When it comes to choosing a foreign exchange rate regime, fixed rate regime have on repeated occasions proved to be crisis-prone, with the latest example being Argentina, according to Andrew Crockett, general manager, Bank for International Settlements (BIS).
A measure of exchange rate flexibility is therefore a key feature of reducing vulnerability to crisis, Crockett said while addressing a bankers gathering at the Administrative Staff College of India here on Monday.
Although fixed-rate regimes have a number of benefits, notably in providing an anchor for domestic monetary policy and a stable environment for international trade, for most large economies the costs outweigh the benefits, he said.
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Countries such as China and India, which still have capital controls, should exercise care while dismantling them. Capital controls should be phased out only as prudential supervision and risk management techniques of financial institutions are developed to adequately manage the risks inherent in a liberalised financial environment, he warned.
A lesson from the Asian crisis in 1990s is that developing domestic markets can help risk management to a greater extent. Concentrating risks in the banking sector increases the systemic vulnerability of an economy. It is important that alternative and competing savings and investment opportunities are available to diversify risks.
Local bond markets can help reduce both maturity and foreign exchange mismatches. When local bond markets are not well developed, local firms are forced to get long-term finance from abroad, exposing themselves to foreign exchange risks, Crockett said.
Andhra Pradesh governor and former Reserve Bank of India governor C Rangarajan said that creation of special drawing rights (SDR) on temporary basis is must for developing countries to solve their crisis.
It is the banking industry in East Asia, which has withdrawn $70 billion of the $100 billion total withdrawals and worsened the situation, Rangarajan criticised.
Y V Reddy, deputy governor of RBI, said that with liberalisation and market-oriented system in place, the direct responsibility of the government is diminishing and the indirect responsibilities are increasing.