in the country’s currency, the real, against the US dollar in 12 months.
The currency, which was trading at about R$1.604 to the dollar on Friday, would reached R$1.30 had Brazil not introduced a series of capital controls, Finance Minister Guido Mantega told the conference last week.
These have included increases in taxes on financial transactions, such as foreign purchases of bonds.
Brazil received $100bn in portfolio and foreign direct investment flows last year and another $37bn in the first quarter of this year. Brazilian exporters blame the strong currency for a loss of competitiveness on international markets.
Mr Blanchard said as an example, capital controls could be kept permanently in place by keeping taxes on different inflows at “zero” when they are not considered harmful.
When these flows rise to undesirable levels, the taxes can be increased by degrees until the threat is curtailed.
He said while the IMF did not consider capital controls a tool of last resort, governments should make sure their macro-economic and fiscal policies are in order at the same time.
Macro-prudential measures – those taken to ensure the stability of the financial system – should also be taken simultaneously.
Brazil coined the term “international currency war” to describe what it saw as its conflict with its leading trading partners over capital flows.
It blamed loose monetary policy in the US for creating a wave of liquidity that flowed to the fast-growing large emerging markets in search of higher returns.
Investors were attracted to Brazil’s interest rates, the highest in the world for a large economy at 12 per cent, which are the opposite of rock bottom rates in the developed world.