Egon & Joan von Kaschnitz Lecture

A Case for An Integrated Policy Framework (IPF)

Clausen Center Conference on Global Economic IssuesNovember 16, 2019

Gita GopinathEconomic Counsellor

Roadmap

• Current issues in emerging market capital flows

• A case study: Indonesia

• Countries’ experience and characteristics

• Key modeling ingredients and preliminary results

• Policy and practical challenges

1

-160

-140

-120

-100

-80

-60

-40

-20

0

20

40

60

10 11 12 13 14 15 16 17 18 19

Global Domestic

Sept. 19

Sources: Haver Analytics; IMF, GFSR October 2019; and IMF staff estimates.

2

Large inflows to EMs partly driven by global factors

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

-100

-50

0

50

100

150

200

10 11 12 13 14 15 16 17 18 19

Equity: China

Equity: excl. China

Debt

U.S. fed funds target rate (percent; rhs)

FCI (rhs)

Oct. 19

Tighten

Nonresident portfolio flows to EMs(U.S. billions; three-month rolling sums)

Change in EMBIG spreads and its drivers(basis points)

Sources: IMF, GFSR April 2019. 3

Growing benchmark driven investments has also increased the sensitivity of portfolio flows to global factors

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

13 14 15 16 17 18 19

US interest rates (10-year Treasury) Risk aversion (BBB spread)

Jan. 190

10

20

30

40

50

60

70

80

90

100

13 14 15 16 17 18

ReversalsEM benchmark drivenOther (for example, hedge funds, global bond benchmarks)

Oct. 18

Estimated foreign holdings of local currency sovereign debt (share of total in percent)

Sensitivity of benchmark-driven debt flows to global factors(percent of invested assets)

Sustained capital inflows contribute to the build-up of vulnerabilities

Sources: Cecchetti, Mancini, Narita, and Sahay (2019). Non-US financial institutions.

Change in asset-to-equity ratio followingUS monetary policy easing (in percent)

Source: IMF, FFA database. 4

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

10 11 12 13 14 15 16 17 18 19

Cumulative portfolio debt Cumulative portfolio equity19Q2

Portfolio inflows to EMs(U.S. billions)

Sources: ESR (2019), Benetrix, Gautam, Juvenal and Schmitz (2019) and Carrier-Swallow, Gruss, Magud and Valencia (2016).

1/ Simple cross-country averages of 18 EMEs included in the External Sector Report are reported. Net FC measures size of the external balance sheet scaled by GDP.

EMs more resilient to currency movements than in the past

5

-100

-80

-60

-40

-20

0

20

40

60

80

100

2004 2007 2017

Liabilities in local currency Liabilities in foreign currency

Assets in local currency Assets in foreign currency

NET foreign currency

Selected EMDEs: Assets and liabilities by currency 1/(percent of GDP)

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

2007 2011 2015 2007 2011 2015

Pass-through 24 month Pass-through 12 month

Import content

Advanced economies Emerging markets

Estimated exchange rate pass-through (percent)

A case study: Indonesia (i)

Source: IIF, Haver Analytics and IMF staff estimates 6

Two main episodes of sudden stops in capital inflows: Taper tantrum (Q2-Q3, 2013) and 2018 EM stress (Q2 2018)

8000

9000

10000

11000

12000

13000

14000

15000

16000

85

90

95

100

105

110

115

120

125

130

135

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

Jan-

15M

ay-1

5Se

p-15

Jan-

16M

ay-1

6Se

p-16

Jan-

17M

ay-1

7Se

p-17

Jan-

18M

ay-1

8Se

p-18

Jan-

19

International reserves (billion USD)IDR/USD (right scale)

International Reserves and Exchange Rate

Taper tantrum

RMB depreciation

-4

-3

-2

-1

0

1

2

3

-5000

-4000

-3000

-2000

-1000

0

1000

2000

3000

4000

Nov-

12M

ar-1

3Ju

l-13

Nov-

13M

ar-1

4Ju

l-14

Nov-

14M

ar-1

5Ju

l-15

Nov-

15M

ar-1

6Ju

l-16

Nov-

16M

ar-1

7Ju

l-17

Nov-

17M

ar-1

8Ju

l-18

Nov-

18

Debt Equity Standardized Flows

Indonesia - Portfolio Equity & Debt Flows(LHS in USD Million; RHS standardized values)

A case study: Indonesia (ii)

Source: Haver, Analytics; CEIC; IMF staff calculations 7

Policy responses include FX intervention, rate hikes as well as macroprudential measures

0

1

2

3

4

5

6

7

8

9

Jan-

12

Jun-

12

Nov

-12

Apr-

13

Sep-

13

Feb-

14

Jul-1

4

Dec

-14

May

-15

Oct

-15

Mar

-16

Aug-

16

Jan-

17

Jun-

17

Nov

-17

Apr-

18

Sep-

18

BI policy rate

Monetary Policy (In percent)

0

5

10

15

20

25

30

35

40

45

50

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

Sep-

15

Jan-

16

May

-16

Sep-

16

Jan-

17

May

-17

Sep-

17

Jan-

18

May

-18

Sep-

18

Total credit growth

Mortgage credit growth

Credit Growth and Macroprudential Policy (In percent and index, y-o-y growth rate)

MPMs tightened

MPMs loosened

Sources: Alam and Others (2019); Haver Analytics; Bloomberg, L.P.; IMF, Balance of Payments; and IMF staff estimates.8

Policy rates changes since March 2018(percentage points)

Foreign exchange intervention, March-October 2018(cumulative; percent of GDP)

Number of macroprudential and capital flow management measures, 2010-11(number of measures)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

BRA CHL COL IDN IND MYS PER POL RUS ZAF

1 2 3 4 5 6 cumulative change

-5

-4

-3

-2

-1

0

1

2

BRA CHL COL IDN IND MYS PER POL ROU ZAF0

2

4

6

8

10

12

SGP

PRK

HKG

CAN

NOR

NZL

SWE

MYS

BRA

PER

TUR

IND

RUS

IDN

POL

Capital flow management measuresMacroprudential measures

Advanced markets Emerging markets

Outflow EpisodeInflow Episode

Countries have used various policy tools for macro management

Country characteristics vary along several dimensions

Sources: Gopinath (2016); IMF staff calculations; and BIS.

Currency of export invoicing (percent of total)

Non-financial corporate foreign currency debt(in percent of GDP; 2018)

0

5

10

15

20

25

30

35

BGR BRA CHL COL IDN IND POL ROU TUR ZAF

FX market turnover(in percent of GDP; 2016)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

BGR BRA COL IDN IND ISR POL ROU TUR UKR ZAF

Own currency US Dollar Others

0

5

10

15

20

25

30

35

DNK

CHE

NO

R

SWE

CAN

NZL

KOR

BGR

BRA

CHL

COL

IDN

IND

ISR

POL

ROU

TUR

ZAF

Emerging marketsAdvanced markets

9

Countries with higher external debt tend to intervene more

Albania

Argentina

Armenia

Brazil

Chile

Colombia

Georgia

Hungary

India

Jamaica

Kazakhstan

MalaysiaMexico

Mongolia

ParaguayPeru

Philippines

Poland

Romania

Russia

Seychelles

South Africa

Thailand

Turkey

Ukraine

Uruguay

Indonesia

y = 5.76x + 30.11

R² = 0.45

0

20

40

60

80

100

120

0 2 4 6 8 10 12

Po

rtfo

lio

de

bt

an

d o

the

r li

ab

ilit

ies

in p

erc

en

t o

f G

DP

Absolute FXI in percent of GDP

External Debt vs. FXI(2010-2016 average)

Note: FXI is calculated using BOP proxies.

10

Key Modeling Ingredients

Policy Options

• Monetary policy/Exchange rate flexibility

• FX intervention

• Macroprudential policy

• Capital flow management measures

Country Characteristics

• Currency of trade invoicing

• Commodity export share

• Financial frictions

Shocks

• Real: Productivity, Commodity price

• Financial: World interest rate, Debt limit, Capital flows

11

Country Characteristics Matter• Example:– Three different countries– Same risk-off shock → Appetite for country’s debt and net capital

flows decline

• Country A:– No financial frictions– Deep FX markets → No or very limited effectiveness of FXI

• Country B:– Borrows in FX → Significant currency mismatches– Deep FX markets → No or very limited effectiveness of FXI

• Country C:– Borrows in FX → Significant currency mismatches– Shallow FX markets → FXI effective

12

Country A: No financial frictions

• No reason to limit ER adjustment after negative shock → Mundell-Flemming

• If DCP: ER flexibility less potent in stabilizing economy → still Mundell-Flemming

• No role for heterodox policies– They do not address the source of imperfect stabilization (sticky dollar prices).

• Just because you have an instrument does not mean you should use it.

t = 0 t = 1

Shock hitsOutput gap closedMonetary policy lets ER

adjust

t = 0 t = 1

Shock hitsOutput gap not fully closed

Monetary policy lets ER adjust

Exports ↑

Exports ↔

Imports ↓

Imports ↓

14

13

Country B: Currency mismatches + Deep FX markets

• Exchange rate depreciations have negative balance sheet effects

• FXI would help if effective, but limited traction (deep markets) → MP to limit ER depreciation

• CFM and macroprudential policies (t=0) can limit mismatches and improve outcomes.– Less need to stimulate the economy (since less overborrowing)– Less need to defend the exchange rate (since lower currency mismatches)

• DCP → higher CFMs, because of larger ER movements for trade reasons.

• Policy tools interact in complex ways. Hence, we need an integrated model.

t = 0 t = 1

Shock hitsConflicting impact on output gap

MP contains ER changesNegative balance sheet effects

Imports ↓ Exports ↑

15

14

Country C: Currency mismatches + Shallow FX markets

• FXI effective because of shallow FX markets• MP freed up

• → FXI limit ER depreciation/MP stabilize domestic demand

• Again, macroprudential measures and CFMs can improve outcomes.

t = 0 t = 1

Shock hitsOutput gap partially closed

FXI limits ER depreciation/MP cuts

interest rate Limited balance sheet effects

Stimulate domestic demand

16

15

Preliminary insights1. Not just the number but the workings of instruments matter

• Not all instruments affect all imperfections• Instruments typically affect multiple imperfections

2. PCP countries receive full benefits from exchange rate flexibility

3. Since exchange rate adjustment is a weaker tool, DCP countries achieve less macro stabilization and may need larger exchange rate movements. DCP alone does not change the M-F prescription

4. Prudential capital controls become optimal when there is a possibility of not being able to borrow. DCP countries impose higher capital controls because of the larger exchange rate movements desired based on trade considerations

5. FX intervention can increase monetary autonomy when foreign exchange markets are shallow and monetary transmission channel is at least partially functional

16

Additional Policy and Practical Challenges • Governance and credibility

• Use of multiple tools may be difficult to coordinate across separate policy authorities• If multiple tools/mandates housed at the central bank, need to carefully design

communication strategy to avoid undermining monetary policy credibility

• Moral hazard and market development

• Expectation of policy interventions may stimulate excessive risk-taking and/or hinder the long-term development of FX markets and government institutions

• Challenges in estimating effectiveness of the policy tools for different shocks and country characteristics

17

What is the IPF?

Shocks Cyclical/Structural Characteristics

Policies

Growth and Stability

Linking Shocks, Characteristics, Policies and Objectives

18

CONFERENCE ON GLOBAL ECONOMIC ISSUES