Living with Volatilities: Capital Flows and Policy Implications for SEACEN Central Banks

Economies with less developed financial markets might find their integration into global financial markets associated with volatility in capital flows. Such variability can prove to be disruptive to domestic economic and financial conditions, raising policy questions about how to realize the benefits from financial integration while minimizing adverse spillovers. In the first instance policy makers need to understand the dynamics of capital flows and the underlying sources of potential instabilities before enacting a response. We dissect the capital accounts of Asia-Pacific economies associated with SEACEN and explore some important trends and exposures. The region has been subject to several financial shocks mainly reflected in bank-related capital flows. This is useful in understanding past crises but not necessarily helpful in looking out for the next bout of instability. We discuss the possible implications of monetary policy normalization in the United States but based on past cycles see little cause for concern. Having said that, this is a unique juncture for the global financial system and uncertainty is higher than usual. The hierarchy of policy responses to concerns about capital movements ranges from longer-term structural economic and financial reforms to allow economies to accommodate volatility, to crisis responses which are more temporary in nature. All policy reactions have costs and benefits. Importantly, even in Asia Pacific there appear to be few regularities that would allow generalized policy advice other than to do what this paper attempts to do – dissect the capital account and exposures to make policy makers aware of looming vulnerabilities and appropriate responses.