the striking thing about these problems is that they erupt without much warning and to the surprise of even the most knowledgeable in this field. they are also not specific to individual economies : market liberalisation and globalisation have made them common problems for all economies that wish to play a part in the international financial system. indeed, with a few economies in asia going through the same process of financial liberalisation and encountering the same problems, the crisis was characterised as one specific to asia, hence the reference to the asian financial turmoil. but explanations of the financial crisis soon moved from regional to international. events in russia and latin america, the long term capital management ( ltcm ) episode, and the subsequent deleveraging of hedge funds soon made it clear that our regional crisis was more than just a problem of a few individual economies not keeping their houses in order. the root of the crisis is in the great increase in the speed, quantity and unpredictability of international capital flows. and many of these capital flows are mobilised or indirectly influenced by highly leveraged institutions operating behind a veil of secrecy interlaced with esoteric mathematical models that do not allow the systemic as well as the rather simpler counter - party risks to be identified, let alone properly managed. as recent events in this region and throughout the world have shown, this phenomenon has reached a level where it is capable of disrupting even the largest markets and completely destabilising smaller markets. it will therefore be useful for us to discuss these issues in greater detail before focusing on what needs to be done. international capital flows for a long time it has been taken for granted that capital flows are exactly analogous to trade flows : that, wherever they occur, and in whatever form, they invariably benefit long - term economic development, and that therefore the looser the rein they are given, the greater the benefit. this presumption, however, has been questioned recently in light of the experience of some emerging market economies. professor bhagwati, for example, in his article last year on “ the capital myth ”, has argued that the assumption that free capital is as virtuous as free trade is wrong and that the claims of enormous benefits from free capital mobility are not persuasive. there are undoubtedly many benefits that go with free mobility of international capital. traditionally, capital flows take the form of commercial bank lending, foreign direct investment, or equity portfolio investment. over the past few decades, these flows have facilitated

the efficient cross border utilisation of capital and have provided liquidity in financial markets. by adding an international dimension to financial intermediation, the mobility of international capital has clearly been helpful in promoting growth and development in both the capital exporting and the importing economies. the mobility of capital has more recently been boosted by advances in telecommunications and information technology, allowing capital to move into or out of an economy in huge amount and within a very short space of time. the virtue of capital mobility therefore carries the risk of capital volatility. the volatility is destabilising in both directions. too rapid a build - up of capital inflows places severe upward pressure on domestic asset prices, fuels inflation, and exacerbates macroeconomic imbalances. conversely, sudden and massive reversals of these flows place intense downward pressure on the exchange rate, and therefore upward pressure on interest rates, causing asset bubbles to burst and splatter. when rapid build - up is followed suddenly by massive withdrawal, we see the kind of crisis that swept across this region in 1997 and 1998. the volatility of international capital flows is also attributable in part to the phenomenal growth of derivatives and the global over - the - counter ( otc ) market in the past decade. a survey by the bank for international settlements ( bis ) in june 1998 estimated the size of the global otc derivatives market at an aggregate notional value of us $ 70 trillion. despite the trauma of the global financial crisis last year, there have been no signs of an overall slowdown. according to the us federal reserve board, the notional value of derivatives contracts outstanding at us commercial banks, the leading players in global derivatives markets, grew by more than 30 % last year : this is the most rapid annual growth since 1994. the sheer volume of derivatives trading does not say much about their associated risks. these new financial instruments have undeniably helped investors to unbundle their risks. they have promoted investments and generated substantial benefits to the developing countries receiving such investments. however, the availability of derivative instruments has also increased the opportunities for speculation that resulted in significant losses with the downturn in markets during the financial crisis. the use of swaps, futures, forwards, and other derivative instruments have enabled investors to take on far greater exposure relative to their capital, and to greatly increase the potential for loss. market stability and highly leveraged institutions let me make it clear that the losses or gains