Tarisa Watanagase: Issues important to small and open emerging market economies Speech by Dr Tarisa Watanagase, Governor of the Bank of Thailand, at the Panel Discussion on Financial Globalisation, Capital Flows, and Challenges for Central Banks, at the 77th Annual General Meeting of the Bank for International Settlements, Basel, 24 June 2007. *  *  *  My discussion will focus on the issues important to small and open emerging market economies. The first is regards to whether the present situation of sustained inflows into emerging markets is really sustainable. What do these seemingly sustained inflows tell us, particularly in terms of investors’ assessment of riskiness of the region? Or from another angle, have risks in the region declined? I will discuss this in the context of financial innovations in risk management, and conclude with a few remarks on how these developments affect central banks across the globe. My first question, therefore, arises from the observable reduction of risk premia for financial assets in the region. On the surface, this low risk premia implies lower risks. But does, it, really? We all realize that the international financial system is currently in an environment with low risk premia across a broad set of asset classes, combined with low volatility in the prices of these assets. Furthermore, this low risk premia has been sustained despite the various episodes of risk aversion in the recent past. This raises concerns about whether prices – and consequently the risk premia themselves – accurately reflect actual risks.
An example of such a change is the wave of worldwide mergers and acquisitions, resulting from globalization, and improvements in efficiency through economies of scale and integration. While this has exerted upward pressure on equity prices, this may not be a great concern for stability. On the other hand, some changes drive prices away from fundamentals. This includes asset price moves caused by excessive investment in developed financial markets, or short term capital inflows into emerging markets in search of yield, or through carry trades, etc., which may result in asset price misalignments. In this regard, the question arises whether the central bank’s price stability objective is enough for financial stability, given destabilizing asset price movements, coupled with movements in the exchange rate, which may not be in line with fundamentals. BIS Review 74/2007  3