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Managing Capital Flows: Search for a Framework

The world has been experiencing global payments imbalances, the sub-prime loan problem in the US, and rising expectations of further monetary easing in the US, all of which can put emerging economies including Asian economies at risk. These economies have received massive private capital inflows while also recording current account surpluses. To moderate currency appreciation pressure, monetary authorities of emerging economies have intervened in the foreign exchange markets. In several economies, official capital outflows—through accumulation of foreign exchange reserves—have been financing the sum of current account surpluses and net private capital inflows. Even so, currencies of many emerging economies have appreciated against the US dollar.

This situation, which has been going on for some time, is expected to continue in the near future. To address this issue, policy makers are implementing or searching for appropriate policy responses. Capital inflows often create problems for recipient economies. They often stimulate too much bank lending, excessive investment and speculative activities, which can lead to goods price inflation, asset market bubbles and potential vulnerabilities in bank balance sheets. Capital inflows can suddenly stop or reverse themselves, leading to a currency crisis, the bursting of asset market bubbles, investment collapse, banking sector and economic difficulties.

The questions that have been raised in the Asian region are: What would be the best policy of an individual economy to deal with large capital inflows? And what regional initiatives can possibly be introduced to best utilize capital inflows while maintaining prudent macroeconomic stability?

This project attempts to provide answers to such questions. More specifically, it aims to develop a policy framework for managing capital flows that can be used as a basis for formulating the following:

  • ADB developing member countries' national policy responses to surges in capital inflows consistent with the goals of macroeconomic and financial-sector stability;
  • Asian regional cooperation initiatives in support of national efforts to manage capital flows; and
  • proposals for strengthening the international financial architecture that can support ADB developing member countries' efforts to manage capital flows.

To best achieve this objective, ADBI has revived the Asian Policy Forum to serve as platform for Asian think tanks to identify and study issues on capital flows and to debate alternative measures for managing such flows. For this project, ASEAN+3 think tanks comprise the core of the study group. International experts who are looking at the issues on capital flows from various perspectives have been invited to this project to enrich the analysis of the issues related to capital flows.

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