The strong increase in net private capital inflows to emerging market economies over the past few years is proving to be a mixed blessing. Although these flows help deliver the economic benefits of increased financial integration, they also create important challenges for policymakers because they can lead to overheating, a loss of competitiveness, and increased vulnerability to crisis, reported the International Monetary Fund.
While a number of studies have examined the policy responses to capital inflows in the 1990s focusing on a limited number of country cases, there have been fewer studies involving recent episodes of capital flows and even fewer attempts to systematically compare how different countries have responded in terms of new policies.
A chapter in the October 2007 World Economic Outlook entitled “Managing Large Capital Inflows“ tries to fill this void by reviewing the experience with large capital inflows over the past two decades in a large number of emerging market and advanced economies. The goal was to describe the various policy responses to these experiences and assess their macroeconomic implications.

Episodes
There have been two great waves of private capital flows to emerging market countries in the past two decades. The first began around the early 1990s and then ended abruptly with the 1997-98 Asian crisis. The recent wave has been building since 2002, but has recently accelerated markedly, with flows in the first half of 2007 already far exceeding the total for 2006.
Both country- and region-specific criteria were used to identify episodes of large net private capital inflows.
An episode was defined as a year or a series of years in which the ratio of net capital inflows to GDP for a particular country not only had to be large in historical terms but also needed to exceed a regional threshold. Using this approach, the IMF identified more than 100 episodes of large net private capital inflows sinceÊ1987.
Policy Responses
The “impossible trinity“ paradigm of open economy macroeconomics--the inability simultaneously to target the exchange rate, run an independent monetary policy, and allow full capital mobility--suggests that, in the absence of direct capital controls, countries facing large capital inflows need to choose between nominal appreciation and inflation.
In practice, however, given that capital mobility is not perfect (even in the absence of direct capital controls), policymakers may have more scope to pursue intermediate options than this paradigm would suggest.
Indeed, the influx of large capital inflows has generally induced policymakers to adopt a variety of measures to prevent overheating and real currency appreciation, and to reduce the economy’s vulnerability to a sharp reversal of the capital inflows. The IMF analysis focused on four policy measures: exchange rate policy, sterilization policy, fiscal policy, and capital controls.

Key Lessons
- Countries with relatively high current account deficits have been more vulnerable to a sharp reversal of capital inflows because they have been particularly affected by increases in aggregate demand and the real appreciation of their currencies.
- Keeping public expenditure growth steady during such episodes can contribute to both a lower real exchange rate appreciation and better GDP growth performance in the wake of inflow episodes.
- Attempts to resist nominal exchange rate appreciation have generally not been successful in preventing real appreciation and have often been followed by sharper reversals of capital inflows, especially when these inflows have persisted for a longer time.
- Whereas capital controls might have a role to play in certain cases, the IMF analysis shows that restrictions on capital inflows have, in general, not facilitated lower real appreciation and a soft landing.
Also, stabilization challenges arising from large capital inflows are most serious for countries with substantial current account imbalances.

Experiences in Amsterdam, Milan and Grenoble illustrated how water management can be more efficient when it is publicly, rather than privately managed.

Water supply could increasingly be managed by private firms once a new European Union treaty enters into force, experts warned.
Delivery of drinking water from the tap is mostly controlled by public utilities in the EU, but fears are being voiced that new policies promoting competition are skewed in favor of giving a greater role to the private sector in this area.
According to AP, under the Lisbon treaty, exclusive power for setting competition rules would be entrusted in the EU as a whole, rather than in member governments. A clause stating that national and local authorities would continue to have wide discretion in providing services of general interest has been included in a protocol attached to the treaty, but not in the main body of its text.
The treaty, signed by EU leaders in December, is largely identical to a proposed EU constitution rejected by French and Dutch voters in 2005. Still described as a constitution by many of its critics, the treaty will come into effect after ratification by all 27 countries in the Union. Ireland is the only country which has given a commitment to hold a referendum on the treaty.
Jan-Erik Gustaffson from the Royal Institute of Technology in Sweden says that there have been several waves of water privatization in Stockholm. These have seen substantial job losses during 2007, when several divisions of the Stockholm Water Company, Sweden’s biggest water utility, were sold off.
Further redundancies and a deterioration in services are feared this year because the company plans to reduce its core business costs by one-fifth.
Gustaffson was a speaker at a January 7 seminar in Brussels, which addressed the extent of water privatization in Europe and how to keep water in public ownership.
Emanuele Lobina from the University of Greenwich in Britain said that experiences in Amsterdam, Milan and Grenoble illustrated how water management can be more efficient when it is publicly, rather than privately managed. Situated in the French Alps, Grenoble is often cited as a case study of how water privatization can go wrong.
Over the past few years, Grenoble has been said to offer the cheapest water of all French cities with more than 100,000 inhabitants. Information campaigns aimed at cutting the amount of water wasted have proven successful, according to some campaigners.
Lobina argued that the public sector has played a key role in ensuring there is virtually universal access to water in the industrialized countries belonging to the Organisation for Economic Cooperation and Development (OECD).
Although he acknowledged that underinvestment and fiscal constraints can present headaches, he suggested that these are not insolvable. “Problems can be addressed and have been addressed,“ he said.
He expressed concern, too, about how the EU’s executive, the European Commission, is pushing principles of competition in a way that public companies are restricted in scope and scale.
The EU law has been used as a pretext to give private firms a greater stake in Scotland’s water services as well.
Despite widespread public opposition to water privatization in Scotland, the authorities have maintained that private funding is needed to provide sewage treatment facilities needed to meet EU standards.

It became clear last year to many Americans that their currency was not as valuable as they once thought.

Analysts think that after a turbulent 2007, the US dollar could be in for a calmer year.
It became clear last year to many Americans that their currency was not as valuable as they once thought. Those on holiday in Europe would have found their trip expensive.
Indian tourist authorities told BBC that they would no longer accept dollars for entrance to the Taj Mahal. The dollar’s slide began last summer when the scale of the crisis in US mortgage industry started to become clear.
Record lows were hit against the euro through the autumn as warnings about a US recession became more frequent and the US Federal Reserve started to cut interest rates. By late November it had fallen to a low of $1.4858 per euro.
Despite regaining some ground in December, the dollar still fell 8 percent against the euro for the year, leaving many wondering whether the greenback could maintain its position as the world’s most important currency.
But now many in the currency markets think the worst might be over.
“A lot of bad news is already priced into the dollar. It’s elsewhere that the shocks could come from, perhaps from the European Central Bank, or the Bank of England,“ says David Bloom, chief currency strategist at HSBC in London.
Bloom expects traders to recognize that the dollar is now relatively cheap. That would prompt a rebound and he thinks the US currency could end the year at $1.35 per euro.
Rabobank’s senior currency strategist, Jeremy Stretch, also thinks that after some early punishment, the US currency could recover by the end of the year. Over the next few months he says it could go as low as $1.50 per euro as traders fret about the US sliding into recession. But by the year end he is predicting the dollar back to around $1.30.
“The euro is heavily overvalued and we’ll find the euro zone economies turning down this year,“ Stretch says.
A reversal of fortune for the dollar will be a relief for companies that export to the United States.
British engineering group Rolls-Royce has experienced similar problems.
Like Airbus, a large amount of its sales are in dollars, but its manufacturing base is in the UK. So the weak dollar hit profits and was partly behind a plan to close a UK-based plant.
But the biggest political trouble last year was caused not by the dollar’s weakness, but by its strength, particularly against the Chinese yuan or renminbi.
US politicians accused China of deliberately keeping its currency weak, which they said gives Chinese manufacturers an unfair advantage and causes job losses in the US.
Repeated trips by US officials to Beijing and loud criticism from Congress only won a modest appreciation in the Chinese currency.

China is threatening to snatch away Taiwan’s last remaining allies in Central America. Costa Rica established diplomatic relations with the People’s Republic of China on June 1, 2007, after more than six decades of ties with Taiwan, which Beijing considers a renegade province, although it has had an independent government since 1949.
The Chinese ambassador to Costa Rica, Wang Xiaoyuan, said that in a meeting last year held in San JosŽ, Honduran President Manuel Zelaya told him that his country’s “relations with China are irreversible,“ including the diplomatic and political spheres as well as trade.
The textile industry in Honduras and Guatemala has attracted private investors from China, but investment in Nicaragua is lower. In Panama, on the other hand, Chinese companies use the Colon Free Zone as a base to re-export their products to other countries. China is also the second largest user of the Panama Canal.
Wang told Ipsnews.net that diplomatic contacts had been established between China and Panama earlier than with Costa Rica, although San JosŽ was the first of the two to formalize relations. Contacts with Panama are being maintained, and hopefully diplomatic ties will be established soon.
In the meantime, China maintains economic and trade representatives in Panama. Costa Rican President Oscar Arias first visited China in 2004, when he was as yet only the National Liberation Party’s presidential candidate.
Bilateral talks led to the Arias administration officially recognizing China last year and simultaneously breaking off relations with Taiwan after 63 years.
China has diplomatic relations with 169 countries while Taiwan is officially recognised by only 24, five of which are in Central America (Guatemala, El Salvador, Honduras, Nicaragua and Panama).
Costa Rica, with a population of 4.4 million, is one of the few countries in the world to have a positive trade balance with China, which has 1.3 billion people. From January to November 2007, bilateral trade stood at 2.6 billion dollars, 24 percent more than for the whole of 2006, when it totaled 2.1 billion dollars.
Of those 2.6 billion dollars, Costa Rican exports made up 2.1 billion dollars, while Chinese sales were worth 500 million dollars. Most of this trade is in high technology goods and services.
Wang said that trade between the two countries is growing. Between January and May 2007, even before diplomatic relations were established, it increased by 60 percent compared to the equivalent period in 2006.
When Arias visited Beijing again in October 2007, a number of economic, trade and cultural agreements were signed. He also invited Chinese President Hu Jintao to Costa Rica, a trip Hu may make this year.
One of the most important agreements was between the China National Petroleum Corporation (CNPC) and the state-owned Costa Rican Petroleum Refinery (RECOPE).
The agreement covers training of Costa Rican personnel in China, renovation of the refinery in Puerto Limon on the Caribbean sea and exploration for oilfields in the Central American country.