A senior IMF official has come out in support of sophisticated capital controls to shield Latin America from the undesirable effect of massive capital inflows.
The IMF western hemisphere director, Nicolas Eyzaguirre, has advocated a combination of macro prudential regulations and a healthy mix of fiscal and monetary policy.
Eyzaguirre told Emerging Markets that he will advise ministers from the region against blunt capital controls that are easily circumvented.
First and foremost, do the appropriate policy mix, he proposed. But I can not rule out that, given the systemic characteristic of these capital inflows, these countries will have to protect themselves further with a set of macro prudential regulations, that may include capital controls.
He added: The philosophy is that prudential macro regulations should be designed to dampen volatility, especially the kind that can impair the financial system.
South American policymakers should not believe that the current monetary environment is here to stay forever, as international conditions are too good to be true, or too good to be sustainable, Eyzaguirre said.
Another massive liquidity problem, similar to the post-Lehman crisis, could for example be prevented by a higher reserve requirement on the more volatile sources of funding such as crossborder flows.
You may put a higher tax on a source of funding that happens to be crossborder flows. In a way it is capital control, but it is not a blunt capital control. It is a kind of capital control that tries to dampen the vulnerability, because it taxes the thing according to its volatility, Eyzaguirre said.
I am sort of panicking, because this is a heterodox [approach] of a kind not usually embraced by the IMF, he added. Capital controls may not be a good policy from the point of view of resource allocation.
A control, which in a way is a distortion, may need to be applied to correct an even greater distortion.
Eyzaguirre said the IMF was moderately worried about the impact of capital flows to Latin America. Some countries, such as Mexico which successfully issued a 100-year bond on Tuesday seem to be making the most of it, he said.
But others, like Brazil, are taking measures to stem capital inflows that put upward pressure on their currencies. Brazil raised a tax on foreign investment in fixed income securities from 2% to 4% on Tuesday.
Nevertheless, the dollar closed at its highest level in two years against the Brazilian real on that day although the Real fell slightly on Wednesday morning in São Paulo. The dollar remained below 1.7 reais yesterday morning. Some medicines do not have an immediate effect, said Guido Mantega, Brazils finance minister.
The Brazilian Treasury announced yesterday that it may buy up to $10.7 billion, and use it for foreign debt servicing purposes by 2014. Foreign currency reserves are already close to $280 billion.