Exchange Rate Appreciation, Capital Flows and Excess Liquidity: Adjustment and Effectiveness of Policy Responses

The 2008-2009 Global Financial Crisis (GFC) brought the global economy to the brink of a global depression not seen since the Great Depression of the 1930’s. While several of the European peripheral countries remain deeply-mired in dealing with banking and sovereign debt problems, the Asian region is fast relegating the GFC as a thing of the past with its swift and immediate recovery from the recent crisis. Most recent indicators of economic performance by individual economies in the region show that indeed, it is the fastest growing region in the world at the moment. Such dynamism in the region, however, also comes with its own set of pressing and immediate challenges. Buoyant growth in the region, spurred to a great extent by the ultra-low policy rates in the region as well as by the series of quantitative easing in the advanced economies to revive their anemic growth prospects, has led foreign capital returning to the Asian region. With memories of the 1997-1998 Asian financial crisis still firmly etched in the memories of policymakers in the region, they know fully-well that capital inflows can both be a blessing and a curse. On the one hand, foreign capital can be tapped to augment the scarce availability of domestic savings and as such, can be crucially drawn upon to improve existing levels of physical and human infrastructures. Large capital inflows and the attendant rise in domestic currencies, however, can create macroeconomic problems and issues in an economy especially when these flows come in droves and are volatile. In particular, substantial capital inflows cause domestic credit to expand and speculative activities to swell, which can lead to inflated values in asset prices and create lingering risks in the balance sheets of households, banks and corporations. Once the tides turn, sudden stops or drastic reversals in these flows can lead to the bursting of asset bubbles, investment and output collapse and, ultimately, to a very costly recession, if not, a widespread depression. Cognizant of these concerns, SEACEN conducted two signature research projects which aimed to identify and debate issues surrounding capital inflows and exchange rate appreciations as well as to explore possible alternative measures in managing capital inflows and exchange rate appreciations