trigger a rapid turnaround in sentiment. this leads me to my next point, which i had raised earlier, of whether the increase in capital flows to emerging markets was likely to result in an increase in risks? this seems the likely case. for example, local investors do not usually provide counter - trade to hedge funds but rather take similar positions, hence increasing the overall risks. in addition, investment of hedge funds in a particular country is usually only a small fraction of their whole portfolios, and inflows reversals may take place easily. individual risk management can also collectively induce systemic risks, and central banks may be required to resolve such problems to avoid adverse impacts from sudden reversal of capital flows. this leads us to the question of whether we are underestimating the inherent risks of these capital flows? let me explain why this may be the case. first of all, net capital flows are small. gross capital flows, however, are much larger : this may suggest that the economy ’ s degree of vulnerability is actually larger than currently accounted for. should we therefore be concerned with large two way ( gross ) flows, as opposed to net flows, and the size of the much larger global balance sheet if counted in this way? arguably, large gross capital flows and the flow of surplus capital from emerging markets to more developed markets may be a structural phenomenon, as mentioned earlier. the characteristics of developed financial markets, in terms of lesser financial frictions, better information and fewer borrowing constraints leading to better liquidity and lending, as well developed social welfare systems, are reflected in the persistent gap in savings compared to developing markets. in addition, financial integration has facilitated cross border arbitrage transactions, resulting in easier liquidity conditions globally. the implications and associated risks of this high level of global liquidity are different depending on whether the current state of affairs is a new equilibrium consistent with the conditions under globalization ( e. g. case above ), meaning that monetary policy should not try to counteract this phenomenon. however, if the current phenomenon is due to temporarily excessively accommodative monetary policy that would eventually translate into higher inflation, this would require eventual tightening and lead to the risk of capital reversals. but there are also compelling reasons to argue that risks have been better distributed, given financial innovation and various credit risk transfer mechanisms. let me therefore pose another question : has the use of these credit risk transfer mechanism helped to distribute risks, making the financial environment a safer place? on the plus

tarisa watanagase : issues important to small and open emerging market economies speech by dr tarisa watanagase, governor of the bank of thailand, at the panel discussion on financial globalisation, capital flows, and challenges for central banks, at the 77th annual general meeting of the bank for international settlements, basel, 24 june 2007. * * * my discussion will focus on the issues important to small and open emerging market economies. the first is regards to whether the present situation of sustained inflows into emerging markets is really sustainable. what do these seemingly sustained inflows tell us, particularly in terms of investors ’ assessment of riskiness of the region? or from another angle, have risks in the region declined? i will discuss this in the context of financial innovations in risk management, and conclude with a few remarks on how these developments affect central banks across the globe. my first question, therefore, arises from the observable reduction of risk premia for financial assets in the region. on the surface, this low risk premia implies lower risks. but does, it, really? we all realize that the international financial system is currently in an environment with low risk premia across a broad set of asset classes, combined with low volatility in the prices of these assets. furthermore, this low risk premia has been sustained despite the various episodes of risk aversion in the recent past. this raises concerns about whether prices – and consequently the risk premia themselves – accurately reflect actual risks. of course, it is arguable that the search for yield in riskier assets is due in part, no doubt, to the historically low interest rates and abundant global liquidity, partly a result of recent expansionary monetary policy around the world. this has encouraged greater risk - taking, resulting in a substantial reduction in risk and liquidity premia over the entire maturity spectrum. on the other hand, however, low risk premia could also reflect changing risk appetite. more importantly, it is unclear whether this change in risk appetite has arisen from permanent or transitory factors. i make this distinction because permanent factors would imply that this reduction in risk premia is here to stay. transitory factors, on the other hand, imply that the risk premia would rise once these factors reversed. let me try to identify some of the permanent factors that have resulted in the shift in risk appetite and preferences. these include, firstly, changing demographics. the aging population has led