regulation in which it is complemented by the newly developed mechanisms for surveillance including across borders, strengthened supervisory oversight and institutional arrangements for resolution. central banks and financial markets a more recently much discussed mandate is the role of the central bank in ensuring the orderly functioning of financial markets. orderly functioning financial markets are vital not only for the efficient allocation of financial resources in the economy but it is also essential for the transmission of the monetary policy and for preserving financial stability. while competitive forces are expected to result in efficient and optimal outcomes, central banks in emerging economies have had the important role of balancing between the market forces and intervention with the objective of ensuring the orderly functioning of the financial markets. it needs to be recognised that several important preconditions need to be in place to generate equilibrium prices that reflect the underlying fundamentals. this includes the institutional and market infrastructure, the incentive structure, the rules of the game and the level of financial literacy that recognise and understand the market signals. when these elements are still yet to be fully developed in many emerging economies, it increases the risk to instability. thus, as a result of the stage of development of such markets, or its size or prevailing market imperfections, emerging economies have tended to be more vulnerable to greater volatility and circumstances in which markets do not self - equilibrate. the recent global financial crisis has shown that such dislocations have occurred even in developed financial systems. institutional structures and rules that become deficient and less relevant heighten the risk for such unstable market conditions. experience has also shown that such market dislocations have severe and far reaching adverse implications on the overall economy. for the effectiveness of such interventions, however, there needs to be clarity in the objectives to be achieved by such central bank presence and the results that are expected to be delivered. of importance, there needs to be the recognition of the temporary nature of such interventions and the challenge of efficiently unwinding such presence when the objectives are achieved. there is also the need to manage the risks of unintended consequences of such direct central bank interventions. such risks could include the potential for circumvention, or the gravitation to other markets not protected by such intervention. there could also be potential costs associated with such interventions, not only the current costs, but also the cost to future generations. while the pace of deregulation and liberalisation may differ across emerging economies, there is a discernable distinct shift to greater market orientation in this

recent decade. these reform efforts have been reinforced by efforts to develop the financial markets and financial infrastructure. within this framework, the nature of intervention has been in the form of direct presence in the financial markets, the setting of rules and regulation, and in the resolution of problem financial institutions. such interventions were evident during the asian financial crisis in the late 1990s to restore stability in the financial markets. this in turn created conditions for the resumption of the financial intermediation process. while the efficient functioning of the financial system was vital for the economic recovery in asia, more important was the comprehensive set of policies that produced the recovery. within a year of the introduction of the pro - growth measures, most of the crisis affected economies experienced a strong recovery. more recently, the global financial crisis has seen several rounds of wide ranging direct market interventions to restore the smooth functioning of these markets. described as actions taken in the most extraordinary and exceptional circumstances, it demonstrates that this phenomenon of severe market dislocations has the potential to occur even in the most developed of the financial systems. as these massive interventions continue, primarily in the public and private securities markets, the concern is on its potential consequences on other parts of the world, in particular, to the emerging world. in the now more interconnected and interdependent world, these actions are already creating significant shifts in capital flows. important for the emerging world is the ability to intermediate such surges in capital flows and to manage the risks associated with such liquidity inflows and its potential to undermine the current recovery. a further element that has frequently been underestimated is the role of behaviour which has had a major influence on the dynamics of the financial markets. extreme forms of such behaviour are evident in asset and foreign exchange markets. while the former is prone to boom and bust, the latter is prone to overshooting. while several emerging economies have successfully relied on macro prudential measures to contain the formation of such asset bubbles, the foreign exchange market is not like any other market. with a daily transaction amounting to usd4 trillion, it is the most liquid and dynamic market in the world. the role of sentiment and expectations has resulted in a market that is frequently prone to excessive movements and overshooting. as highly open economies, disruptions and disequilibrium in the foreign exchange market have far reaching consequences in the real economy. intervention operations to maintain orderly market conditions reinforced by sterilisation operations have aimed at ensuring liquid