Safe to Return?

It is nine years since the IMF/World Bank annual meetings were last held in East Asia. Those Hong Kong meetings were held during a lull in the financial crisis that was ravaging the region. Partly at least to prevent a recurrence, virtually every country in the region has since built up its reserves to a level where a new crisis is, at least for now, inconceivable. But everyone knows that this insurance is expensive. One of the main benefits of international capital flows is negated if a country that receives a capital inflow feels obliged to build up its reserves to cover a subsequent outflow. If the international capital market is ever again to fulfil its potential of reallocating resources to parts of the world where the return on investment is highest, countries need to be given the confidence to use their capital inflows to finance current-account deficits.

Looming demographic and development trends make this task especially important. Over the next 50 years, virtually all population growth will occur in parts of the world that are now labelled as developing countries, while most of the currently developed countries are likely to experience a gradual population decline. Moreover, many (with luck, most) developing countries – and certainly most in East Asia – seem likely to develop. Undeniably, this requires good institutions, a work ethic, entrepreneurial attitudes and a good education system, but it also requires lots of investment. Meanwhile, many developed countries should be saving more than they can profitably invest, in part to build up assets for the coming explosion in their retired population. The world would benefit from arrangements that facilitate a flow of capital from developed to developing countries. That means real capital flows, transferred via current-account deficits, not having reserve changes provide the counterpart to capital inflows. Large capital flows to emerging markets would also help attenuate the pressure for large-scale migration.

Several things can be done to facilitate this process. Potential capital-importing countries need to manage their economies in ways unlikely to cause investors to panic. They need to maintain low rates of inflation and a sound fiscal position, adopt modern methods of economic management (involving flexible exchange rates and inflation targeting), allow automatic fiscal stabilisers to work, avoid large currency mismatches in their asset/liability positions, borrow in forms that do not impose the risk of sudden large demands for repayment, and avoid a reputation for corruption. The world’s major economies need to maintain a healthy rate of growth and avoid crises and recessions.

t would help if groups of capital-importing countries could create regional capital markets, in part because this would enable regional surplus countries to satisfy a part of the needs for capital, and also because it would reassure investors that unexpected changes in the rules of the game by debtors would be resisted by peers as well as outside lenders. The international financial institutions need to create mechanisms, such as the IMF’s proposed arrangements for high-access contingency financing, which will give confidence to debtor countries that in the event of a withdrawal of funds for reasons other than their own irresponsible policies they would be able to draw as quickly on liquid facilities as they can currently mobilise their reserves. Finally, the international capital market needs to play its part in creating and lending through instruments that do not pose the threat of imposing sudden large demands for repayment unrelated to the debtor’s actions.