These international funds are generally highly alert to shifts in the expectation of risk, return and liquidity. They can therefore be highly volatile, with the tendency of reversing direction whenever there is the slightest hint of trouble, in respect of the macroeconomic policies, in particular financial policies pursued by governments, the robustness of the financial markets in which they operate, the soundness of the financial intermediaries with which they deal, etc. 8. Those economies which are dependent upon such capital inflows are clearly vulnerable to their reversal. Ideally therefore they ought to pay a lot of attention to pursuing sound macroeconomic policies and be transparent about them. This has perhaps proven to be politically difficult to achieve in some cases. They also need to ensure that they are in a position to deal with the volatility that characterizes the flow of international capital. And this means having: first, an effective monetary management mechanism that is capable of delivering currency stability; second, a regulatory and supervisory framework that safeguards the integrity of financial markets and the financial intermediaries in accordance with internationally accepted standards; and third, a robust financial infrastructure that enables financial transactions to be conducted efficiently and with a minimum of risk of failure. 9. This is a tall order, even for a relatively closed financial system that operates under more benign circumstances, not to mention for a newly liberalized financial system under stressful conditions.
Furthermore, when stable exchange rates are replaced by flexible, volatile and, in all likelihood, depreciating ones, the demand for hedging in the more volatile environment and under liberalized arrangements may drive exchange rates to such debilitating levels that many would regret the lack of resolve in pursuing sensible policies and in the defence of stable exchange rates in the first place. There is no doubt that confidence in the stability of a few Asian currencies has now been badly undermined and rebuilding it may take more than just time. Nevertheless, as the very productive Asian economies find their feet again, they will soon be on their way with renewed vigour. 23. For Hong Kong, as very much a service-oriented economy, any erosion of competitiveness, as a result of our currency holding stable against the US dollar while others have fallen, is likely to be mild. Our economy is not particularly sensitive to exchange rate changes. The IMF forecast for Hong Kong’s growth rate next year is 4.25%, only a shade below our trend growth rate of 5%, representing a healthy consolidation in the circumstances. BIS Review 115/1997