IEO Evaluation Report on the IMF's Approach to Capital Account Liberalization 2005

International Monetary Fund. Independent Evaluation Office

• Publisher: INTERNATIONAL MONETARY FUND
• eBook ISBN:
  9781589064157
• Year: 2005

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CHAPTER 3: Advice to Member Countries, 1990–2002

This chapter reviews the IMF’s advice (or views expressed) to member countries on capital account issues, particularly capital account liberalization and managing capital flows. It first discusses the role of the IMF in capital account liberalization during 1990–2002 in the full sample of emerging market economies, paying particular attention to how its views, as expressed in country work, evolved over time. It then shifts to the IMF’s advice on managing capital flows in the context of bilateral surveillance, covering macroeconomic and structural policies to deal with large capital inflows and, in a separate section, the temporary use of capital controls to deal with both inflows and outflows.

Capital Account Liberalization

Out of the 27 countries examined, the evaluation identified 18 countries for which the IMF staff provided advice or otherwise expressed a view on capital account liberalization in staff reports during 1990–2002 (Table 3.1).¹ The table summarizes the evaluation team’s best judgments on whether or not the staff’s view or advice made a reference to the need for proper sequencing. For each country, when the staff report for a particular year makes no mention of sequencing, it is indicated by 1; when mention is made of sequencing, it is indicated by 2.

Table 3.1. The Nature of the IMF’s Advice on Capital Account Liberalization in Selected Countries¹

Source: IEO judgments based on IMF staff reports, supplemented by internal documents where necessary.

¹ The IMF’s advice for a particular year is assessed when capital account liberalization was part of that year’s discussion with country authorities. “1” indicates that no explicit mention is made of sequencing, and “2” indicates that mention is made. A shaded area corresponds to a period in which there was an IMF-supported program.

² The advice refers mostly to the liberalization of outflows after 1991.

³ In the case of South Africa, in addition to the financial sector, documents also explicitly spelled out country-specific risks whenever capital account liberalization was raised.

⁴ The advice refers mostly to the liberalization of outflows.

The nine countries not listed in the table include six countries that either had a relatively open capital account or liberalized the capital account at the beginning of 1990 (or before becoming members of the IMF): Estonia, Latvia, Lithuania, Malaysia, Mexico, and Venezuela. In most of these countries, the IMF had endorsed the authorities’ overall capital account liberalization strategies. In the case of Mexico and Venezuela, this endorsement was given in the context of IMF-supported programs;² in the Baltic states of Estonia, Latvia, and Lithuania, the IMF endorsed the liberal regimes already in place when they joined the IMF in 1992 or in subsequent policy dialogue. The absence of Colombia and Malaysia from the list may be conspicuous, as they substantially opened the capital account in the early to mid-1990s. Surprisingly, no discussion of capital account liberalization can be found in staff reports for these countries (Malaysia’s capital controls are discussed in the section “Temporary Use of Capital Controls” of this chapter).³

Some countries had a very open capital account but are still included in the table, when remaining restrictions were a subject of discussion. For example, Thailand, which had a very liberal capital account regime in 1990 with respect to inflows, retained some restrictions on outflows, and the IMF staff expressed its views on the liberalization of outflow controls (as well as on capital inflow promotion measures). Likewise, Chile abolished or eased most administrative controls on inflows from the late 1980s to 1991, so the IMF staff’s subsequent views on Chile mostly concerned the liberalization of outflow controls (Chile’s capital inflow controls are discussed in the section “Temporary Use of Capital Controls” of this chapter).

We first discuss the role of the IMF in capital account liberalization in terms of program conditionality and technical assistance. We then divide the period 1990–2002 into three subperiods, (1) the early 1990s, (2) following the Mexican crisis; and (3) following the East Asian crisis. For each period, we discuss how the IMF viewed capital account liberalization within the context of a specific country and see how its views might have changed over time.

Program conditionality and technical assistance

Of the 18 countries to which the IMF staff provided advice on capital account liberalization, 13 countries had an IMF-supported program at one time or another. In none of these countries did the IMF require capital account liberalization as formal conditionality for the use of its resources, where formal conditionality is understood to include prior actions, performance criteria, or structural benchmarks. In addition to the country documents for these countries, the evaluation also examined PDR’s comprehensive database on conditionalities for all programs, which confirms the almost complete absence of formal conditionality on capital account liberalization. This is consistent with the established interpretation of the Articles of Agreement, as given by the IMF’s Legal Department (LEG), which states that the IMF, as a condition for the use of its resources, cannot “require a member to remove controls on capital movements.”⁴

The Articles, however, are interpreted to allow the IMF to require as conditionality certain actions related to the capital account that are relevant to the mandate of the IMF, notably elimination of payment arrears (which typically arise from capital controls) and imposition of limits on external borrowing (which may implicitly require capital controls). Moreover, programs may also support capital account liberalization as part of country authorities’ overall package of economic policies. In fact, a number of IMF-supported programs with some of the sample countries included references to aspects of capital account liberalization in the letters of intent (LOIs) or accompanying policy memorandums. LOIs are statements of the authorities’ policy intention and do not constitute conditionality that links compliance with disbursements of funds.

For example, Hungary’s 1991 LOI for an extended arrangement expressed the authorities’ commitment to promote FDI by encouraging foreign participation in the banking sector and in the privatization process. Likewise, Russia’s 1992 LOI for the first credit tranche included the authorities’ intention to issue necessary foreign exchange regulations covering both capital and current transactions and to extend the same convertibility to nonresidents as soon as the monetary arrangements in the ruble area had been settled. The LOI for Croatia’s 1997 request for an extended arrangement was more explicit in stating the authorities’ intention to “put the liberalization of capital account transactions on its policy agenda, including restrictions that relate to outward portfolio and direct investment.”⁵

For the most part, available evidence suggests that the process of capital account liberalization was determined by country authorities’ economic and political agendas. In some cases, the process was driven by prospective OECD or EU accession and, in later years, commitments under bilateral or regional trade agreements. In other cases, such as Latvia (Box 3.1), it was driven by the countries’ desire to attract foreign investment. The IMF’s deference to country ownership is particularly evident in countries that chose a gradualist approach to capital account liberalization, such as Hungary or India; in these cases, we found no evidence that the IMF pushed for a faster pace in program negotiations or other policy discussions.

The IMF also provided technical assistance on issues that are broadly related to capital account liberalization. The documents we examined for 15 countries included advice on such issues as the development of indirect monetary policy instruments, establishment or development of a foreign exchange market, and drafting of a foreign exchange law. A Board paper prepared by the staff in 1995 noted that, while “the IMF’s treatment of the issue of capital account convertibility [had] been on a case-by-case basis in the context of its surveillance and use of IMF resources activities, an effort to facilitate capital liberalization [had] been applied more generally through the medium of technical assistance to develop foreign exchange markets” (Quirk and others, 1995).

In technical assistance discussions, the staff in the early years tended to be more encouraging toward capital account liberalization. The back-to-office report for a 1995 technical assistance mission to the Czech Republic, for example, stated that the mission “argued strongly” in favor of a “more decisive program of liberalization.” A 1995 technical assistance report for China concluded that an effective way to enhance the efficiency of the foreign exchange market was to eliminate restrictions that prohibited foreign banks from operating in the domestic market. Even in India, where the staff supported the country’s gradualist approach in its surveillance work, a 1995 technical assistance report on foreign exchange market development noted the need for a broad strategy for capital account liberalization as a precondition for developing a dynamic market. Little advice was given, however, on the specifics of sequencing capital account liberalization until later in the 1990s.

In the late 1990s, the nature of the IMF’s technical assistance seemed to change in two important respects. First, it began to emphasize the notion of sequencing. For example, in a December 1997 seminar held in China, the staff stressed the need to coordinate capital account liberalization measures with concurrent measures to strengthen financial markets and institutions and to sequence properly the liberalization measures in FDI, portfolio inflows, and outward investments. Second, technical assistance also became more accommodating of use of capital controls, especially for prudential purposes. In January 1999, for example, the technical assistance mission to Russia argued that countries that had opened up their capital account typically had in place regulations restricting certain transactions between residents and nonresidents, and recommended that the ability of nonresidents to access credit in the domestic market be restricted, especially where such borrowing could be leveraged to speculate against the ruble.

Surveillance in the early 1990s

In the early 1990s, the IMF viewed capital account liberalization favorably in its country work. The countries that liberalized the capital account may have done so on their own, but the IMF approvingly accepted their liberalization plans. In Israel, the IMF even advised the authorities to accelerate the pace of liberalization. For example, the staff report for the 1991 Article IV consultation with Israel stated: “The removal of foreign exchange controls should be speeded up to encourage capital inflows and improve allocation.” In Thailand, in 1992 the staff “urged” the authorities to remove the remaining restrictions on capital outflows.

The IMF staff, in its discussions with country authorities, stressed the benefits of an open capital account, including greater resource flows to supplement domestic savings (as in Poland in 1991), better resource allocations (Israel in 1991), lower interest rates (Slovenia in 1993), and greater price stability (Russia in the early 1990s). The 1992 staff report on Russia noted that the anti-inflationary policies crucially depended on accelerating the pace of institutional and structural reforms, including opening the economy to foreign capital. For Israel (in 1994), the staff listed Israel’s strong financial market and stable currency as reasons for moving forward with capital account liberalization. The staff occasionally pointed out the problems posed by a weak banking system, lack of exchange rate flexibility, or weak fiscal policy, but the awareness of these problems did not translate into operational advice on the pace and sequencing of capital account liberalization (for example, Poland in 1991; and the Czech Republic in 1993).

Box 3.1. Latvia

In 1991, independence for Latvia meant an immediate dismantling of all the capital controls that existed in the former Soviet Union. Independence also meant a reorientation of trade away from the Soviet bloc, which brought about a deterioration in the terms of trade and a shortage of energy and raw materials. In the early 1990s, coupled with the impact of a severe drought affecting agriculture, the economic outlook for Latvia was bleak. From 1992 to 1993, industrial output collapsed and unemployment soared, threatening to undermine the broad political support for economic reforms. Under these circumstances, the Latvian authorities chose not to replace the Soviet-era ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Foreword
• Abbreviations and Acronyms
• The Imf’s Approach To Capital Account Liberalization
• Executive Summary
• I Introduction
• 2 General Policy and Analysis
• 3 Advice to Member Countries, 1990–2002
• 4 Ongoing Country Dialogue on Capital Account Issues
• 5 Major Findings and Recommendations
• Boxes
• References
• Statement By The Managing Director, Imf Staff Response, Ieo Comments On Management/Staff Response, And Summing Up Of Imf Executive Board Discussion By The Acting Chair
• Statement by the Managing Director
• IMF Staff Response
• IEO Comments on Management/Staff Response
• Summing Up of IMF Executive Board Discussion by the Acting Chair
• Footnotes