Published Date: 10 July 2006

Opening Remarks by Mr Heng Swee Keat, Managing Director, Monetary Authority of Singapore, at the IMF-Singapore High Level Seminar on Crisis Prevention, Singapore, 10 Jul 2006

Mr Taktoshi Kato, Deputy Managing Director of the IMF,

Colleagues from the IMF, fellow Central Banks and Ministries of Finance,

1   My colleagues and I at the MAS warmly welcome you to Singapore and to this high-level seminar on Crisis Prevention in Emerging Market Economies. This seminar is organised by the IMF and the Singapore government in the run up to the 2006 IMF-World Bank Annual Meetings, which will be held here in  September. We are delighted to have here today a group of economists and policymakers from approximately 40 countries. Speakers from the IMF, Asia, Latin America and Europe will present their research and experience, and I am sure there is much that we will learn from each other.

2   Financial crises have been a prominent and recurrent feature of the financial landscape. Indeed, Professor Charles Kindleberger who has studied many of these crises, characterised them as 'hardy perennials', and traced the history of such crisis to as early as 1619, at the outbreak of the Thirty Years War. Since then, we have witnessed many more major financial crises with serious international repercussions. These include the 1873 crisis in continental Europe, the Wall Street crash in 1929, the Mexican default and Latin American debt crises of the 1980s, and closer to home, the Asian financial crisis of 1997 that resulted in a region-wide meltdown.

3   The topic of this seminar complements an earlier IMF-MAS high level seminar on "Asian Regional Financial Integration" just two months ago in Singapore. At the May seminar, participants agreed that significant benefits can be derived from greater economic and financial integration.

4   The increasing integration of global capital markets has resulted in a more efficient allocation of savings and investment, thereby promoting faster economic growth and development. Nevertheless, it is also clear that "sudden stops" in capital flows or outright reversals can lead to significant dislocations in economic activities, and cause distress to households and corporates. Indeed, increased integration of markets has also raised the risks of contagion effects, affecting countries that are otherwise regarded as "healthy".

5   Apart from greater integration, another feature of financial markets in recent years is the speed of innovation. Many more new financial instruments, including structured products and derivatives have been introduced in the markets. On the whole, these have served very important functions of deepening markets and facilitating more efficient risk transfer. However, we also need to better understand the pricing and incidence of risks of these products, and their impact on financial stability. Our regulatory knowledge and policies must continue to evolve to keep pace with the developments of these innovative products.

6   In short, the faster pace of integration and innovation in financial markets can bring even more opportunities for many markets including emerging markets. But to benefit from these, we must learn to manage the risks and volatilities that are associated with these. Today's seminar, focusing on crisis prevention in emerging markets, is therefore very timely.

7   Our challenge is to try to understand the nature and causes of crises, devise indicators that may serve as warning signs of impending crises, and take proactive measures to avert possible crises. We will not be able to fully eliminate crises. But we can draw useful lessons from the past, and take proactive steps, both individually and collectively, to reduce the incidence and severity of such crises. Allow me to share three observations.

8   First, a sound macroeconomic framework with appropriate fiscal and monetary policies serves as the core in crisis prevention. A country's own economic policies remain the primary line of defense against external shocks. Prof Graciela Kaminsky of George Washington University, found that in a sample of 96 crises, 86% were characterised by multiple domestic vulnerabilities, including highly expansionary credit growth or loose monetary policy, debt problems and macro-policies that were inconsistent with a pegged exchange rate regime.

9   Structural and balance sheet vulnerabilities, as well as inconsistent macroeconomic policies and inappropriate exchange rate regimes, are potential problems that need to be addressed early, before the effects of self-reinforcing negative confidence take hold.

10   In crisis prevention, there is considerable agreement that adopting the appropriate choice of exchange rate regime is important. Unfortunately, there is less agreement as to what constitutes an "appropriate" exchange rate regime. I share the view that no currency regime can be right for all countries and at all times. A few years ago, bipolar options - either fixed or free-floating, were fashionable. Nevertheless, some countries have found success with intermediate regimes. At this point, perhaps I can share a little on Singapore's experience as a small open economy that has chosen the "middle ground".

11   Since 1981, monetary policy in Singapore has been centred on the management of the exchange rate, with the primary objective to promote price stability as a sound basis for sustainable economic growth. Singapore's exchange rate is managed against a basket of currencies of its main trading partners and is characterised by the Basket-Band-Crawl framework, which allows us to accommodate both short-term market volatility and medium- to longer-term changes in economic fundamentals. This intermediate option of a managed float has worked well for Singapore, helping to buffer the adverse effects on the economy of short-term financial volatility, and to avoid sustained currency misalignments that can invite speculative attacks.

12   My second observation is that besides sound macroeconomic policies, we need sound micro-prudential policies and institutions. More often than not, currency crises are accompanied by banking crises. Twin crises not only raise the cost of crises but also complicate the formulation of crisis management policies. The liberalization of the financial sector therefore needs to be accompanied by the strengthening of financial institutions and systems. Strong prudential supervision, corporate governance and market discipline are all required to build a healthy system resilient to external shocks. In a recent comprehensive study on bank regulation, James Barth, Gerard Caprio and Ross Levine concluded that regulatory policies that boost private-sector monitoring of banks tend to make banking systems more developed and crises less likely.

13   It is heartening that many emerging economies including those in this region have made significant strides in both macro-economic as well as micro-prudential policies in crisis prevention. For example, a number of central banks in the region have adopted inflation targeting as the monetary policy regime. Inflation targeting commits the central bank towards explicit medium term inflation targets. This and the associated institutional reforms and enhancement of transparency have generally been welcomed by the markets. The anchoring of the public's inflation expectation has permitted a greater degree of exchange rate flexibility. In addition, there have been significant improvements in the health of East Asian financial systems. External debt as a percentage of GDP has been reduced in most East Asian economies. In the corporate sector, debt levels have decreased while profitability has improved significantly after a period of consolidation and restructuring. Going forward, it is critical for countries to carry on the implementation of sound macroeconomic policies and structural reforms.

14   History suggests that sound macroeconomic policies and institutions are a necessary but not sufficient condition for crisis prevention. Countries with fundamentally sound economic policies and balance sheets, but with a high degree of integration into international capital markets, may still face significant capital account pressures or contagion effects that could spiral into a general loss of confidence, leading to a self-fulfilling run on its currency.

15   Hence, my final observation is that sound policies and effective surveillance do not always guarantee the elimination of all sources of vulnerabilities. There is therefore an important role for international financial institutions, regional self-help mechanisms and self-insurance in preventing crisis and in mitigating its impact. For example, international financial institutions can help in identifying and highlighting the potential vulnerabilities and global systemic issues resulting from increasing cross border flows.

16   This seminar will provide a platform for a lively discussion as we delve deeper into the various aspects of crisis prevention. There is indeed much we can do and learn from each other. With these thoughts, it is my pleasure to invite IMF Deputy Managing Director Mr Takatoshi Kato to give his welcoming remarks. Thank you.