IMF Says Emerging Economies Must Promote Forex Flexibility

Emerging economies should promote exchange rate flexibility and, in some cases, tighten fiscal policy to guard against volatility in capital flows, the chief of the International Monetary Fund said Tuesday.

Rodrigo de Rato told businessmen in Manila that risks associated with financial globalization and the dramatic increase in large leveraged private equity buyouts pose threats to global growth and investment flows. He said risks to financial globalization, which has greatly contributed to prosperity in recent years, don't seem to be fully appreciated, as the turmoil in the US subprime mortgage market has illustrated. But even as he called for a fresh look at lenders' underwriting standards, he downplayed the impact on the US economy. He said the IMF expects the world's biggest economy to regain momentum later this year as the drag caused by the current housing correction dissipates. "These developments don't pose a systemic threat," said Rato. "The scale of any potential subprime losses, in our opinion, looks to be much lower than earlier savings and loans crises." He said the market is already adjusting to the new credit risk environment. "We are in the midst of a rerating of credit risk, which in our opinion is welcome," he added. Emerging markets that have recently benefited from the steady inflow of portfolio capital should brace themselves for the fickle nature of these investments, he said. Rato suggested a twofold response to a possible abrupt reversal of substantial capital flows - sound macroeconomic management and financial sector deepening. "The best macroeconomic policy response is to pursue exchange rate flexibility with limited intervention....In some cases, fiscal tightening is also appropriate," he added. As for China, which the IMF expects to be the main driver of world economic growth this year, Rato said the country needs more flexibility in its exchange rate policy to help cool its economy. "It needs to cool its investment rhythm and translate that to more private consumption," he said. He said a more active monetary policy would reward savers in China, which would increase domestic savings, generate investments and create more domestic jobs than just promoting exports. "And to do that more flexibility in the exchange rate is needed," Rato said. China needs more sustainable growth as it will be the main driver of global growth this year, overtaking the US and Europe, he said.