Hoping to learn from the past and devise more effective tools for the future, a High-Level Seminar on Crisis Prevention in Emerging Markets in Singapore on July 10–11 focused on four key issues: the genesis of capital account crises; effective macroeconomic management in countries with open capital accounts; options for country self-insurance and regional reserve pooling; and the Fund’s proposed contingent financing instrument. The seminar—jointly organized by the IMF Institute, the IMF’s Policy Development and Review Department, and the Government of Singapore—drew officials from about 40 emerging market countries as well as participants from the private sector.
Genesis of capital account crises
Countries become vulnerable to capital account crises when they have mismatches on their private or public sector balance sheets—for example, between assets and liabilities in terms of their maturities or currencies of denomination. A crisis, however, usually also requires a specific trigger, either external—contagion, a terms of trade shock, a deterioration in market conditions—or domestic, such as macroeconomic policies that damage investor confidence.
Emerging market countries should seek to minimize balance sheet vulnerabilities and avoid conditions that might trigger a crisis. To minimize balance sheet vulnerabilities, countries should ensure adequate prudential regulation and supervision of the financial system and take precautions to avoid the kind of “one-way” bets on fixed exchange rates that can cause private balance sheet exposures. Countries should also fortify themselves against crises by pursuing sound macroeconomic policies and adhering to internationally accepted transparency and financial sector standards and codes.
Macromanagement with open capital accounts
While participants agreed that implicit guarantees by the government might encourage risky currency exposures in private sector balance sheets, there was less consensus on the appropriate exchange rate policy. Views split roughly along regional lines. Participants from Latin America and Central Europe advocated flexible exchange rates with inflation targeting frameworks for monetary policy. Policymakers from Baltic countries argued in favor of a pegged exchange rate regime as long as it could be supported by a credible exit strategy (in their case, the eventual adoption of the euro), full financial market integration, and a flexible labor market. The dominant view among Asian policymakers, however, favored an intermediate regime, with discretionary interventions in exchange rate markets.
Also useful, participants concurred, were sound macroeconomic policies, including fiscal cushions; adequate international reserves; and adherence to transparency standards and codes to minimize the likelihood of contagion triggering a crisis. The quality of institutions plays a vital role, too, as this reinforces credibility and thus offers room for countercyclical macroeconomic policies.
Reserves, self-insurance, and regional pooling
Participants agreed that reserves can play an important role in preventing crises—and that they should be sufficient to cover at least debt payments due within a year. There was less clarity, however, on when the benefits of further reserve accumulation outweigh the costs. Most participants acknowledged that in a few Asian countries reserve accumulation may have gone well beyond prudential requirements.
One alternative—a regional pooling of reserves such as the Chiang Mai Initiative—was viewed as a potentially useful source of support. However, given limited regional diversification possibilities, regional pools were seen at best as a complement to, rather than a substitute for, support from the IMF. Also discussed was the possibility that governments could contract with the private sector, which would provide contingent credit lines with guaranteed drawing rights at a predetermined spread. Generally, participants believed such instruments would entail a substantial insurance premium and be prohibitively expensive. In this regard, any feasible contingent arrangement would have to include covenants, such as prequalifying criteria and activation clauses.
The IMF’s proposed new instrument
The Fund’s proposed contingent financing instrument generated considerable interest. As the IMF’s Deputy Managing Director Takatoshi Kato explained, several emerging market member countries have asked the Fund to create a financial instrument that meets their need for predictability and flexibility. The proposed new instrument would, he said, be a “high-access line of credit to emerging markets that have strong macroeconomic policies but which remain vulnerable to shocks.” It would provide a liquidity cushion and help countries avoid crises and respond to those that do occur.
Both officials and private sector participants argued that such an instrument would need to provide significant access up-front in the event of market turbulence. They also stressed the need for automaticity for suitably qualified countries, while recognizing that very large access could engender moral hazard.
Bikas Joshi and Miguel Messmacher
IMF Policy Development and Review Department and IMF Institute