A quarterly magazine of the IMF

March 2007, Volume 44, Number 1

From the Editor

Friend of Foe?

Since 1995, global capital flows have tripled to $6.4 trillion—reaching about 14.5 percent of world GDP—after 15 years of staying within a relatively narrow range of 2–6 percent. Should the surge in capital swirling around the globe be cause for joy or alarm? Alarm seemed to dominate in the aftermath of the East Asian financial crisis in the late 1990s. But a major reappraisal is now under way of the costs and benefits of these global flows, especially since many developing countries are grappling with the question of whether they should open up more to these flows or resist them, using capital controls.

This issue of F&D explores the two faces of financial globalization, beginning with an IMF study that suggests that "financial globalization appears to be neither a magic bullet to spur growth, as some proponents would claim, nor an unmanageable risk, as others have sought to portray it." A second IMF study asks if it makes sense (and if it is sustainable) to have the industrial countries running current account deficits while emerging markets, who have less capital, export some of that capital. It suggests that this perverse phenomenon of capital flowing uphill could be because developing countries may not have the capacity to efficiently intermediate the capital and to prevent adverse effects on the tradable sector.

A third IMF study, based on material in the April 2007 Global Financial Stability Report, tries to figure out who's supplying all the global capital. It finds that, with the integration of markets and the involvement of a wider array of participants, financial risk taking has also increased. It warns that it's too soon to conclude that the expansion and deepening of the international investor base is, on balance, stabilizing. A fourth article explains why the IMF is stepping up its own efforts to better analyze the role of financial sectors when it regularly does health checks of its 185 member countries. We also touch base with a policymaker, Governor Reddy of India's central bank, who reflects on his country's experience over the past 15 years with gradually and cautiously opening up its capital account. And for a private sector viewpoint, we turned to Mohamed El-Erian, who manages Harvard University's $29 billion endowment fund.

* * * * *

In "Back to Basics," we take on the debate over whether to rely on market exchange rates or purchasing power parity (PPP) rates when comparing GDP across countries. Using market rates, the United States dwarfs all other countries in terms of contributing to global growth; but using PPP rates, as the IMF's World Economic Outlook does, China grabs the top spot by a long shot. Not surprisingly, this debate on market versus PPP rates is increasingly becoming a political one as well. When PPP rates are used, developing countries generally have relatively bigger economies, as captured by the level of GDPs. Many of them are thus pushing the IMF to use PPP rates for determining quotas and voice—which would give these countries a bigger say in the institution.

Laura Wallace
Editor-in-Chief