While this is definitely a concern for every country, we open-economy EMs are especially concerned about how SMEs—particularly medium-size firms—would cope with the trade and supply chain disruptions. Medium-size manufacturing firms are the backbone of EM economies. Prior to the onset of the trade tension, the new global environment has already brought upon these firms considerable pressure. Technological disruption tends to favor large corporations who better understand the technology and have the resources needed for the adaptation. Low interest rate environment also allows large firms to access bond financing at very low  1  funding costs. These factors have increased market power of large firms and forced smaller firms to quickly redefine their business model in order to stay afloat. Amidst these structural changes, the ongoing trade tension becomes an additional burden to medium-size firms’ survival both directly and through the disruption of the supply chains. Moreover, the increased uncertainty that forces firms to diversify their production locations and hedge against the growing risks together with the ongoing economic downturn have squeezed the profit margins. In such a circumstance, mediumsize firms are in a much more difficult position than large firms that have deeper pockets and larger buffers. Trade tension might be comparatively short-lived when compared to other structural changes like demographic shift and technological disruptions, but these short-term factors could result in a long-term impact to medium-size firms and the structure of the economy through channels such as changes in competition landscape, market dominance power, and investment and employment patterns.

On a domestic-level, financial stability will have to play a more prominent role in monetary policy decisions. This is especially true in the current environment where inflationary pressure is subdued. For EMs that still have a lot of ground to cover in regulating non-bank financial activities,  3  financial stability cannot be addressed by macroprudential measures alone. EMs also need to equip themselves with policy tools to deal with rapidly changing capital flows; these tools encompass macroprudential measures, microprudential measures, capital flow management measures, and at times foreign exchange intervention. On an international level, we need to recognize the changing landscape and the impact of the financial spillovers on small open economies, advanced economies and EMs alike. First, the burden of adjustment needs to be proportionately shared by both the source and recipient countries of capital flows. At present, EMs as recipients of flows are often restricted and reproached in their response to capital flows, while source countries have full flexibility in their conduct of monetary policy. In this regard, we very much welcome IMFs’ work on the Integrated Policy Framework which will allow small open countries to respond to spillovers more effectively taking into account each country’s specific context and circumstances. We would very much hope that source countries of capital flows take into account spillover and spillback effects in their policy deliberation.