Edited by Masahiro Kawai, David G. Mayes and Peter Morgan
Chapter 6: Liberalization and Regulation of Capital Flows: Lessons for Emerging Market Economies
Rakesh Mohan and Muneesh Kapur 6.1 INTRODUCTION Since the early 1990s, there has been a large trend increase in the volume of private capital flows to and from emerging market economies (EMEs). This increase can be attributed to EMEs’ growing degree of financial openness, the perception of continuing strong growth prospects, increasing productivity, growth in the overall profitability of firms, positive interest differentials in favor of these economies and, sometimes, the expectation of continuing currency appreciation. However, capital flows are not necessarily the outcome of domestic developments alone in recipient countries; they also reflect the role of push factors emanating from source countries. The stance of monetary policy and the state of financial markets in major advanced economies have led to the emergence of comparatively low interest rates and overall low returns in these economies, giving rise to the search for yields. These factors again came to the fore in 2010 following unprecedented quantitative easing by the central banks in major advanced economies and the likelihood of such policies being pursued for an extended period of time. With near zero interest rates in these countries likely to continue into 2011, EMEs are attracting large capital flows. The consequent rapid appreciation of exchange rates has generated concerns over potential ‘currency wars’, with a number of EMEs resorting to capital controls. Issues related to capital flows and their management have, therefore, re-emerged as a key concern for EMEs. The traditional pattern of capital flows to EMEs has been the result of the...
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