Bandid Nijathaworn: The role of Early Warning Systems in economic
policy formulation
Speech by Mr Bandid Nijathaworn, Deputy Governor of the Bank of Thailand, at the panel
discussion on "The Role of Early Warning Systems in Economic Policy Formulation", IMF
High-level seminar "Early Warning Systems and Their Role in Surveillance", Singapore,
9 February 2010.
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First, let me thank the IMF for the invitation. At first, when I was asked to speak on this panel,
I was not sure why the Fund is organizing a high-level seminar in Asia on Early Warning
Systems, as interest on the topic seems to have faded completely with the recovery of the
Asian economies from the crisis in early 2000's. Then, it becomes clear that the resurgence
of interest on EWS, now called EWE or Early Warning Exercises, is very much the mandate
of the G20 that requires the IMF and the FSB to lead the conduct of such exercises in
response to the current crisis. Given the severity of the current crisis, I think this initiative is
important and needs to be supported.
For this afternoon, I want to make three observations on how the new Early Warning
Exercises can be made most useful to help sustain global growth and maintain financial
stability, especially in light of the lessons learned from the current and past crises. My
observations will be on: (1) the nature of future crises; (2) their implications for the role and
the conduct of EWE going forward; and (3) some suggestions on what should constitute the
important components of the EWE process.
First, on the nature of future crises. One criticism we often hear about EWS in the past is that
the system is often good in replicating the last crisis but is less useful in anticipating future
crises. This point I believe has been echoed also in today's seminar. A key reason for this is
the way the EWS models have been calibrated to fit the explanation for the last crisis, and
hence, becomes less useful for anticipating future crises when circumstances or the risk
factor change. Similarly, lessons learned from the previous crisis tend to over-prepare
policymakers for a repeat of a similar crisis, thereby leaving them vulnerable to the new
cause of the next crisis. Therefore, for EWE to be useful, it must have the ability to anticipate
the nature of future crises with certain accuracy. This, of course, is going to be a demanding
task, but it is this quality that the EWE process needs to have. This is because without
certain degree of accuracy, it will be difficult to persuade policymakers to collectively become
engaged in addressing certain risk and vulnerabilities.
In my view, the task could be easier achieved if the focus of EWE is narrowed down to the
really important systemic issues i.e, the issues that have high-global impact but are beyond
the capabilities of market and individual economies to monitor and make assessment. For
example, instead of trying to spot vulnerabilities in all the possible key risk, in all markets,
and in all economies, EWE should narrow its focus instead on the systemically-important
issues, especially the known-unknowns. This include the robustness of the key global
financial markets and infrastructure, risk relating to the systemically-important large
economies and the operations of the internationally-important financial institutions. Such
focus will make the whole EWE process more valuable and complements well with the
surveillance that are done elsewhere at the country or regional level.
With regards to the nature of future crises, a few realities have emerged from the current
global financial turmoil.
First, it is clear from recent experience that nobody is above crisis. Crisis can happen in any
economy regardless of whether it is large or small, developed or emerging, with or without a
sophisticated financial system, and regardless of whether the country adopts a fixed or
flexible exchange rate system. And once happens, the impact is large because of the
globalized nature of markets that drives the spillover or contagion. For emerging markets,
this means the risk of future crises are wide-ranging and can be both externally and internally
induced. And as we have seen in the current crisis, the impact from an externally-induced
crisis through contagion can be as large as an internally-induced or home-grown crisis.
Second, given the tendency that lessons from past crises will encourage policymakers to
adopt more cautious policy and reform, this change in the policy conduct will help reduce the
likelihood of an internally-induced crisis based on policy weakness, domestic misalignment,
and moral hazard. Instead, the nature of future crises will relate more to the
externallyinduced factors.
Third, features of the externally-induced crises will mirror a fundamental shift from crises
based on macro-misalignment in the individual economies to crises based on failures of key
markets, system, and institutions, that are systemically important and have a global-wide
impact because of the underlying interconnectedness. The issues of trust, robustness of
markets and financial infrastructure, counterparty-risk, information gap, as well as, liquidity
will become important possible triggers of the future market disruptions. In addition,
geopolitical events or trade tension can also lead to disruptions in global liquidity and trigger
a global-wide impact.
The main message here is that, going forward, future crises will be different. They will relate
less to misalignment in the individual economies because of better policy and regulation, but
will relate more to the resiliency of the global system, market and institutions, as well as the
ability of the policymakers to prevent or address the vulnerabilities beforehand.
Forth, for emerging markets, the most threatening externally-induced crises going forward
will be those that relate to the concentration of global liquidity, either too much or too little, in
the form of large, persistent, and volatile capital flows that overwhelm the capacities of
individual countries to manage and adjust to. And the most worrying aspect of this is that the
trigger would lie outside the controls of emerging market's policymakers since the flows
would be the results of market conditions and policy prescription elsewhere.
Let me now turn to my second observation on the implications that the changing nature of
future crises can have for the conduct of EWE going forward. On this, I have four points to
make.
First, in view of the changing nature of future crises, it is therefore important that the thrust of
the EWE is mindful of this possibility. In my view, the focus of EWE should expand beyond
macro-misalignments based on historical relationships to include assessing the robustness
and the resiliency of the systemically-important markets, system, and institutions. This
means the key objective of EWE will not be to forecast future crises per se, but to identify
vulnerabilities in the most important areas in advance, especially those risks that are not
covered by market data or by the surveillance process elsewhere.
Second, for EWE to be effective and comprehensive, it should be done at two levels to cover
both the global dimension and the country-specific dimension of risk. The global dimension
must be the responsibilities of the IMF and the FSB given their comparative advantage as
international organization. And as I already noted, EWE by the IMF and the FSB should
focus on monitoring the development of risk in the key global financial markets, risk linked to
activities of the internationally-important financial institutions, and the economic conditions
and policies of the systemically-important economies. These are the areas of risk that have
global-wide implications but are not being monitored sufficiently relative to their importance.
Third, the focus of the EWE at the country-level also needs to expand beyond detecting and
avoiding local macro-misalignments, and to include assessment of the resiliency and
robustness of the domestic economy and financial system to withstand large external
shocks. The key point here is that, even with good policies, crisis can happen to an economy
if the externally-induced factors overwhelm the abilities and the robustness of the domestic
economy to cope with.
And forth, the value of early warning is that warning leads to the needed actions being taken
in advance. This means the EWE process should serve to facilitate actions to deal with the
important risk and issues by the relevant parties. To serve this end, credibility and
effectiveness of the EWE depends on appropriate degree of transparency of the structural
models and its appropriateness to the context, whether national or markets, as much as its
track record.
In closing, let me summarize my points in the form of suggestions for the current efforts on
the EWE.
First, the focus of EWE should expand beyond detecting misalignments to include assessing
vulnerabilities and robustness of the global markets, system, and institutions.
Second, EWE should be a two-level process. The global level process focuses on the
systemically important markets, institutions, and economies. At this level, the FSB can play a
role in ensuring consistent implementation of regulatory standards, as well as undertaking
stress-testing to check the robustness and the resilience of the key markets, institutions, and
system. Likewise, EWE at the country-level, which can be a part of the normal article IV
cycle, should have an additional focus on stress-testing the resiliency of the economy and
domestic financial system to large external shocks. The shock scenario can be a common
set of assumptions provided by the IMF for all countries and draws on EWE findings at the
global level. This will provide a good connection between the perceived global systemic risk
and the abilities of the individual economies to handle them.
Lastly, EWE must be part of a global policy process, in that information of EWE must be
used and if needed leads to timely policy action. On this note, increased transparency of the
process, as well as its recommendations, can be a way of allowing market to have a view
and force the issue.
I hope this has been useful. Let me stop here and again I want to thank the IMF for the
invitation. Thank you.