Major advanced economies have taken policy measures to strengthen the resilience of the financial system since the 2008 global financial crisis. On that basis, the G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences was established in 2011, followed by discussions among policy circles including the OECD and IMF. Emerging economies have also taken various policy measures to manage systemic risks associated with cross-border capital flows. In 2010, the Korean government and central bank announced foreign exchange-related macroprudential measures (MPMs) aimed at building resilience against external financial shocks. These measures have greatly contributed to limiting systemic risk by curbing excessive capital inflows. Twelve years have passed since the global financial crisis started, and ten years after the introduction of FX-related macroprudential policy measures in Korea. It is now an opportune time to check the performance and effectiveness of these policies. Given the newly heightened risky environment, it is urgent to discuss how to improve macroprudential measures in response to emerging external risks.
Chapter 2 reviews trends in macroprudential policies from a global perspective, and approaches by several international organizations to cross-border capital flow management measures. The IMF and OECD take different approaches to capital flow management measures to mitigate volatility in capital flows in emerging counties. Such conflicting signals from the OECD and IMF regarding those macroprudential measures make it difficult for emerging counties to implement tools relevant for themselves. Cooperation between the IMF and OECD is essential to enhance the consistency between the IMF’s institutional view and OECD approaches for the management of capital flows.
Chapter 3 analyzes the determinants of macroprudential policy measures in the external sectors and examines the empirical effects of these measures. As determinants of capital flows, pull factors (private credit, foreign exchange reserves, and economic size) as well as push factors (the VIX index) were significantly associated with cross-border capital flows. An analysis reveals that reinforcement of capital inflow regulations and deregulation of capital outflows were significantly related with a depreciation of domestic currency. We also find that the strengthening regulations on capital inflows had a large effect on scaling down capital inflows, and deregulation on capital outflows also lowered the accumulation of net capital inflows. Further analysis also reveals that deregulation of capital outflows is significantly associated with lower volatility of portfolio investment.
In Chapter 4, we check the performance and effectiveness of FX-related macroprudential measures in Korea. In 2010, Korea’s authorities introduced three-pronged macroprudential policies ‒ a regulation on the ratio of FX derivatives position, an FX stability levy, and a tax on bond investment by foreigners ‒ in order to mitigate volatility from capital flows. These measures are considered to have contributed greatly to easing vulnerabilities in the FX sector through curtailment of external debt in the banking sector and improvements in maturity structures. In particular, the short-term portion out of total external debt in foreign bank branches has declined greatly. In March 2020, the authorities relaxed FX macroprudential regulations in a flexible manner to cope with external shocks triggered by the Covid-19 pandemic.
In Chapter 5, we make an effort to identify new types of risks unanticipated by policy authorities and to recognize thin markets usually ignored due to their relatively small business sizes. The Covid-19 pandemic led to globally tighter US dollar funding conditions as the US dollar money market became severely strained. Under these circumstances, it also tightened the local financial conditions in Korea, which remain heavily exposed to US dollar funding risks.
Finally, based on the analysis outcome, we suggest the following policy implications. Korea’s FX-related macroprudential policies greatly contributed to stabilizing systemic risk by curbing excessive capital inflows to Korea since its 2010 introduction of macroprudential measures. However, it is necessary to note that financial stability is threatened by potential risks not comparable with risks in the past. In particular, the global financial market is now grappling with difficulties in funding the US dollar. This indicates that the Korean authorities should strengthen monitoring of changing trends in the international financial market, while prioritizing to secure enough US dollar liquidity during a crisis. As a result, it is critical to sustain a resilient framework for curbing excessive capital inflow, but to respond with caution to the trend of decreasing capital inflow. In this regard the current macroprudential system in the external sector – introduced to mainly curb excessive capital inflow – should be overhauled.