Policy Responses to Capital Flows in Policy Responses to Capital Flows in Emerging MarketsEmerging Marketsg gg g

B k I d i d IMF J i t C fB k I d i d IMF J i t C fBank Indonesia and IMF Joint Conference onBank Indonesia and IMF Joint Conference onCoping with Asia’s Large Capital Inflows in a MultiCoping with Asia’s Large Capital Inflows in a Multi--Speed Global EconomySpeed Global Economy

Bali, March 2011Bali, March 2011

Mahmood Pradhan, Reza Baqir, Geoffrey HeenanMahmood Pradhan, Reza Baqir, Geoffrey Heenan, q , y, q , y

International Monetary FundInternational Monetary Fund

Policy Responses to Capital Flows in Policy Responses to Capital Flows in i ki kEmerging MarketsEmerging Markets

Impact of Capital Inflows

Policy Responses in Asia

Policy Responses in Other Emerging Markets

2

Net Capital Flows to Emerging Markets Comparable to Previous Episodes

12.0

Gross Inflows(In percent of GDP)

7.0

Net Inflows(In percent of GDP)

10.0

Past episodes

Current episodes6.0

Past episodes

Current episodes

8.0

4.0

5.0

4.0

6.0

2 0

3.0

2.0 1.0

2.0

3

0.0Selected Non-

Asia EMsAsia ex

China EMsOther EMs

0.0Selected Non-

Asia EMsAsia ex

China EMsOther EMs

Macro Policy Responses Have Varied

Currency Appreciation

Reserves Fiscal Policy

Other Measures to

Manage

Monetary Policy

Capital FlowsPercent change in the NEER from the

trough since the crisis

Increase in percent of GDP from the trough since the crisis

Change in cyclically

adjusted fiscal stance

Change in policy rates in the recent wave

crisis since the crisis stance between 2009-

10

Brazil 38.4 6.0 Yes

Indonesia 19.4 7.4 Yes

Korea 17.5 10.7 Yes

Peru 5 6 9 0 YesPeru 5.6 9.0 Yes

South Africa 41.4 2.6 No

Thailand 9.3 22.3 Yes

4

Turkey 6.5 1.7 No

Net Portfolio Flows, 2010:Q1-Q3

Flows to Debt Markets have Dominated in this Episode

50Debt

Net Portfolio Flows, 2010:Q1 Q3(In billions of U.S. dollars)

40Equity

20

30

10

20

0Brazil Korea Indonesia South Africa Turkey Thailand

5

Brazil Korea Indonesia South Africa Turkey Thailand

Source: IMF, International Financial Statistics.

Leading to a Substantial Rise in Foreign OwnershipLeading to a Substantial Rise in Foreign Ownership

Foreign Holdings of Local Government Bonds(In percent outstanding)

35 30

25

30Indonesia

Korea

Malaysia

25

BrazilMexicoPoland

Turkey

20

25Thailand

15

20

y

10

15

10

0

5

4 4 4 4

0

5

6

00Q

100

Q4

01Q

302

Q2

03Q

103

Q4

04Q

305

Q2

06Q

106

Q4

07Q

308

Q2

09Q

109

Q4

10Q

3

00Q

1

00Q

4

01Q

3

02Q

2

03Q

1

03Q

4

04Q

3

05Q

2

06Q

1

06Q

4

07Q

3

08Q

2

09Q

1

09Q

4

10Q

3

Sources: CEIC Data Co., Ltd.; Bloomberg L.P.; EMEA Databases; and country authorities.

Change in Nonresident Bond Holdings and Long Term Bond Yields

Larger Markets Better AbleLarger Markets Better Able to Absorb Inflowsto Absorb Inflows

16

Change in Nonresident Bond Holdings and Long-Term Bond Yields (Between June 2009 and November 2010)

12

14

d m

arke

t Indonesia

Sphere represents the size of bond markets in mid 2009 (in

8

10

ents

in b

one

in p

pt)

bond markets in mid-2009 (in U.S. dollars)

4

6

f non

resi

de(c

hang

e

TurkeyThailand

Korea

0

2

0 100 200 300 400 500 600 700

Shar

e of

Brazil

7

0 100 200 300 400 500 600 70010-year government bond yields

(Decline in basis points)

The Impact of Foreign Ownership on Domestic The Impact of Foreign Ownership on Domestic Bond YieldsBond Yields——Empirical EstimatesEmpirical EstimatesBond YieldsBond Yields Empirical EstimatesEmpirical Estimates

Summary of Results 1/

Short/Monthly Model Long/Quarterly ModelImpact on Long-Term B d Yi ld t-Statistic

Policy rate 0.65 *** 0.74 *** 7.29Inflation expectations 0.49 *** -0.02 -0.11Expected depreciation -0.05 * -0.23 *** -2.61

Coefficient t-Statistic CoefficientBond Yields

5.532.94

-1.82Expected depreciation 0.05 0.23 2.61VIX 2/ 0.04 ** 0.02 1Real activity 3/ 0.08 *** 0.05 ** 2.12Fiscal balance … 0.06 * 1.71Foreign holdings of bonds -0.04 ** -0.05 ** -2.3-2.24

…

1.822.246.55

Constant 0.23 2.31 *** 3.12

Adj. R-squaredSample 2000:Q1-2010:Q42006:M1-2010:M12

0.94

0.18

0.86

No. of observations 333 252

1/ The t-statistics are corrected for serial correlation and cross-sectional heteroskedasticity. Estimates are robust, qualitatively and quantitatively to different assumptions about the error terms. In both samples, the Hausman test strongly rejects a random effects specification and the country fixed effects are found significant. *** denotes significance at 1 percent, ** at 5 percent and * at 10 percent.

8

3/ Year-on-year growth of the 3-month moving average industrial production in the monthly model. Year-on-year growth of seasonally adjusted quarterly GDP in the quarterly model.

p , p p2/ The results are qualitatively the same when the VIX is replaced by long-term sovereign CDS spreads.

Summary of ResultsSummary of Results

Flatter yield curves.Flatter yield curves.

One percentage point increase in foreign One percentage point increase in foreign ownership reduces long bond yields by ownership reduces long bond yields by about 5 basis points.about 5 basis points.

But monetary policy remains effective: But monetary policy remains effective: y p yy p y25 basis points increase in the policy 25 basis points increase in the policy rate increases long yields by 10 basis rate increases long yields by 10 basis g y yg y ypoints.points.

9

Policy Responses to Capital Flows in Policy Responses to Capital Flows in i ki kEmerging MarketsEmerging Markets

Impact of Capital Inflows

Policy Responses in Asia (Korea, Indonesia, Thailand)Thailand)

Policy Responses in Other Emerging MarketsPolicy Responses in Other Emerging Markets (Brazil, Turkey, South Africa)

10

Korea: Implemented prudential measures inKorea: Implemented prudential measures in2 Stages but a 32 Stages but a 3rdrd wave of measures is underway:wave of measures is underway:2 Stages but a 32 Stages but a 3rdrd wave of measures is underway:wave of measures is underway:

November 2009November 2009 measures measures focused on strengthening funding focused on strengthening funding g g gg g gof the banking sector.of the banking sector.

June 2010June 2010 measures targeted at reducing short term external measures targeted at reducing short term external d bt ti i fl d t th d N bd bt ti i fl d t th d N bdebt generating inflows and strengthened November debt generating inflows and strengthened November measures.measures.

Withholding tax on foreign holdings of Treasury and central Withholding tax on foreign holdings of Treasury and central g g g yg g g ybank securities reinstated in bank securities reinstated in January 2011January 2011. .

The authorities announced plans in The authorities announced plans in December 2010December 2010 to to i d l b k ’ f i b i f J l 2011i d l b k ’ f i b i f J l 2011introduce a levy on banks’ foreign borrowing from July 2011. introduce a levy on banks’ foreign borrowing from July 2011.

11

Korea: June 2010 MeasuresKorea: June 2010 Measures

Ceilings on FX derivatives positions of banks to reduce shortCeilings on FX derivatives positions of banks to reduce short--term external debt and term external debt and leverageleverage.. The ceiling on domestic banks’ FX derivatives contracts to be no moreThe ceiling on domestic banks’ FX derivatives contracts to be no more The ceiling on domestic banks FX derivatives contracts to be no more The ceiling on domestic banks FX derivatives contracts to be no more

than 50 percent of their capital in the previous month. than 50 percent of their capital in the previous month.

For foreign bank branches, ceiling set at 250 percent of their capital in For foreign bank branches, ceiling set at 250 percent of their capital in the previous monththe previous monththe previous month.the previous month.

Banks limited to providing 100 percent of underlying transactions for Banks limited to providing 100 percent of underlying transactions for forward contracts with exporters (previously 125 percent).forward contracts with exporters (previously 125 percent).

Limit use of foreign currency bank loans to reduce leverage ofLimit use of foreign currency bank loans to reduce leverage of Limit use of foreign currency bank loans to reduce leverage of Limit use of foreign currency bank loans to reduce leverage of corporatescorporates..

Reducing FX asset/liability mismatch.Reducing FX asset/liability mismatch. Local banks' FX loans and heldLocal banks' FX loans and held--toto--maturity securities with more than maturity securities with more than

or equal to oneor equal to one--year maturity must be covered by at least 100 percent year maturity must be covered by at least 100 percent (previously 90 percent) of FX borrowing with maturity more than one (previously 90 percent) of FX borrowing with maturity more than one year.year.

12

Korea’s Measures: How Effective?Korea’s Measures: How Effective?

100200Share of banks in ST FX borrowing Lehman's bankruptcy

US$ billions Percent

Short-Term External Borrowing

85

90

95

140

160

180

Domestic banks (left scale)Foreign banks (left scale)

Share of banks in ST FX borrowing(right scale)

Lehman s bankruptcy

75

80

85

100

120

140 g f

60

65

70

40

60

80

50

55

60

0

20

40

13

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10

Source: CEIC Data Company Ltd.

Indonesia: Managing ShortIndonesia: Managing Short--Term VolatilityTerm Volatility

Concern about volatility of fixedConcern about volatility of fixed--income flows into income flows into l b kl b kcentral bank papercentral bank paper

ShortShort--term capital flows can disrupt Bank Indonesia’s liquidity term capital flows can disrupt Bank Indonesia’s liquidity managementmanagementmanagementmanagement

Introduced minimum 1Introduced minimum 1--month holding period on SBIs (June month holding period on SBIs (June 2010), lengthened SBI tenors from 12010), lengthened SBI tenors from 1--3 months to 63 months to 6--9 months, 9 months, introduced shortintroduced short--term deposits available only to banks, term deposits available only to banks, increased RR (September 2010).increased RR (September 2010).

Dec 2010: BI to raise RR on FX deposits to 8% from 1% by JuneDec 2010: BI to raise RR on FX deposits to 8% from 1% by June Dec 2010: BI to raise RR on FX deposits to 8% from 1% by June Dec 2010: BI to raise RR on FX deposits to 8% from 1% by June 2011.2011.

14

C i i f S ili i I

Indonesia: ForeignIndonesia: Foreign Investors’ Appetite Investors’ Appetite SStill till HHighigh

60600SBIs (3 months or less)

( h h )

Composition of Sterilization Instruments (In trillions of rupiah)

40

50

400

500SBIs (greater than 3 months)Term depositsO/N depositsOther

30

40

300

400

20200

0

10

0

100

15

May-08 Sep-08 Dec-08 Apr-09 Aug-09 Nov-09 Mar-10 Jun-10 Oct-10 Jan-11

Sources: Bank Indonesia; and authors' calculations.

Thailand: Recent MeasuresThailand: Recent Measures

February/September: Liberalized outflowsFebruary/September: Liberalized outflowsMainly as a signal; existing limits were not bindingMainly as a signal; existing limits were not bindingMainly as a signal; existing limits were not bindingMainly as a signal; existing limits were not binding

October: Removed foreign investors’ withholding October: Removed foreign investors’ withholding tax exemptiontax exemptiontax exemptiontax exemptionExemption was granted in 2005Exemption was granted in 2005

Reinstating the 15 percent tax equalized treatment ofReinstating the 15 percent tax equalized treatment ofReinstating the 15 percent tax equalized treatment of Reinstating the 15 percent tax equalized treatment of resident and nonresident individual investors, as well resident and nonresident individual investors, as well as the treatment of gains from state and corporate as the treatment of gains from state and corporate bonds Domestic institutional investors continue to paybonds Domestic institutional investors continue to paybonds. Domestic institutional investors continue to pay bonds. Domestic institutional investors continue to pay 1 percent.1 percent.

16

Thailand:Thailand: Foreign Flows to Bond Market ResumedForeign Flows to Bond Market Resumed

1801,600Net inflow into bonds (left scale)

Weekly Foreign Portfolio Inflows and ReservesUS$ millions US$ billions

160

170

800

1,200

Net inflow into bonds (left scale)Net inflow into equities (left scale)Gross reserves (right scale)

150

160

400

800

130

140

-400

0

withholding

120-800

n-10

b-10

r-10

r-10

y-10

n-10 l-1

0

g-10

p-10

t-10

v-10

c-10

n-11

tax imposed

17

Jan

Feb

Mar

Apr

May Jun Jul

Aug Se

p

Oct

Nov Dec Jan

Sources: Thai Bond Market Association; and Bloomberg L.P.

Policy Responses to Capital Flows in Policy Responses to Capital Flows in i ki kEmerging MarketsEmerging Markets

Impact of Capital Inflows

Policy Responses in Asia

Policy Responses in Other Emerging Markets (Brazil Turkey South Africa)(Brazil, Turkey, South Africa)

18

Brazil: Extensive Measures to Manage Capital FlowsDollar Exchange Rate after IOFDollar Exchange Rate after IOF Measures(Day of measure = 100, increase denotes appreciation)

2020

Foreign Long Real Interest and Banks' FX Cash Position(In billions of U.S. dollars)

104

106

108

104

106

108

Measure tightened on October 18, 2010

10

15

20

10

15

20

Banks' FX cash position

Foreign long R$ futures interest

100

102

104

100

102

104

0

5

10

0

5

10

96

98

96

98

3/12/2008 -10

-5

0

-10

-5

0

90

92

94

90

92

943/12/200810/19/200910/4/2010

-20

-15

10

-20

-15

10

9090-20 -15 -10 -5 0 5 10 15 20

Sources: Bloomberg L.P.; and Fund staff

2020Sep-08 Mar-09 Sep-09 Mar-10 Sep-10

Sources: Central Bank of Brazil; and JP Morgan.

19

Turkey: Some Macro MeasuresC iti f C it l Fl

2020

Composition of Capital Flows, January-November 2010(In billions of U.S. dollars)

88

Interest Rates (In percent)

15.6

12.311.3

1515

6

7

6

7

9.0

4.3 3.52.4

5

10

5

10

4

5

4

5

-5

0

-5

0

2

3

2

3

CBT overnight deposit rate-5.3

-10-10

nmen

tri

ties

and

bilit

ies

cy a

ndas

sets

icat

edan

s

Equi

ty

rs a

ndss

ions

Oth

er

pora

teoa

ns

0

1

2

0

1

2 g p1-week repo rateISE repo rateISE repo rate (10-day moving average)1-month swap rate

20

Gov

ern

secu

rCu

rren

cy

depo

sit l

iab

Curr

enc

depo

sit a

Synd lo

a E

Erro

omis

Corp lo 00

06/10 07/10 08/10 09/10 11/10 12/10 01/11

Source: Bloomberg L.P.; and Haver Analytics.

South Africa: Macro Response

Nonresident Net Purchases of Share and Bonds(In billions of rand)

90

92

South African Rand

10

20

3092

94

96

-10

098

100

102

-40

-30

-20

Stocks

102

104

106

Rand/U.S dollar(1/1/2010)

-60

-50-0

7

-07

-07

-08

-08

-09

-09

-09

-10

-10

Bonds108

110

10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10

21

Jan-

Jun-

Nov

-

Apr

-

Sep-

Feb- Jul-

Dec

-

May

-

Oct

-

Source: South African Reserve Bank.04-J

an-

26-J

an-

17-F

eb-

11-M

ar-

02-A

pr-

26-A

pr-

18-M

ay-

09-J

un-

01-J

ul-

23-J

ul-

16-A

ug-

07-S

ep-

29-S

ep-

21-O

ct-

12-N

ov-

06-D

ec-

28-D

ec-

OTHANK YOU

22