Earlier this week, Brazil announced it would place a tax of 2% on money entering the country to invest in shares and fixed income instruments (FDI is excluded from the measure). Brazilian authorities were responding to a wave of capital inflows that has driven up the real and created worries about macroeconomic stability.
No, the other Brazilan real. (Photo by Flickr user xn44.)
Predictably, news of the tax was met with a fair amount of scepticism in the financial press. But there has also been a degree of understanding, including an editorial in yesterday's FT which went so far as to describe the move as a 'good choice'. I wonder whether Brazil's move is a sign of things to come.
Before the onset of the GFC, emerging markets had been facing their second great wave of private capital inflows in two decades. As risk appetite adjusts in the aftermath of the crisis, those inflows are resuming. With interest rates in the major developed economies expected to remain low for some time and growth prospects similarly depressed, there is a good chance that net capital flows to emerging markets will be ramped up even more than in the pre-GFC environment.
The resultant wall of capital would pose a major policy challenge for emerging markets, which will want to avoid the destabilising sequence of crises associated with the big wave of private capital inflows in the 1990s.
That 1990s experience, the resilience of countries like China and India that took a relatively cautious stance towards capital account liberalisation, plus recent empirical work questioning the impact of capital flows on developing country growth, all mean that policymakers in emerging markets are likely to be more sceptical about the benefits of very large capital inflows, more aware of the risks, and hence more willing to turn to the kind of policy measures just adopted by Brazil.
Source: The Paradox of Capital.
Finally, there is a consensus that a major impact of the GFC has been a rebalancing of economic power from the developed world toward the major emerging markets, with the rise of the G-20 the institutional counterpart of this shift. As these emerging markets become bigger players in the world economy, inevitably they will have more influence over the prevailing international policy settings.
Given that views in Beijing, New Delhi and Brasilia on the merits of open capital accounts and the free flow of international capital have been quite different from those held by Washington over the past two decades, an important question for the world economy is, will the rise of these new economic powers trigger a significant shift in the international financial environment, or will the new powers end up adopting the same views as the old order?