Emerging market countries have a much stronger fundamentals, better growth prospect and higher interest rates. These differences in fundamentals have attracted growing and significant capital flows to these parts of the world. Net private capital flows into emerging markets was projected by the Institute of International Finance to rise to USD825 billion by the end of 2010, representing a 42% increase from last year. Many analysts expect the recent Federal Reserve’s policy decision to purchase another USD600 billion of US Treasury bonds under “QE2” will intensify further flows to the region. Economists estimated that between a quarter to half of the QE2 liquidity will flood into emerging markets. The inflows if not managed properly will pose difficulties to Asian and emerging markets. Policymakers would face several predicaments from policy perspectives. The influx of capital inflows, have led to a rapid expansion of liquidity translating into rising prices, leading to concerns on asset bubbles and the possibility of overheating the economy. However, the impact on each economy will differ depending on the size of the inflows and the ability of those markets to manage the flows. The upward pressure on the exchange rates has also been significant as seen by the appreciation of regional currencies at an average of 4% on a real trade-weighted basis since beginning of the year. Understandably, such pace of appreciation has raised some concerns among businesses especially in highly open economies, where movements of exchange rates will certainly impact businesses.
Under this new normal situation, the agility of businesses and the economy to adapt and adjust to the challenging environment is critical. There are a number of possible adjustments which can be done including raising productivity and efficiency. In formulating public policy, policymakers are faced with the challenge to strike a fine balance in handling the capital flows and its impact to the economy. Because of the enormity of the flows, a combination of approaches had been adopted by emerging economies to manage capital flows. Even measures regarded as unorthodox at one time are now being implemented. Most countries  BIS Review 162/2010  1  have allowed greater currency flexibility; and many have ended up accumulating foreign reserves. These inflows were typically sterilised by the central banks to avoid pressure to domestic liquidity and price level. Regional market developments Turning now to the second part of my remarks on key developments in the regional financial markets. The ability of regional economies to weather the recent financial crisis has its root in the aftermath of the 1997–98 crisis. Many had use the past financial crisis period to embark on bold financial reforms and restructure their financial landscape. Of particular importance were the successful efforts and policy initiatives to develop the bond market. As a result of these initiatives, the depth and breadth of regional capital markets have reached a level of maturity which can now absorb and intermediate large and volatile flows without posing risks to financial stability.