In other words, a central bank can run the risk of being insolvent, even when it has been successful in maintaining the stability in the value of its currency. The insolvency risk of a central bank is less obvious, because of the very nature of a central bank. A central bank, even if its capital is negative and its currency liability is not matched by an equivalent value of foreign assets or valuable domestic assets, could still continue to be in business unlike a private organisation. In the case of a private organisation, if the net-worth is negative, it has to be re-capitalised as an urgent need. If it does not happen, it cannot operate as a going concern and has to be liquidated on the ground of insolvency. However, a central bank can still operate with a negative net-worth, by continuing to issue currency as long as the members of the public are willing to accept such currency in exchange for the assets held by them. It could, in these circumstances, defer and hide the need for recapitalising itself and continue to be in operation. The fact that the insolvency of a central bank is not known to the outside world does not mean that a central bank is without problems. A central bank’s operations are smooth and faultless, if its expenses are funded out of net interest income it earns on its foreign reserves or its domestic asset portfolio.
Assessing whether capital flows to emerging market economies are permanent or transitory is a challenging task. The current wave of capital inflows reflects both global push factors (including ample liquidity and low interest rates across advanced economies) as well as country-specific pull factors (including buoyant growth prospects, relatively sound fiscal positions, and decreasing country risk perceptions). Over the medium term the pull factors  BIS central bankers’ speeches  1  are likely to remain complacent, as relative to advanced economies, emerging markets are expected to grow faster, which would put upward pressure on interest and exchange rates, perpetuating their attractiveness for international capital. Although it is far from certain whether quantitative easing in several advanced economies would persist in the medium term, monetary authorities in these countries are likely to maintain their accommodative stance in the near future as well. All in all, the current outlook suggests that capital flows to emerging market economies may be a permanent phenomenon, while its magnitude is subject to change in risk perceptions. While tools to manage large capital inflows are well known, the appropriate policy mix depends on country-specific circumstances. Fiscal policy, monetary policy, exchange rate policy, foreign exchange market intervention, macro-prudential tools, and capital controls could be used to cope with the inflows, but each of them entails some tradeoffs, which are likely to be quite costly for emerging deficit countries in particular.