Managing International Capital Flows after the Global Financial Crisis Chin-Long Yang Deputy Governor Central Bank of the Republic of China ( Taiwan )

Managing International Capital Flows after the Global Financial Crisis

Chin-Long Yang

Deputy Governor

Central Bank of the Republic of China ( Taiwan )

June 29, 2010

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Financial Account Liberalization

International Capital Flows and Financial Crisis

Macro-prudential Policy for Central Banks

Capital Controls: No Longer Unthinkable

Taiwan’s Experience in Managing Capital Flows

Regional Financial Cooperation

Conclusion: Reforming the International Financial System

Outline

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Liberalization of financial account accompanied by increase in FX transactions

2007 BIS Triennial Survey Global foreign exchange turnover: US$750 trillion

Global trade volume: US$30 trillion

Exchange rate movements can no longer be explained by trade or economic fundamentals

Exchange rates mainly determined by short-term capital flows

Financial Account Liberalization (1)

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Financial Account Liberalization (2)

Short-term capital flows:

1. Highly volatile

2. Heavily influenced by exchange rate expectations and interest rate differentials

3. Amplify market volatility

4. Undermine financial stability and economic development

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International Capital Flows and Financial Crisis (1)

Surging capital inflows:

1. Overheat the economy

2. Speed up growth of bank credit and money supply

3. Create speculative bubbles in stock markets and the real estate sector

Once the bubbles burst, sudden financial reversals result in a breakdown in the financial system.

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International Capital Flows and Financial Crisis (2)

1997~1998 Asian Financial Crisis:Contagion effect from Thailand to South Korea

2008~2009 Global Financial Crisis:Collapses of Bear Stearns and Lehman Brothers sent shock waves across regions.

European Sovereign Debt Crisis:Capital flight from Europe to the U.S. and Asia, casting a dark shadow over the outlook of global economic growth

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Macro-prudential Policy for Central Banks (1)

Financial stability as important as price stability

Overlooked for years by advanced countries

Massive capital flows cause financial and economic instability

Macro-prudential policy can mitigate systemic risks

China, Hong Kong, South Korea, Singapore, and Taiwan have all announced a variety of targeted prudential measures to curb real estate speculation.

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Macro-prudential Policy for Central Banks (2)

Implementation of monetary policy:

1. Open market operations

2. Required reserve ratios

3. Rediscount policy

4. Selective credit management

Greater exchange rate flexibility:

1. Nominal exchange rate should remain flexible.

2. Real exchange rate should reflect economic fundamentals.

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Setting up an effective monitoring system for foreign exchange transactions

Maintaining an appropriate level of foreign exchange reserves

Having the authority to conduct financial examinations

Macro-prudential Policy for Central Banks (3)

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Capital Controls: No Longer Unthinkable (1)

IMF managing director Strauss-Kahn “The IMF is not in principle opposed to

emerging markets using capital controls.”

UNCTAD “… different types of capital flows can be

limited effectively by a variety of instruments.”

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ADB President Kuroda “Some sort of managed flow with regional coo

peration would be the best for Asia.”

Nobel laureate Joseph Stiglitz A country does not “build robust growth base

d on easy money” and “It's worth it for the money to come in only if it improves the productivity of the economy.”

Capital Controls: No Longer Unthinkable (2)

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10/20/2009 Brazil: 2% tax on foreign investment in local

bonds and stocks

6/13/2010South Korea: ceilings on foreign exchange derivatives positions Domestic banks: 50% of capitalForeign bank branches: 250% of capital

Capital Controls: No Longer Unthinkable (3)

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Capital Controls: No Longer Unthinkable (4)

6/16/2010Indonesia:

1. Abolish banks’ On Balance Sheet net open positions (NOPs) limit of maximum 20% of capital, maintain Overall NOPs at 20% of capital

2. Widen the overnight inter-bank rate corridor 3. Impose a minimum one-month holding perio

d for Bank Indonesia Certificates (SBI)

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1. Article 2

Four operational objectives:

1) Promote financial stability

2) Guide sound banking operations

3) Maintain the stability of internal and external value of the currency

4) Foster economic development, within the scope of the above objectives

Taiwan’s Experience in Managing Capital Flows (1)

Price and Financial Stability: Taiwan’s Central Bank Act

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2. Articles 19 to 31 list a variety of monetary policy instruments, including targeted prudential measures listed in Articles 28, 29, and 31.

3. Article 34 authorizes the CBC to maintain an orderly foreign exchange market.

4. Article 38 authorizes the CBC to conduct target financial examinations.

These instruments are essential for the CBC to maintain financial stability.

Taiwan’s Experience in Managing Capital Flows (2)

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Capital Flows Management

1. Taiwan’s stock market: 30% foreign ownership

2. Total FINIs: over 10,000

3. Active FINIs: around 6,000

4. Around 20 are responsible for over 40% of all FX transactions by FINIs

5. FINIs FX trading frequently disrupts Taiwan’s FX market

Taiwan’s Experience in Managing Capital Flows (3)

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6. FINIs more interested in currency speculation than securities investment?

7. CBC measures to curb FINIs currency speculation:

1) Foreign investors urged to deploy funds in a manner consistent with the declared purpose of securities investment

2) A reporting system to track large FX transactions and monitor international capital flows

Taiwan’s Experience in Managing Capital Flows (4)

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In a speech to the 2010 ADB annual meeting our governor Mr. Perng pointed out:

“Besides efforts by individual countries, it is even more important to elevate the issue of managing international capital flows to the regional level.”

“If Asian countries can take concerted and coordinated actions, it will help promote regional financial stability.”

Regional Financial Cooperation Governor Perng’s Viewpoints (1)

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On financial support facility:

1. Multilateral swap arrangement across Asia with ADB as intermediary is best way forward.

2. Loan arrangements between ADB and members with high foreign exchange reserves as additional source of funding

Regional Financial Cooperation Governor Perng’s Viewpoints (2)

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On regional exchange rate coordination mechanism:

1. Stable exchange rates lower transaction costs, reduce uncertainty, and boost intra-regional trade and investment.

2. Suggestion to set up formal regional exchange-rate coordination mechanism so stable currency relationships can be established

Regional Financial Cooperation Governor Perng’s Viewpoints (3)

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Conclusion: Reforming the International

Financial System (1)

In addition to managing international capital flows we should:

1. Overhaul international financial regulatory and surveillance frameworks

2. Combine micro- and macro-prudential policies effectively

3. Reform the international monetary system

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G20 Toronto Summit Declaration released on June 27, 2010 also:

1. Outlined the steps to reform and strengthen financial systems

2. Stated G20 have already strengthened the global financial system by

fortifying prudential oversight, improving risk management, promoting transparency, and reinforcing international cooperation

Conclusion: Reforming the International Financial System (2)

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Conclusion: Reforming the International

Financial System (3)

4) transparent international assessment and peer review

3. Outlined the 4 Pillars for reform：

2) more effective supervision that includes new and stronger rules that are complemented with more effective oversight and supervision

3) designing and implementing a system in which all financial institutions can be restructured or resolved in crisis without tax payers’ money

1) stronger regulatory framework based on the work undertaken by the Basel Committee on Banking Supervision to build a new global regime for bank capital and liquidity

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Conclusion: Reforming the International

Financial System (4)

Moreover, the G20 are committed to

1. Strengthening the legitimacy, credibility, and effectiveness of the IFIs,

2. Ensuring the ratification of the 2008 IMF Quota and Voice Reforms and expansion of the New Arrangements to Borrow, and

3. Preparing policy options to strengthen global financial safety nets.

The goal is to build a more stable and resilient international monetary system.

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Conclusion: Reforming the International

Financial System (5)

Working together towards

financial stability & sustainable economic growth

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Thank You