I. Research Programme
(R1) Strengthening Financial Stability Indicators in the Midst of Rapid Financial Innovation: Updates and Assessments
Supporting Reasons:
In response to the global financial crises in the 1980s and 1990s, national and international institutions started to monitor the soundness of the financial system more intensively. A wide range of instruments/indicators is used to assess financial system stability in analytical practice. These include in particular, analysis of quantitative indicators of financial system soundness and stability, including stress testing. These indicators strive to cover the issue of financial stability as a systemic phenomenon and therefore concern, not only financial institutions and markets, but also the real and government sectors as the main debtors of financial institutions, as well as the financial infrastructure. The inclusion of non-banking sector indicators in the financial stability indicators (FSIs) reflects the interconnectivity of the financial and real sectors, such as for example, unfavourable developments in the corporate sector pass-through to the loan portfolio of banks, thus having possibly a negative effect on financial stability.
Unlike price stability, financial stability has neither a fully established definition nor an aggregate indicator that the central bank can use as a measure of financial instability. Whereas at least some consensus has been reached on the definition of financial stability, the construction of an aggregate financial stability indicator continues to be in the research and experimental phase. The swift pace of financial innovation that has taken place over the course of the last decade further heightened the challenge to establish a comprehensive set of financial stability indicators. The rapid financial innovation has brought about a proliferation of new and increasingly sophisticated financial products and has led to the appearance of new types of institutions as well as created new and expanded roles for existing institutions.
Objectives:
Against this backdrop of increased complexity, the primary goals of this study are as follows:
- To assess and review the array of financial stability indicators employed by the SEACEN member central banks as well as the strength and the shortcomings of the available tools, especially in the context of the recent global financial crisis;
- To assess the comparability and consistency of the FSI indicators across the SEACEN economies as well as globally since the objective of a set of financial stability indicators is to provide users with a rough idea of the soundness of the financial sector as a whole; and,
- To examine the recent efforts undertaken to further enhance these indicators both globally and also at the SEACEN member central banks, especially in the wake of the recent global financial crisis.
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(R2) Policy Responses and Adjustments in the Course of Exchange Rate Appreciation
Supporting Reasons:
One of the common features of economic and financial crisis is a volatile foreign exchange market, as clearly demonstrated by the current global financial market. Furthermore, in times of prolonged deficient demand, crisis economies are prone to engage in deliberate policies to weaken their currencies ---often referred to as ‘beggar thy neighbour policies’ or ‘ugly contests’. Unlike past crises, the three major global currencies (the US dollar, the yen and the euro) are currently in the throes of competitive devaluation. Understandably, the International Monetary Fund has since warned of widespread synchronous currency interventions carried out by central banks around the world to weaken their currencies, all of which could derail the fragile economic recovery and fan global tension.
As quantitative easing measures are expected to continue in some developed economies, particularly the United States, ample supply of the US dollar is likely to further depress its value. This will, in turn, fuel a strong surge in demand for emerging market currencies, including those in the SEACEN region, driving up their values. As many emerging markets, including the SEACEN economies, rely heavily on exports for economic growth, the dramatic appreciation of their exchange rates and therefore more expensive export prices, will dissipate their competitive edge. Moreover, strong currencies have also been linked to asset bubbles in the domestic economy.
The most common way for many emerging market countries to manage the strong appreciation pressure is by purchasing large amounts of US dollars. However, as the US dollar yield remains at an all time low, the cost of foreign exchange interventions are likely to rise and hence, costly for the balance sheets of central banks around the globe, including those in the SEACEN economies. Given the current global scale of this competitive depreciation, many have questioned the effectiveness of these foreign exchange policy measures. The role of a third currency (the Chinese Yuan) has also been debated in recent months. As China continues to cement its role as a major global trading partner, the influence of the Chinese Yuan on the currency management of many economies, including those in the SEACEN region, is likely to rise.
Objectives:
Against the above challenges and concerns, the key objectives of this research project are:
- Assess the movements and fluctuations of the SEACEN currencies and their implications on the key sectors of the economy, particularly the tradable sectors;
- Assess and review short and medium term foreign exchange policies of the SEACEN economies. Have we seen more active policy responses in recent years? Have responses in the foreign exchange currency market been effective? What are the costs and implications of policy options? and,
- The importance of the role of the US dollar and other major world currencies for the management of exchange rates in the SEACEN economies. Do we see the growing influence of the Chinese Renminbi on movements of SEACEN currencies?
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(R3) Living with Capital Flows and Excess Liquidity: Assessing Effectiveness of Monetary Policy in SEACEN Economies
Supporting Reasons:
The transmission of abundant global liquidity and the accompanying surge in capital flows to economies with comparatively higher interest rates and a stronger growth outlook pose policy challenges as appreciation pressures and rising asset valuations return. As uncertainty concerning economic recovery in developed economies remains, investors are turning to emerging markets to find higher yields for their investment capital. This increased capital flow into emerging markets is causing a stir in the global economy, creating a conundrum for emerging markets.
Despite their beneficial effects, capital inflow surges can pose challenges to the recipient economies. While benefits include providing additional financing to countries with limited savings, allowing risk diversification, and contributing to the depth and development of financial markets; surges of capital inflows can complicate macroeconomic management as the real economy may not be able to adapt to large swings in the exchange rate. They can fuel a boom in domestic demand leading to overheating and a widening current account deficit through the appreciation of the real exchange rate. They may also lead to asset price bubbles and increase systemic risk in the financial sector, even in the presence of a generally effective prudential supervisory and regulatory system. The surges in capital inflows also raise early concerns about vulnerabilities to sudden stops once the global liquidity is unwound, with implications for financial stability.
Objectives:
This research project attempts to address the following set of questions:
- Are capital flows into SEACEN economies primarily driven by the economies’ strong economic fundamentals and, therefore, likely to remain stable over the medium to long term, or are they primarily driven by the abundant global liquidity?
- What policy challenges do SEACEN economies face in absorbing global liquidity?
- List and assess monetary policy measures implemented by the SEACEN economies to manage the flows and the impacts.
- What options are available to policymakers in response to a rapid global liquidity expansion and surges in capital inflows? To what degree are policy tools effective in managing a surge in capital flows as well as their potential sudden stop?
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(R4) Framework for Macro-prudential Policies for Emerging Economies in a Globalised Environment
Following the 1997 Asian financial crisis and currently the subprime crisis, there is much debate on the need for authorities to enhance supervisory and surveillance capacities of the financial markets. The recent crises have shown that micro-prudential policies alone which focus attention on individual financial institutions, in contrast to macro-prudential approaches which centres on the market as a whole, were inadequate. While both sets of policies need to be manifested into a coherent and effective approach which can mutually reinforce and support each other to achieve financial stability, macro-prudential regulations and surveillance, following globalisation and liberalisation, is becoming increasingly important. There is now a widespread recognition of the need to focus on pro-cyclicality issues, systemic risk and internal and external shocks on the overall financial system.
There is also a need for supervisory policies to take into account the macro-financial linkages and examine potential feedback effects. As such, it is important to harmonise macro-prudential policy and monetary policy objectives. Potential conflicts and inconsistencies could arise, particularly in a situation where the statutory supervisory functions do not fully reside within the central banks. Furthermore, as illustrated by the case of Northern Rock (NR), there is a need to build closer working relationships amongst different stakeholders such financial safety net players and the fiscal authority. The NR debacle also shows that it is extremely important to look at communication strategies to ensure their effectiveness; for instance, how best to communicate the outcome of macro-prudential risk assessment and risk warning.
No macro-prudential framework would be complete without its international dimension. Following globalisation, the domestic financial markets have become increasingly integrated across countries with complex interrelationships. Cross border banking with the presence of multinational banks, newly emerging regional multinational banks included, has enhanced the ‘interconnectedness’ factor. In this regard, cross-border surveillance should be made an essential part of the macro-prudential framework for the regional financial system.
Objectives:
This research is thus intended to provide a clearer understanding on the need for macro-prudential approaches to complement micro-level supervision:
- Practical challenges in developing a consistent macro-prudential approach to regulation and supervision;
- Evaluate emerging macro-prudential tools and their suitability for developing economies; and,
- Potential regional cooperation in oversight and surveillance for macro-prudential policies.
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II. Case Studies
In line with the strategy to link research to learning, the Research and Learning Contents Department in OY 2011/12 aims to prepare 6 case studies. 2 of these case studies is proposed to be conducted “in-house”.
- Strengthening Financial Stability Indicators in the Midst of Rapid Financial Innovation: Updates and Assessments (BSFS)
- Policy Responses and Adjustments in the Course of Exchange Rate Appreciation (MMPM)
- Living with Capital Flows and Excess Liquidity: Assessing Effectiveness of Monetary Policy in SEACEN Economies (MMPM)
- Framework for Macro-prudential Policies for Emerging Economies in a Globalised Environment (BSFS)
- 2 “in-house” case studies as required for the proposed learning events for OY 2011/12
III. SEG Activities
The SEACEN Centre will continue to provide secretariat support for the SEACEN Expert Group (SEG) on Capital Flows. Specifically, the following activities are proposed for OY 2011/12:
1. 9th SEG Meeting
It is proposed that the 9th SEG Meeting be held to provide a forum for SEG members to exchange views on current issues of common interest related to capital flows.
2. Exchange of Data on Capital Flows
The SEACEN Centre will continue to facilitate the exchange of data in the confidential SEG database system and ensure the timely updating by SEG members.
3. Capacity-building in SEACEN Member Banks
To promote capacity building and exchange of views and experiences, various learning events have been proposed as part of the learning programme for OY 2011/12 to enhance expertise in the area of capital flows.
4. Assessment of Capital Flows
The SEG Secretariat is planning to prepare twice a year brief reports on capital flows to be circulated to members which includes forward looking indicators, namely, the Exchange Market Pressure (EMP) index as an initial stage of the Early Warning System (EWS) composite index.
IV. High Level Seminars on Exchange Rates and Capital and Capital Flows
2 High-level Seminars on Exchange Rates and Capital Flows respectively, are proposed for OY 2011/12, to be organized jointly between the Research and Learning Departments of the Centre.
V. Publications
1. 4 Research Studies
- a. Strengthening Financial Stability Indicators in the Midst of Rapid Financial Innovation: Updates and Assessments (BSFS)
- b. Policy Responses and Adjustments in the Course of Exchange Rate Appreciation
- c. Living with Capital Flows and Excess Liquidity: Assessing Effectiveness of Monetary Policy in SEACEN Economies
- d. Framework for Macro-prudential Policies for Emerging Economies in a Globalised Environment
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2. 6 Staff Papers
3. 4 Occasional Papers
4.2 SEACEN Economic Letters
(provides insights on topical global/regional issues, disseminates findings of research studies, staff papers, occasional papers and other research output)
5. 2 SEG Reports
6. 2 Background Papers for High-level Meetings
7. 2 Background Papers for High-level Seminars
8. Guide to SEACEN Bank Watch 2012
9. SEACEN Profile 2011
10. Annual Report 2011
11. SEACEN Programme 2011/12
12. SEACEN Newsletter
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