Managing Foreign Capital Flows in the Transition Economies of Central and Eastern Europe
Project

Over the recent years, the economies of Eastern and Central Europe faced surges in capital inflows as well as rapid outflows. These inflows and outflows were due to exogenous factors as well as to transition-specific features, slow convergence of inflation and nominal interest rates to international levels, widespread privatization and rapid opening of capital accounts.

Several factors have deepened the difficulties of managing capital inflows for these transition economies as compared to other middle-income economies. The average volume of inflows as well as the gap between the level of inflows and the absorptive capacity of these economies has been large; and inflows coincided with structural changes and institutional deficiencies (weak banking system and poor banking supervision in many economies, low level of capitalization of stock exchanges among others).

The project prepared series of country studies that reviewed and analyzed the experiences of transition economies in managing capital flows; developed policy recommendations; and suggested ideas for frameworks and/or institutions that facilitate stability in capital flows and exchange rates. Countries studied included the Czech Republic , Hungary , Poland , Russia , Croatia , Slovenia , the Baltic's (especially Estonia ), Romania , Slovakia , and Bulgaria . Specifically, the country papers:

• assessed the major structural characteristics of inflows according to the sector and maturity breakdown, as well as of their major types;
• evaluated the macroeconomic consequences of inflows including the impacts on the exchange rate regime, the nominal, real and equilibrium exchange rate levels,.
• examined the impacts of capital inflows on current account and balance-of-payments position of recipient economies; the relative size of tradable and non-tradable sectors; on changes in money demand and money supply, the money and credit multiplier, real and nominal interest rate levels; on inflation and inflation volatility, and on the flow and stock position of the general governments;
• examined in the individual economies the relationship between capital flows and structural factors, including the banking sector, the soundness of capital markets and changes in the capital market and existing regulatory framework;
• evaluated all five major "defence lines" that have been used in managing inflows, i.e., (i) administrative regulations reducing the gross inflow of foreign capital, (ii) measures that weaken net capital inflows (including import liberalization, increase in the current account deficit and liberalization of capital outflows), (iii) exchange rate and associated sterilization policies, (iv) macroeconomic adjustment driven by fiscal consolidation, and (v) changes in the regulation and supervision of the financial sector;
• evaluated the specific macroeconomic, structural and institutional aspects of capital flows management including their relationship with fiscal adjustment, exchange rate policies, monetary regime and other issues;
• analysed the role of the banking sector (privatization and regulation) and the capital market (regulation and privatization) in determining the structure and consequences of inflows;
• assessed the policy response of several economies to macroeconomic and exogenous factors that led to significant—albeit short-term—reversal of capital flows (either within a currency crisis or outside it).

A comparative evaluation of adopted policies served as a guide to the most appropriate and efficient policies in the future both in terms of the transitory and long-lasting macroeconomic consequences. The country papers were prepared in a relatively similar structure focusing at the aforementioned issues, while the analytical papers tried to determine region wide trends.