Oecd amro s1 14_kobe univ mr takuji kinkyo


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2nd OECD-AMRO Asian Regional Roundtable

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Oecd amro s1 14_kobe univ mr takuji kinkyo

  1. 1. 2nd . OECD-AMRO Joint Asian Regional Roundtable (19 July 2013) 1 Portfolio Investment Flows and Capital Controls Comments for Session 1 Roundtable Discussion Takuji Kinkyo Kobe University The risk of Financial Contagion After the Asian financial crisis of 1997-98, there were two noticeable changes in Asian economies’ exchange rate regimes. These economies did not return to dollar pegs even after the currency market regained stability. Instead, they shifted towards more flexible exchange rate regimes, particularly managed floating. As shown by Kinkyo (2012a), the degree of flexibility in the crisis-hit Asian economies has increased substantially. Although the authorities continue to intervene in foreign exchange markets to prevent large fluctuations and excessive volatility, few have explicit or rigid exchange rate targets. A notable example is China, which maintains a de facto adjustable peg against the US dollar. The increased flexibility in exchange rate regimes has rendered Asian economies less vulnerable to a currency crisis triggered by speculative attacks. In addition, as the proposition of Impossible Trinity suggests, the greater exchange rate flexibility creates more room for monetary policy autonomy despite these Asian economies’ higher degree of integration with global capital market (Kinkyo, 2013). While East Asia’s economic integration has been led by foreign trade and FDI, Asia’s economic integration through intra-regional financial transactions is lagging. However, East Asian equity markets are showing greater integration with global markets, as well as with the region. For example, the estimated conditional correlation of equity returns increased significantly within the ASEAN throughout the 2000s (Kinkyo, 2012b; Kinkyo and Hamori, 2013). There is also a tendency for the levels of correlations to converge among ASEAN countries. Although it is not obvious whether
  2. 2. 2nd . OECD-AMRO Joint Asian Regional Roundtable (19 July 2013) 2 the observed convergence is caused directly by the intra-regional integration or indirectly by the integration with global markets, it is conceivable that both factors have contributed to the convergence. The increased correlation of equity returns indicates that financial shocks can be rapidly transmitted across Asian markets. The risk of financial contagion will be greater if foreign investors fail to differentiate between ASEAN equities and treat them as one asset class due to market imperfections, such as asymmetric information and costly enforcement. A Guideline for Capital Controls There is a growing consensus that some forms of capital controls are effective in maintaining external stability when they are used for prudential purposes. In particular, restrictions on short-term capital inflows can be helpful to reduce the risk of financial contagion. Examples of restrictions on short-term capital inflows are taxes on inflows and unremunerated reserve requirements. These measures were introduced by a number of emerging economies, including Brazil, Chile, Columbia, Russia, and Thailand (Ostry et al, 2011). By contrast, the restrictions on capital outflows tend to be ineffective and even harmful when they are used as a substitute for required policy adjustments, such as fiscal consolidation and monetary tightening. Capital controls can be used as a temporary measure to prevent and mitigate the adverse impact of financial contagion. However, unilateral imposition of such controls could distort cross-border capital flows and exert harmful spill-over effects on financial stability in neighbouring countries. To avoid this, it will be desirable to develop a regional guideline for capital controls. The guideline will help Asian countries to avoid the adverse impact of unilateral actions by outlining prerequisites and procedures for the imposition of macroprudential controls (Kinkyo, 2010). AMRO can play a leading role in developing such a guideline in close collaboration with other relevant international
  3. 3. 2nd . OECD-AMRO Joint Asian Regional Roundtable (19 July 2013) 3 organisations, such as the IMF and OECD. Capital Market Development At the same time, it should be emphasised that capital controls must be used as a short-term measure and should not be an obstacle to the long-term development of domestic capital markets. The empirical evidence indicates that the presence of capital controls could have detrimental effects on financial development in the long-run (Chinn and Ito, 2002). Limited market liquidity is one of the key challenges facing Asian capital markets. Greater foreign participation in domestic capital markets will lead to better price discovery and less price volatility by improving market liquidity and exerting pressures for better corporate governance (Prasad and Rajan, 2008). Deep and liquid capital markets can not only better absorb external shocks, but also serve as a spare tire in the event of severe disruption of the bank financing channel (Felman et al., 2011). In a similar vein, broadening the base of domestic institutional investors, such as pension funds, insurance companies, and mutual funds, is important to improve market liquidity. Although the asset size of domestic institutional investors remains relatively small, there is a substantial scope for increasing the coverage of pension and insurances in most emerging Asian countries. In addition, regulations on the investment of pension funds and insurance companies are generally conservative, limiting the scope for diversifying investment allocations. The government can promote the development of institutional investors by adopting international best practices for these regulations. Remittances For many developing countries, workers’ remittances are becoming a major component of capital inflows and they could significantly impact macroeconomic and
  4. 4. 2nd . OECD-AMRO Joint Asian Regional Roundtable (19 July 2013) 4 financial stability. There is empirical evidence that remittances contribute to economic growth through their positive impact on consumption, savings, or investment. However, a surge in inflows of remittances could have adverse effects on long-term growth by causing Dutch Diseases through the real exchange rate overvaluation and the associated de-industrialisation. It is therefore important to closely monitor the cross-border flows of remittances and assess their impact on macroeconomic balances. However, monitoring the flows of remittances is not straightforward because a substantial part of their funds are often channelled through informal financial systems in developing countries. Such informal financial systems are not under the effective control of financial supervisors in these developing countries. Bearing in mind the growing importance of remittances, Asia’s regional economic surveillance should pay more attention to the economic impact of remittances and promote cooperation to better monitor the intra-regional flows of remittances. References Chinn, M. and Ito, H. (2002) “Capital Account Liberalization, Institutions and Financial Development: Cross Country Evidence,” NBER Working Papers, No. 8967, Cambridge, MA: National Bureau of Economic Research. Felman, J., Gray, S., Goswami, M., Jobst, A., Pradhan, M., Peiris, S., and Senevirante, D. (2011) “ASEAN5 Bond Market Development: Where Does It Stand? Where Is It Going?” IMF Working Paper WP11/137, Washington, DC: International Monetary Fund. Kinkyo, T. (2010) “Policy Reponses,” in Rosefielde, S. Kuboniwa, M. and Mizobata, S. (eds) Two Asias: The Emerging Postcrisis Divide. Singapore: World Scientific Publishing. Kinkyo, T. (2012a) “De Facto Exchange Rate Regimes in Post-Crisis Asia,” Economics Bulletin, 32, pp. 2155-2165. Kinkyo, T. (2012b) “Securities Market Integration in East Asia,” Journal of Economic & Business Administration, 206 (4), pp. 63-78 (in Japanese). Kinkyo, T. (2013) “Coordinating Regional Financial Arrangements with the IMF: Challenges to Asia and Lessons from the EU.” In: Christiansen, T., Kirchner, E., and Murray, P., (eds.) Handbook on EU-Asian Relations. Basingstoke: Palgrave Macmillan. Kinkyo, T. and Hamori, S. (2013) “Exchange rate Flexibility and Securities Market Integration in East Asia,” (unpublished manuscript).
  5. 5. 2nd . OECD-AMRO Joint Asian Regional Roundtable (19 July 2013) 5 Ostry, J.D., A.R. Ghosh, K. Habermeier, L. Laeven, M. Chamon, M.S.Qureshi, and A. Kokenyne (2011) “Managing Capital Inflows: What Tools to Use?” IMF Staff Discussion Note, SDN/11/06, Washington DC: International Monetary Fund. Prasad, E.S. and Rajan, R.G. (2008) “A Pragmatic Approach to Capital Account Liberalization,” Journal of Economic Perspectives, 22, pp.149-172.