The International Monetary Fund, the fierce advocate of financial orthodoxy on the international scene, appears to have had a change of heart.

A new study by the IMF suggests that capital controls - where countries seek to limit the flow of foreign investment in and out of their borders - may not be such a bad thing after all.

Many countries reverted to such measures during the world financial crisis that swept through Asia, Russia and Latin America between 1997 and 1999.

At the time, the IMF insisted that it would only give economic assistance to countries if they abandoned capital controls and opened their economies to foreign investment.

But now it admits that "where prudential standards are weak, other measures, including capital controls, may prove useful in managing the specific risks associated with international capital flows."

The risks include the rapid withdrawal of funds by short-term foreign investors, leading to a run on the currency of the vulnerable country.

Financial panic

One by one, Asian currencies like the Thai baht, the Philippine peso, and the Indonesian rupiah faced massive devaluation as investor panic spread across the region.

In its study, the IMF concluded that countries using capital controls were unable to fully meet their objectives - reducing pressure for devaluation while also keeping interest rates down.

The IMF admitted that controls could provide a short-term remedy in limiting capital flow where banking supervision was weak.

But it insisted that the capital controls would ultimately fail if not accompanied by economic reform, and that the costs of administering them was high.

Differing effects

The IMF study looked at different types of capital controls employed by a number of countries, including Brazil, Chile, Thailand Malaysia and Spain.

It found that, perhaps ironically, countries with more sophisticated financial systems like Brazil found it more difficult to implement these controls, as the private sector found ways around them.

It admitted that in Malaysia, the comprehensive nature of controls "helped stabilise the exchange rate" while there were no signs of "speculative pressures on the exchange rate despite the marked relaxation of fiscal and monetary policies to support weak economic activity."

"The controls gave the Malaysian authorities some breathing space to deal with the crisis," it concluded.

Malaysia's criticism of international speculators, and its imposition of strict currency controls, was widely attacked at the time.

Long standing controls

The report also concluded that some of the Asian countries who have a long-standing limits on the free movement of capital - notably India and China - fared better than their neighbours in the Asian crisis.

The controls "may have had some effect on reducing the vulnerability of these countries to the effects of recent regional crises," the report said.

But both China and India benefited from some special factors, including strong foreign currency reserves, a smaller banking sector, and a command economy that could enforce controls.

Nevertheless, the report noted that there is increasing avoidance of controls, and a growing administrative burden that could stifle future growth.

Parallel criticism

The new IMF stance, at least from its economists, echoes the criticism made at the time of the crisis by the World Bank's chief economist, Joseph Stiglitz.

Mr Stiglitz, who resigned from his job at the beginning of January, challenged the so-called "Washington consensus" that free trade and open markets were always the best thing for developing countries.

He argued that the cost of adjustment was too often borne by poor people, and that banks and other financial institutions should be required to contribute to IMF restructuring efforts.