as opposed to a stabilizer of shocks and capital flows, especially in ems with strong external positions that are considered as safe haven like thailand. while capital flows in and out of ems might be small relative to global financial activities, they could have real and significant impacts on the em economies through the exchange rate channel. concerning volatile exchange rate movements that could undermine financial stability, capital flows could affect ems ’ monetary policy stance. for example, in the low - for - long interest rate environment, ems may need to follow aes in delaying or reversing normalization of monetary policy to avoid appreciation of their currencies. because of spillovers, monetary policy of ems could be distracted from their core domestic policy mandates. the delayed normalization in the low - for - long or negative - for - long interest rate environment further exacerbates financial stability risks. debts — both household and corporate — are now reaching historic highs. emerging nations, often with nonbank financial activities outside the regulatory perimeter, are more susceptible to risk buildups. financial spillovers need to be addressed at multiple levels. 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, 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. second, assessments of global imbalances and

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