Introduction

The global financial instability that was spawned by the 1997 East Asian financial crisis generated a broad consensus that the international financial architecture (IFA) had to be reformed. The proposed reforms had two wide-ranging objectives (Griffith-Jones and Ocampo, 2003): (i) to prevent currency and banking crises and better manage them when they occur; and (ii) to support adequate provision of net private and public flows to developing countries, particularly low-income ones. Much progress has been made in terms of reforming the IFA during the past ten years. However, the progress has been uneven and asymmetric and in certain areas patchy (Griffith-Jones and Ocampo, 2003; Wang, 2004; Kawai, 2005; World Bank, 2005; and Kawai and Houser, 2007).

For example, there have been many advances in terms of regional financial and monetary cooperation in East Asia. Just last 5 May 2007, the ASEAN+3 nations agreed to pool the region’s vast foreign currency reserves. However, the urgency of architectural reform in the G-7 countries has receded considerably (Wang, 2004). This was echoed by Sakakibara (2003) when he argued that the lack of global governance, including a global lender of last resort and international financial regulation, is not likely to be remedied anytime soon. As long as the structural problems on the supply side of international capital such as volatile capital movements and G-3 exchange rate gyrations persist, the East Asian countries will remain as vulnerable to future crises.

There are many indications of the inadequacies in the reform of the IFA. For example, Table 1 [ PDF 40.5KB | 1 page ] shows that in 2006 aggregate net resource flows into developing countries reached $566 billion, the bulk of which comprised foreign direct investment (FDI) and portfolio equity. This $94 billion in “hot money” that poured into developing countries in 2006 is three times the peak reached in 1997. The development is largely brought about by a situation of excess global liquidity, which in turn is related to the problem of global macroeconomic imbalances. With the abundance of global liquidity, investors are lured into emerging markets which offer higher returns. The resulting inflow of capital has created “important challenges for policymakers because of their potential to generate overheating, loss of competitiveness, and increased vulnerability to crisis” (IMF, 2007a).

The macroeconomic difficulties spawned by the surge in capital inflows have elicited various policy responses (IMF, 2007a):

“Whereas some countries have let exchange rates move upward, in many cases the monetary authorities have intervened heavily in foreign exchange markets to resist heavy currency appreciation. To varying degrees, they have sought to neutralize the monetary impact of intervention through sterilization, with a view to forestalling an excessively rapid expansion of domestic demand. Controls on capital inflows have been introduced or tightened, and controls on outflows eased, to relieve upward pressure on exchange rates. Fiscal policies have also responded—in some cases, stronger revenue growth from buoyant activity has been harnessed to achieve better fiscal outcomes, although in many countries rising revenues have led to higher government spending.”

The chart in Figure 1 [ PDF 223.2KB | 3 page ] shows that recently real effective exchange rates in four of the five countries hardest hit by the 1997 crisis are generally following the same pattern observed prior to July 1997.¹ Meanwhile, many economies in emerging East Asia are accumulating reserves beyond the optimal level, either to self-insure against financial crises or to prevent nominal and/or real appreciation of their currencies in the face of increasing capital flows (see Figure 2 [ PDF 49.4KB | 1 page ]). The stock of foreign exchange reserves in these economies rose from an average of $289.5 billion in 1990–95 to $2.1 trillion at the end of 2006.

In this paper, the experience of the Philippines with regard to managing capital inflows— or more generally foreign exchange inflows—from 1987–2007 is reviewed, with focus on the post–1997 period since earlier work (Lamberte, 1995) has adequately analyzed the experienced prior to the crisis. The impact of foreign exchange inflows will be analyzed and the policy responses, particularly those initiated by the BSP will be evaluated. The findings of this paper will be input into a cross-country study of managing capital flows in Asia.

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