Foreign fund inflows can be risky, warns IMF

“The resurgence of capital flows to emerging markets, including several in Asia, is presenting policy challenges,” he said according to the text of a speech to be delivered in Singapore.

The flow of funds to emerging economies was a sign of renewed investor appetite for higher-risk assets as financial conditions normalise after the height of the financial crisis. “While capital inflows are generally beneficial, they can raise risks of rapid and potentially destabilising movements of currencies and asset prices,” Strauss-Kahn said.

Giving this year’s annual lecture at Singapore’s central bank, he said policymakers had a range of tools at their disposal to address the adverse side-effects of such fund flows. “They include exchange rate appreciation, tighter fiscal policy, and, where appropriate, lower interest rates. In addition, macro-prudential instruments can limit the risk of asset price bubbles. Market-based controls on capital inflows can help reduce the volatility of such flows,” he said. He noted that those measures were costly and tended to lose their effectiveness over time.

Strauss-Kahn, in Singapore to attend the Asia Pacific Economic Cooperation meetings, also said Asian currencies should appreciate over time as part of a global economic rebalancing.

“Many Asian currencies are still undervalued related to those of their major trading partners, while the euro is somewhat overvalued on this basis. In my view, the region should not resist a gradual appreciation of its exchange rates, which I consider an important prerequisite for long-term rebalancing.” He reiterated that while the world economy had turned a corner after the crisis, the recovery was still fragile.

“Policymakers should therefore keep supportive measures in place until a recovery is firmly established and conditions for unemployment to recede are in place. In some emerging markets, including a few in Asia, the recovery is further along, and crisis support policies may need to be unwound sooner rather than later.” He noted that regardless of the progress of economic recovery policymakers everywhere should start planning their exit strategies from easy monetary policy now.