Exchange rate flexibility has increased in emerging markets, says IMF working paper

By Reshmi Basu

New York, June 1 - Exchange rate flexibility in emerging markets has increased in the last decade, according to an International Monetary Fund working paper by Dalia S. Hakura.

In the paper titled "Are emerging market countries learning to float?" Hakura suggests that "learning to float" appears to have "involved a strengthening of monetary and financial policy frameworks aimed at directly addressing the key vulnerabilities that give rise to the 'fear of floating.'"

According to Hakura, the "fear of floating" stems from the actual or perceived costs of exchange rate volatility.

Since currency fluctuations carry dangers such as inflation, and therefore can affect balance sheets and debt-servicing burdens, some policy makers believe that the room to pursue independent monetary policy and increased exchange rate flexibility is limited.

Research has shown that the strengthening of monetary and financial policy frameworks is crucial for the successful introduction of more flexible exchange rates, said the author. The paper reflects his own views, not official IMF policy.

"Stronger monetary and financial policy frameworks (or a 'learning to float') can reduce the constraints on the conduct of monetary policy," Hakura noted.

The author finds that the number of emerging markets countries with free floats rose from virtually zero in the early 1990s to more than one-third in recent years.

"While there have been some transitions toward less flexible regimes, most have been toward greater flexibility. The number of peg-to-intermediate and intermediate-to-fee float transition were broadly similar, and both were nearly evenly split between voluntary and crisis-driven transitions," writes Hakura.

In addition, Hakura finds that voluntary transitions were generally not associated with an increase in macroeconomic stability.

Another finding is that the transition to greater exchange rate flexibility has to do with the strengthening of monetary and financial policies.

"Also, most EM countries that moved to a free float introduced full-fledged inflation targeting only after the transition," noted the author.

Furthermore, those countries making a voluntary first step had on average less financial liberalization.

The empirical analysis suggests that "learning to float" involves increased monetary autonomy through the strengthening of monetary and financial policy frameworks, in particular banking supervision.

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