Policy responses to the challenges posed by capital inflows in Asia

Speech by Mr Hervé Hannoun, Deputy General Manager of the BIS, to the 42nd SEACEN Governors' Conference, Bangkok, 28 July 2007.

Abstract

Asian central banks have responded to the challenges of increased financial integration by selecting policies that appear to lie between a pure fixed or floating exchange rate. While this can be justified during a transition, an intermediate choice leaves policymakers managing very difficult trade-offs, and may hinder private sector incentives to develop appropriate hedging capacity. In particular, resistance to exchange rate appreciation risks contributing to the build-up of imbalances both at home and abroad.

Three main factors could contribute to greater exchange rate flexibility in the region:

1. the end of the zero or close to zero interest rate policy in Japan, which could counter yen depreciation pressures over the medium term;
2. China's move towards greater exchange rate flexibility, which would facilitate a similar move elsewhere in Asia; and
3. building up the risk management tools required by a flexible exchange rate regime and a high degree of financial openness.