Edward S Robinson: Managing external shocks - Asia's shifting
experience with capital flows
Remarks by Mr Edward S Robinson, Deputy Managing Director (Economic Policy) and
Chief Economist of the Monetary Authority of Singapore, at the 2024 Beijing Financial
Street Forum on "Improving Modern Central Bank Systems, Enhancing
MacroGovernance", Beijing, 18 October 2024.
* * *
Distinguished speakers and guests, good afternoon
Introduction
It is an opportune time to address the impact of US Fed policy on the global economy
and on Asia. After a series of negative shocks, from the Covid pandemic, to supply
chain disruptions, to the rapid tightening of interest rates in industrialised economies,
Asian economies are now facing the more favourable prospect of falling interest rates in
the US, Europe and elsewhere. Lower rates should help boost local economies,
improving the outlook for capital inflows and creating space for Asian central banks to
loosen policy domestically, should local conditions warrant it.
But every opportunity comes with risks. These include the possibility that inflation will
resurge, the chance of recession as still-restrictive monetary policy continues to
percolate through some markets, and the disconcerting spectre of global fragmentation.
In considering how these risks might propagate through the global economy, I would
like to focus on the effects of capital flows, historically a major channel for transmission
of shocks.
Primacy of the Global Financial Cycle
Asia's open trading economies have been susceptible to waves of sometimes
destabilising capital flows, from surging inflows in boom times to sudden stops when
risk appetite drops. Driving the flows, at least in part, were economic conditions in the
large, industrialised economies and the monetary and fiscal policy settings associated
with them. Experience from the Asian financial crisis, the Global Financial Crisis, and
other episodes suggests that policymakers can be severely constrained in responding
to these surges and stops, and that responses tended to be procyclical - loosening
policy in the face of inflows and tightening to limit outflows. This history has led some
researchers to propose the notion of a global financial cycle that can dominate financial
conditions in emerging and smaller industrialised economies. On a strong interpretation
of this view, the power of the global financial cycle has compressed the traditional
trilemma of international economics into a dilemma, forcing a choice between an open
capital account or monetary policy autonomy.1
Experiences with Capital Flows
However, the experience of Asian economies in the recent tightening cycle points to an
increased latitude in managing the impact of the global financial cycle while maintaining
some policy autonomy. ASEAN economies weathered the post-pandemic round of
interest rate hikes in industrialised economies surprisingly well, avoiding the capital
surges and sudden stops they had suffered through during the earlier shocks. What
conjunctural and structural factors might explain this apparent improvement?
First, the common global inflation shock and resulting synchronicity of monetary
tightening across developed and emerging market economies reduced the risk of
destabilising capital flows or currency fluctuations. The inflation cycle in ASEAN was
also somewhat more contained than in the advanced economies. ASEAN economies
reacted to the global inflation shock earlier, and their pre-emptive monetary tightening
reined in domestic inflation and reduced incentives for capital outflows. Improved
communication and orderly transmission of higher policy rates also supported risky
asset classes, such as emerging market bonds and equities.2
Second, ASEAN economies had stronger buffers against outflows than in previous
cycles. They maintained broadly balanced current accounts and benefited from positive
foreign direct investment trends, terms of trade tailwinds and continued recovery in key
sectors. With generally strong external positions, ASEAN economies also reduced their
reliance on foreign capital, deepening their local currency asset markets and increasing
domestic participation in these markets.
Third, ASEAN economies relied on expanded toolkits to reduce financial stability risks
and dampen the impact of the global monetary cycle. Over the past few years, most
have deployed macroprudential measures to reduce leverage, limit balance sheet
mismatches, and discourage the formation of asset bubbles. When regional currencies
faced depreciation pressures earlier this year, ASEAN policymakers engaged in
discretionary policy management, accepted some currency flexibility, and used targeted
foreign exchange interventions and administrative measures to temper currency
volatility and capital outflows.
3
Extending our perspective to the last 30 years, recent research by MAS confirms that
capital flows to emerging markets in Asia - both in debt instruments and more generally
- were heavily influenced by the external global financial cycle during the period from
1995 to 2010 - from the Asian financial crisis through the global financial crisis. On
average, about 45 percent of the variation in capital flows during this period was
attributable to external or global factors. However, our research also shows that this
influence has diminished over the past 15 years, to the point where a much-reduced 10
percent of the variation in flows can be ascribed to external "push" factors. That looks
like good news for policymakers in the region, who could reasonably conclude that they
now have more policy space to address domestic shocks. Some of the policy initiatives
already mentioned - notably the increased use of macroprudential measures and
stronger commitment to inflation targeting - likely contributed to this encouraging
development.
Global Synchronisation is Intact
This transition to seemingly more benign capital flows is not the whole story, though.
While capital flows might be less linked to the global financial cycle than they once
were, the same cannot be said for some important domestic economic variables. For
example, the influence of the external cycle on GDP growth appears to have increased
rather than decreased in the more recent period. Domestic interest rates have also
become more rather than less dependent on the global cycle.
An apparent implication is that other markets or channels may have taken over the role
of traditional portfolio and other capital flows in transmitting external shocks to emerging
economies. Possible alternative channels could include trades in currency and interest
rate derivatives, which have grown significantly since the Global Financial Crisis. Other
channels, including trade channels, may be doing more to transmit external shocks,
although the evidence for this is preliminary. Further, it may be the case that emerging
market economies pre-emptively adjust monetary policies to major shifts in interest rate
cycles of monetary-dominant advanced economies, in addition to internal balance
factors.
While the increased independence of capital flows from the global financial cycle is a
promising sign for the development of policy autonomy and countercyclical policy
space, it is clear that global factors are still important determinants of domestic prices
and activity in Asian emerging market economies.
Policy Considerations
Policymakers in the region recognise that we do not have the luxury of adopting a neat,
textbook approach to the world. We cannot assume that capital flows will always
respond to push the economy towards equilibrium.
Capital flows ought to respond to fill in savings-investment gaps, and exchange rates
shift to reduce imbalances in the external sector. But we are often in a second-best
world, in which fund flows are more driven by the short-term search for yield through
carry trades, and by push factors related to the particular fiscal-monetary policy mix of
the sending countries.
In these circumstances, inflation targeting remains an appropriate policy to respond to
external shocks, supported by a credible fiscal policy framework. Policies to support
economic and financial resilience include maintaining an adequate level of foreign
reserves and building capital and liquidity buffers to shield the financial system against
outflows. When markets overreact, when policy credibility is limited, or when balance
sheets are overextended, some supplementary measures may prove useful. These
could include foreign exchange interventions and macroprudential adjustments.
Clearly, emerging market currencies may sometimes overshoot, undershoot, or present
financial stability risks. Hence the need for foreign exchange interventions. It could be a
form of Jeffrey Frankel's "systematic managed floating", where the central bank
regularly responds to pressures on the exchange rate by allowing them to be partly
4
reflected in currency movements but also as changes in official reserves. While we
recognise the benefits of exchange rate flexibility as an effective shock absorber, the
currency should not become a propagator of volatility itself. In this sense, policy
frameworks and calibrated interventions facilitate emerging market economies'
continued, constructive engagement with the international economy and capital markets.
Singapore's Price and Financial Stability Approach
In Singapore, the Monetary Authority of Singapore (MAS) is responsible for both price
and financial stability. We hold the view that as a small open economy, a hub for both
regional trade and financial flows, Singapore requires stability in both dimensions to
ensure market confidence. MAS' mandate for both monetary and macroprudential
policy means there is room to explore and exploit complementarity between the two
policies. We have found it efficient to assign monetary policy to price stability, and
macroprudential policy to financial stability.
The choice and effectiveness of monetary policy instrument have been substantially
shaped by Singapore's circumstances - especially the high degree of openness to trade
and capital flows. The exchange rate is the policy instrument, and it is managed against
a trade-weighted basket of currencies, which is normally significantly less volatile than
individual bilateral exchange rates. The currency is also managed within a policy band.
This allows the trade weighted exchange rate to fluctuate and absorb temporary
shocks, including the pressures of volatile capital flows; it provides us the flexibility to
manage the exchange rate in line with price stability, while allowing some market
determined movements. Conversely, macroprudential policies tend to be directed at
preventing an excessive build-up of credit especially for property market transactions, to
which the domestic banking system has important exposures. Macroprudential policies
are complemented by comprehensive microprudential regulation that ensure individual
banks' soundness.
Concluding Observations
I would like to conclude with two observations.
First, price and financial stability are public goods and are secured in the global
commons. Domestic policies alone cannot provide full protection against external
shocks. Some degree of international cooperation will always help to improve
outcomes. There are gains from cooperative engagement at the regional and
international level. In monetary policy, this implies measures like standing or emergency
swap lines from major economies and international institutions to provide liquidity during
periods of heightened risk aversion. These proved useful during the last few global
crises, and are likely to remain so as the world adjusts to a new monetary policy
trajectory.
Second, in the final analysis, it is important that the suite of macroeconomic,
macroprudential, and structural policies work in concert to promote a stable
environment in which investors and domestic private agents are encouraged to adopt a
long-term planning and investing horizon that promotes sustainable economic growth.
Miranda-Agrippino and Rey (2020), "U.S. monetary policy and the global financial
cycle", The Review of Economic Studies, Volume 87, Issue 6.
2
Hardy, Igan and Kharroubi (2024), "Resilience in emerging markets: what makes it,
what could shake it?", BIS Bulletin, No 88.
3
The key findings will be published in MAS' forthcoming Financial Stability Report in
November 2024.
4
Frankel (2017), "Systematic Managed Floating", National Bureau of Economic
Research Working Paper No. 23663, August 2017, p. 2.