The head of the International Monetary Fund said on Friday that capital flows to emerging markets reflected the positive outlook for those economies but warned that they can destabilise currencies and asset prices.
The resurgence of capital flows to emerging markets, including several in Asia, is presenting policy challenges, IMF Managing Director Dominique Strauss-Kahn said according to the text of a speech to be delivered in Singapore.
He said the flow of funds to emerging economies was a sign of renewed investor appetite for higher-risk assets as financial conditions normalise after the height of the financial crisis.
While capital inflows are generally beneficial, they can raise risks of rapid and potentially destabilizing movements of currencies and asset prices, Strauss-Kahn said.
Giving this year's annual lecture at Singapore's central bank, he said policymakers had a range of tools at their disposal to address the adverse side-effects of such fund flows.
They include exchange rate appreciation, tighter fiscal policy, and, where appropriate, lower interest rates. In addition, macro-prudential instruments can limit the risk of asset price bubbles. Market-based controls on capital inflows can help reduce the volatility of such flows, he said.
He noted that those measures were costly and tended to lose their effectiveness over time,
Strauss-Kahn's comments reflect concern among policymakers in some emerging markets that the inflow of hot money could create asset price bubbles and boost their currencies to levels that are uncompetitive and would undermine exports.
Earlier this week, Taiwan imposed capital controls by banning foreign funds from investing in time deposits in a move that appeared to be aimed at deterring bets on currency appreciation. Brazil last month announced a 2 percent tax on foreign investment in stocks and fixed-income securities to limit the strengthening of the real.
Several central banks in Asia have been intervening in foreign exchange markets to calm the ascent of their currencies.
ALLOW ASIAN APPRECIATION
Strauss-Kahn, who is in Singapore to attend the Asia Pacific Economic Cooperation meetings, also said Asian currencies should appreciate over time as part of a global economic rebalancing.
Many Asian currencies are still undervalued related to those of their major trading partners, while the euro is somewhat overvalued on this basis.
In my view, the region should not resist a gradual appreciation of its exchange rates, which I consider an important prerequisite for long-term rebalancing.
He reiterated that while the world economy had turned a corner after the crisis, the recovery was still fragile.
Policymakers should therefore keep supportive measures in place until a recovery is firmly established and conditions for unemployment to recede are in place. In some emerging markets, including a few in Asia, the recovery is further along, and crisis support policies may need to be unwound sooner rather than later.
He noted that regardless of the progress of economic recovery policymakers everywhere should start planning their exit strategies from easy monetary policy now.
This applies to monetary policy, fiscal policy, and financial sector support. Such early planning will help the eventual unwinding of exit policies and ease the transition to more normal economic conditions. LINKS > Strauss-Kahn: U.S. to avoid double-dip recession