Emerging markets and developing economies (EMDEs) have managed to endure severe external strains, including an abrupt capital flow reversal, during the ongoing Covid-19 crisis, the International Monetary Fund said in a report issued Wednesday by the Independent Evaluation Office (IEO).

The report showed that emerging and developing countries offered aggressive fiscal and monetary support while letting exchange rates bear the brunt of the external adjustment, with limited recourse to foreign exchange intervention or capital flow management measures (CFMs).

“Most EMDEs were able to weather the sharp outflows in March-April 2020 and benefit from recently improved conditions, although the outlook remains highly uncertain,” according to the report.

It also noted that while total flows recovered quickly after the global financial crisis, capital flows to EMDEs in particular have been subject to repeated surges and reversals. Sources of volatility have included shifts in risk appetite and policy expectations in major source countries as well as shifting policies in recipient countries.

Moreover, capital flow dynamics have also been affected by very easy global liquidity conditions, by the increasing importance of portfolio inflows and resident outflows, by the growing role of institutional investors, by rising foreign currency indebtedness, and by the emergence of significant “South-South” flows, particularly out of China, according to the report.

It added that continuing relevance of capital flow volatility was underlined by the dramatic sudden stop in capital flows to EMDEs in March 2020 in the wake of the Covid-19 pandemic.

On the other hand, foreign direct investment (FDI) flows have generally remained less volatile than other flows, though as the composition of FDI shifts, these flows appear to be becoming more volatile, according to the report.

IMF executive directors said in a statement that in light of recent challenges, the IMF’s Institutional View (IV) needs to be revisited for 2021. They underlined that the key principles of the IV remain valid, including the overall presumption that capital flows can bring substantial benefits to recipient countries and that CFMs, while useful in certain circumstances, should not substitute for warranted macroeconomic adjustment.

They added that the IV framework should continue to aim to help countries reap the benefits of capital flows while managing risks to ensure stability.

IMF managing director Kristalina Georgieva said in a statement that the adoption of the IV represented a major advance in the IMF’s policy framework on liberalisation and the management of capital flows.

“Before the adoption of the IV, there was no consistent framework to guide policy advice on these areas. The IV was a major step towards filling the gap existing at the time. It welcomed the economic benefits of capital flows while recognizing the risks associated with capital flow volatility, developed a playbook for safe capital account liberalization, and incorporated capital flow management measures (CFMs) into the policy toolkit. It also noted the importance of international cooperation on capital flow policies in allowing countries to harness the benefits of capital flows safely, while minimising negative spillovers. It was a demonstration of the institution’s flexibility and willingness to embrace theoretical advances and lessons from experience,” according to Georgieva.