Pongpen Ruengvirayudh: Managing currency stability
Speech by Ms Pongpen Ruengvirayudh, Deputy Governor for Monetary Stability of the Bank
of Thailand, at the SCB Collaboration with Myanmar Banks Dinner Talk, Yangon, 13 August
2015.
* * *
Good evening,
Excellencies, Governor of the Central Bank of Myanmar,
Distinguished guests, Ladies and Gentlemen,
I would like to thank the Siam Commercial Bank for inviting me to give a keynote speech on
this occasion. Myanmar and Thailand have a long-standing cultural and economic
relationship, particularly in trade and investment. This auspicious event marks yet another
crucial step forward in promoting Myanmar-Thailand friendship, especially through financial
and banking system. It is my hope that our two nations will continue to mutually benefit from
their strong economic bind for many generations to come.
Living in a more volatile and interconnected world
Ladies and Gentlemen,
One of the most important trends over the past decades is the rapid integration of
international finance. From the perspective of our ASEAN economies, we have also gone
through both regional and global interconnectedness. This is especially apparent for
Myanmar, whose pace of integration is among the fastest, with ongoing liberalization on
many fronts. Myanmar is thus becoming one of the attractive destinations for foreign
investments.
This configuration of financial integration is a double-edged sword. On the one hand, it
helps distribute and diversify risk, raising economic efficiency and strengthening system
stability. On the other hand, tighter financial linkages imply large and swift transmission of
shocks across countries, particularly through a large expansion in gross capital flows with an
increased volatility of those flows and exchange rates. The challenges we face in Thailand to
large extent also apply to emerging markets as a group. The massive equities and bonds
sell-offs in emerging markets during the taper tantrum episode in 2013 were vivid examples
of "financial spillovers". There is no doubt that the benefits of integration into global economic
and financial markets outweigh their costs. Therefore, the relevant question is thus how
countries should respond to increased capital flows volatility.
This year, we gather here at an important juncture of what seems to be yet another
shift in global economic and financial landscape. This may create a challenging
environment for small open economies to conduct policy, particularly capital flows and
exchange rate policy. Given recent economic and financial development, it is clear that
the main drivers of ensuing volatility in capital flows and exchange rates are threefold.
First, policy divergences among advanced economies appear to be on course recently.
While the US is expected to raise its policy rate, likely by the end of this year, recovery of the
euro area economies and Japan remains unsteady, with ultra-loose monetary policies put in
place for a longer period. Second, uncertainties surrounding Greece's bailout program have
rendered great shifts in market players' risk on and off sentiments. Third, growth momentum
and prospects in China and some other emerging markets are deteriorating. These changing
global dynamics, interacting with market's reactions to potential US rate hike, may cause
volatile ups and downs of financial markets.
I will not discuss these at length. Rather, at this juncture, the key question is how to
design or adjust policy frameworks to cope better with these financial spillovers while
preserving monetary policy independence. Undoubtedly, there is no single recipe that fits
all central banks. Thus the aim of my talk is to offer a central bank's overall perspectives and
Thailand's experiences on policy framework in managing capital flow and exchange rate
stability. I will also touch on some beneficial policy cooperation among regional countries.
A brief background of Thailand's monetary policy framework
Let's begin with a broad perspective of Thailand's monetary policy framework. The Bank of
Thailand (BOT) has been conducting monetary policy under "Flexible Inflation
Targeting" framework since May 2000. As a pragmatic response to the failure of a pegged
exchange rate system, transparency of the policy making process under IT was deemed
appropriate for Thailand, particularly after the 1997 Asian Financial Crisis. Under this regime,
price stability is the overriding and explicit objective, while economic growth and financial
stability are also taken into policy deliberation. The policy interest rate is our main tool in
achieving the mandate.
With managed-float exchange rate regime, the Thai baht is generally allowed to be
determined by the market. In this regard, flexible exchange rate serves as an automatic
stabilizer to cushion against external shocks and economic imbalances in the short-term, and
as an important price signal for resource allocations and catalyst for structural changes in the
long term.
In some cases, however, exchange rate flexibility and fluctuations can have costly
consequences given some economic contexts, particularly in emerging market
economies, including Thailand. First, financial markets in these economies are less
developed and relatively illiquid compared to advanced economies. This may potentially
cause extremely large asset prices and exchange rate movements in response to capital flow
volatility. Additionally, the availability of foreign currency hedging instruments, especially to
small enterprises, remains limited, amplifying the negative repercussions from exchange rate
volatility. Moreover, many emerging market economies, including Thailand, rely on exports
as the main engine of growth. Many of their export items often command little bargaining
power and hence need to compete on the basis of price. As a result, extreme and sudden
exchange rate movements would affect firms' competitiveness. For these reasons, many
emerging market economies cannot neglect the implications of exchange rate movements.
This leads us to the next part of my talk this evening.
Managing capital flow and exchange rate stability
Ladies and Gentlemen,
There is no one-size-fits-all measure to deal with capital flow and currency volatility,
as well as its impacts on the real economy. Take Thailand as an example. We have
adopted multi-dimensional responses to the financial spillovers. The exchange rate
management framework focuses on mitigating short-term excessive exchange rate volatility
and ensuring alignments with economic fundamentals in the medium to long term. Exchange
rate flexibility constitutes the primary buffer to cushion the effects of capital flow volatility. In
the case that resulting movements in exchange rates are deemed excessive and unjustified
by fundamentals, foreign exchange interventions can be undertaken. More controversial,
but now increasingly accepted internationally as one of the policy options, are capital flow
management measures (CFMs), aimed at directly curbing international financial flows via
regulations and taxes. While there are clear economic rationales for CFMs, given the
abundance of market inefficiencies and externalities, many countries tend to regard these
measures only as a last resort. As such, reputation costs, asymmetric effects in managing
outflows versus inflows, lack of long-term effectiveness, and limited room for calibration are
but a few considerations that policy makers need to take into account.
Regarding foreign exchange rate interventions, we are always mindful of its costs and
limited effectiveness. In particular, interventions against market views would employ large
financial resources while yielding limited success, usually only to delay the pace of exchange
rate movements. Active interventions under the inflation targeting framework regime may
also have unintended consequences on policy framework credibility, as the central bank's
commitment to safeguard the overall macroeconomic stability may be called into question by
the public. For this, consistent communications about monetary policy framework and stance
would help increase central bank's transparency and public understandings.
From a longer-term perspective, currency should be able to move flexibly in line with
economic fundamentals. Active foreign exchange interventions can cause potential
distortions. First, financial market development would be hindered. A certain level of
exchange rate volatility is often a pre-condition for market development. Without sufficient
volatility, there would be no incentive for firms to hedge themselves against currency risks
and for financial institutions to start offering currency hedging tools. It should also be noted
that heavily managed exchange rate may discourage businesses from upgrading their
technology, productivity, and competitiveness, so as to command more bargaining power in
the global market and better withstand exchange rate volatility.
Given limitations and side effects of short-term exchange rate management strategies,
exchange rate interventions should only be employed to deal with excessive
movements or special circumstances when the market needs anchoring. Interventions
should also be two-way, not aiming to resist trend movements but to cushion the impact of
extreme movements. For normal times, the exchange rate should move flexibly to serve its
role as shock absorber for the economy.
Ladies and Gentlemen,
Now, policymakers have to strike the right balance between implementing short-term
measures and building long-term capacity for the economy to better withstand
external shocks. To promote economic resilience in the long run, it is important to press
ahead with reforms that deepen local capital markets. Deeper and more liquid markets
help absorb higher capital flow volatility and large shocks, preventing large swings in price
movements. In addition, active and widespread use of foreign currency hedging
instruments is also beneficial to mitigate the negative knock-on effects from exchange rate
volatility.
Liberalization of outward investment by domestic investors also helps promote more
balanced capital inflows and alleviate upward pressure on the exchange rate. These
international asset holdings can provide a buffer when domestic market faces rigorous tests
of volatility. Nevertheless, liberalization needs to be well planned, timed, and sequenced in
order to ensure that its benefits outweigh costs. The appropriate degree of liberalization for a
country at a given time depends on its specific circumstances, notably its financial and
institutional development. More stable and long-term flows, particularly direct investment
flows, should be liberalized prior to short-term portfolio flows, which are more volatile and
sensitive to cyclical factors.
In October 2012, the BOT launched the Capital Account Liberalization Master Plan.
This was part and parcel of our longer-term plan to facilitate Thai companies to diversify their
investments abroad, especially in neighboring countries. This would encourage private
companies to operate their businesses more efficiently by expanding their markets and
production bases. In turn, such diversification will help strengthen their competitiveness and
absorptive capacity. At the other end of the spectrum, limiting leverage in the banking
system would add more cushions to the economy against external shocks.
Last but not least, developing fundamental economic strengths to enhance countries'
resiliency to external shocks can work through well-diversified export items focusing on
high value-added products. This would lead to more bargaining power, and hence less
sensitive to exchange rate fluctuations. Stronger domestic consumer base would also help
lessen the dependence on external demand.
All reforms I mentioned require concerted efforts from all public and private
stakeholders. Policymakers should provide economic environment and infrastructure
conducive to reforms. Particularly, financial literacy and risk management awareness should
be fostered at all levels and sectors. Financial institutions also play a crucial role in
developing financial products to facilitate transactions and risk managements. Businesses
should upgrade productivity to enhance industry's resilience to shocks. Advanced
preparations will surely pay off.
Lessons learned, challenges ahead, and policy implications
Ladies and Gentlemen,
As we are approaching the end of my talk, let me now share some final thoughts on
lessons learned and challenges ahead. First, for countries that want to maintain
autonomy on interest rate policy, exchange rate flexibility is a pre-requisite to living
with capital flows. Nevertheless, extreme exchange rate fluctuations may cause
misalignments. A trade-off between flexibility and stability thus requires policymakers to
identify the exchange rate framework suitable for the economy. This can be a daunting task
in practice, as the target is often country-specific and subject to dynamic economic
developments. Keep in mind that monetary policy can do little to influence real exchange
rates in the long term. Attempts to give the exchange rate more weight in monetary policy
deliberations will also reduce the autonomy in controlling interest rate, leading to more
interest rate volatility. In any case, policymakers need to be more practical and innovative in
detecting and assessing impacts of the exchange rate on real economy. An ability to monitor
adjustments at the micro or firm levels is also a helpful guide on when and how to manage
currency risk.
Second, amidst an increasing global interconnectedness, policymakers should also
be mindful of policy externalities on other economies. Policy coordination and
information sharing are thus needed for the optimal policy setting. Of course none of
this is entirely new for ASEAN countries. One example is the strengthening of regional
financial safety net through institutional mechanisms and arrangements such as the
development of Chiang Mai Initiative Multilateralization (CMIM), which will increase the
region's ability to respond to crises, build confidence, and hence lessen possible market
turbulence during times of financial stress. Going forward, further collective actions in the
region can help mitigate market volatility and enhance countries' resilience to global shocks.
These include promotion of regional currencies as invoice currencies in addition to the US
dollar or the Euro, and a bilateral swap agreement as a last resort for foreign currency
liquidity.
Last, I would like to stress that sound economic fundamentals and policy credibility
provide a solid first line of defense, probably the best defense, against capital flow
and exchange rate volatility. Despite the global nature of volatility, not all emerging market
economies suffer equally. Domestic fundamentals are subject to unrelenting scrutiny by the
financial market. Countries with stronger macroeconomic fundamentals experience less
volatile capital flows and are therefore less disrupted by them. "Fragile five" episode was a
case in point for the market to differentiate countries, with high current account deficits and
high inflation as the focal point. In most cases, strong macroeconomic fundamentals include
both internal and external fronts. Internal front involves improved fiscal discipline, banking
system with prudent supervisory and regulatory frameworks, stabilized inflation,
wellequipped financial markets, and credible monetary policy framework. External front includes
sufficiently flexible exchange rate, adequate foreign reserves, and manageable external debt
levels. In addition, well-diversified sources of finance among bank-based, debt and equity
markets would be supportive of financial stability.
Concluding remarks
Ladies and Gentlemen,
I have spoken at length, from the subject of global volatility, onto more policy options issue
based on central banks' perspectives. Let me now wrap up by leaving you with a final
remark on these issues.
In the world of increased financial integration, volatility of capital flow and exchange
rate is unavoidable. A sustainable path forward requires going beyond coping with
capital flows to living with them. Therefore, public and private stakeholders must
remain vigilant of any impacts they may have on real economy. Thailand's approach so
far has been to allow the exchange rate to act as an automatic stabilizer, while its extreme
movements are carefully managed. At the same time, reforms are actively pursued with the
economy's long-term resilience as our ultimate goal. It is also imperative for central banks to
continue exploring various policy toolkits to bolster resilience against volatile capital flows
and exchange rate in the near future.
Thank you for your attention.