Staff Papers
Published Date: 01 November 2007

Ten Years from the Financial Crisis: Managing the Challenges Posed by Capital Flows.

MAS Staff Paper No. 48, November 2007 - By Khor Hoe Ee and Kit Wei Zheng


Asia has made a remarkable, if incomplete recovery in the ten years since the Asian Financial Crisis. Reflecting the economic recovery and more broadly, the globalization of finance, Asia has once again experienced massive foreign capital inflows since 2002. Unlike in the early 1990s however, a reversal of capital flows this time is unlikely to lead to a balance of payments or banking crisis similar in nature to 1997/98. Post-crisis structural reforms have strengthened the macroeconomic fundamentals of Asia, making it more robust and resilient to financial shocks. Notwithstanding the greater resilience of the region, large and volatile capital flows have brought with them other forms of risks and challenges, including excessive credit growth, sharp corrections in asset prices and high costs of sterilized foreign exchange interventions. Unfortunately, large and volatile capital flows are a permanent feature of the global financial landscape in the post-Bretton Woods era of open capital accounts and financial liberalization. Asian economies have no choice therefore but to manage the risks posed by capital flows while trying to retain control over exchange rates and monetary conditions. The best thing Asian economies can do is to enhance the robustness of their financial systems, pursue sound macroeconomic policies, judiciously build up reserves, and allow a greater degree of flexibility in their exchange rates to avoid major misalignments.