India has safeguards in place to mitigate risks from capital inflows: IMF

Capital flows have several benefits and as a financial asset they need investments. These are helpful in insuring against some kinds of risks. There are many benefits to countries from having capital flows in India and India also benefits from receiving those capital flows. India which has received a record number of foreign direct investments during the last few years despite COVID-19 crisis has quite a few safeguards in place to mitigate the risks from capital flows. The IMF released a paper on the Review of the Institutional View (IV) on the Liberalization and Management of Capital Flows. The IV was adopted in 2012 and provides the basis for consistent Fund advice on policies related to capital flows. The IV aims to help countries reap the benefits of capital flows while managing the associated risks in a way that preserves macroeconomic and financial stability and does not generate significant negative outward spillovers. The Review introduces important changes that expand the toolkit for policymakers such as allowing the pre-emptive use of capital flow measures on inflows if financial vulnerabilities exist.

In response to a question, Gita Gopinath, IMF’s first Deputy Managing Director noted that there are other kinds of financial risks associated with having large amounts of capital inflows. “In the case of India there are a large number of capital restrictions already in place. The Indian government uses these restrictions quite proactively in dealing when the external environment changes. So, by putting restrictions on the amount of external borrowing the corporate can do, that is an instrument that they use. India is still in the process of liberalizing its capital accounts.” Gopinath said. The top IMF official an Indian American said capital flows are desirable because they can bring substantial benefits to recipient countries. But they can also result in macro-economic challenges and financial stability risks she said.

''The dramatic capital outflows we witnessed at the start of the global pandemic and the recent turbulence and capital flows to some emerging markets following the war in Ukraine are stark reminders of how volatile capital flows can be and the impact this can have on economies ”she said. In the aftermath of the great financial crisis where interest rates were low for a long time in advanced economies, capital flows to emerging markets in search of high returns. In some countries this led to a gradual buildup of their external debt in foreign currency which was not offset by foreign currency assets or hedges, she noted. “Then when the taper tantrum struck and there was a sudden loss of appetite for emerging market debt it led to severe financial distress in some markets. Now the lessons learned from a large body of research is that in some circumstances countries should have the option of preemptively curbing debt inflows to safeguard macro-economic and financial stability”. Accordingly, the main update to the policy toolkit released by the IMF is the addition of capital flow management measures and macro prudential policies that can be applied preemptively.