In recent decades, there has been a gradual trend toward liberalisation of capital flows, both inward and outward, among member countries. The trend has been particularly pronounced in emerging Europe, although systemically important emerging economies (including, for example, China and India) have also announced plans for further liberalisation. The pace of liberalisation moderated slightly in the wake of the global crisis, but the general trend across the world remains one of increasing openness to cross-border capital flows. Where authorities have intervened to influence capital flows, they have generally done so not by re-regulating permanently significant parts of the capital account but by targeting temporarily specific types of flows.
It is recognised that CFMs can impose costs on the economy. They can reduce discipline in financial markets and public finances, tighten financing constraints by restricting the availability of foreign capital, and limit residents’ options for diversifying their assets. They can also be costly to monitor and enforce, promote rent-seeking behaviour and corruption, and facilitate repression of the financial sector, impeding financial development and distorting the allocation of capital.
The move toward liberalisation reflects countries’ recognition of the benefits of capital flows under the right conditions. At a microeconomic level, capital flows can enhance the efficiency of resource allocation and the competitiveness of the domestic financial sector. Moreover, as countries develop they require more advanced financial systems, which often go hand in hand with greater cross-border capital flows. In addition, capital flows can facilitate the transfer of technology and management practices, particularly through foreign direct investment (FDI). Capital flow liberalisation can have indirect or collateral benefits for intermediate objectives, such as financial sector development, macroeconomic policy discipline, trade, and economic efficiency. At a macroeconomic level, capital flows enable countries to fund welfare-enhancing current account imbalances. Moreover, they can enable beneficial portfolio diversification. The empirical relationship between capital flows and growth is well documented for FDI and other non-debt flows, including for low-income countries, but it is less clear cut for debt-creating flows.
Well-designed capital flow liberalisation can help countries realise the benefits of capital flows, forgo the costs of CFMs, and support key economic objectives. At the same time, some countries have sustained rapid growth rates notwithstanding relatively closed capital accounts, with China and India being notable examples. Capital flows have, nonetheless, played a role in growth in some cases; in China, for example, large inward FDI flows over