FX flexibility can act as buffer to hot money: IMF’s Shinohara

Naoyuki Shinohara, a deputy managing director of the International Monetary Fund, on Friday said greater exchange rate flexibility would help protect emerging market countries from growing capital inflows.

At a conference in Colombo, Sri Lanka, Shinohara said: "Greater exchange rate flexibility can offer an important buffer against the risk… that large capital inflows may undermine efforts to tighten the monetary stance. With global interest rates likely to remain low, countries with tightly managed exchange rates in effect import easy global monetary conditions, unless they tighten capital controls."

Shinohara said most emerging market countries had so far relied on a combination of currency appreciation and reserve accumulation to accommodate capital inflows. Shinohara said that while sterilisation policies in the region appeared to have worked so far, the question was whether the structure of central banks' balance sheets and the limited size and depth of domestic fixed-income markets could support a significant further expansion in sterilisation operations.

"This may require introducing new instruments, such as allowing central banks to issue their own paper where this is currently not possible," Shinohara said.

Click here to read the speech.