I Introduction

International Monetary Fund
Published Date:
January 1995
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International capital markets have once again passed through an eventful period since the last report on capital markets surveillance in September 1994. The re-evaluation of prospects for emerging markets by foreign investors, which accompanied the cyclical upswing in industrial countries in 1994—gathering momentum in the aftermath of the Mexican crisis at the end of December—left few developing country markets untested. Barely a little more than a decade after the Mexican debt-service moratorium opened the first chapter in the previous developing-country debt crisis, key emerging markets were again being supported by international loan packages intended to reduce the risk of a regional or global economic disruption. Meanwhile, the possibility that derivatives-related losses by firms such as Barings and Metallgesellschaft, as well as by Orange County, could have had serious spillovers suggests that there is room for further improvement in the international regulatory and supervisory infrastructure.

These events underscore the challenges that financial authorities around the world will have to meet in this new period of rapidly evolving global capital markets. They also motivate the choice of topics for this year’s international capital markets surveillance report. Chapter II of the report addresses the international financial markets aspects of the current turbulence in emerging markets. After briefly reviewing the sources of capital flows to emerging markets and the developments that led to the Mexican crisis at the end of 1994 and the beginning of 1995, the report discusses five issues related to recent developments in emerging markets. These are the contagion from the Mexican crisis; the influence of resident investors in emerging market countries on cross-border flows; the extent to which the fragility of banking systems in emerging market countries limits the increases in interest rates that can be implemented to defend exchange rates; the stability of global banking and payment systems; and the impact of the changing global capital markets environment on the modalities of resolving external debt-servicing difficulties. The report then considers the challenges faced by emerging market countries in managing the risks that are part and parcel of capital inflows. These are the risk to macroeconomic stability; risks to the financial sector; and debt-management and liquidity risks. It should be noted explicitly that this report does not take up questions about the potential role of international financial institutions in dealing with the consequences of the growing scale and speed of international capital flows to and from emerging markets.

Chapter III contains a discussion of international financial supervisory and regulatory issues. It considers the challenges for international regulators and supervisors posed by the continuing growth of international derivative markets and their impact on the activities of the major money-center banks. The chapter reviews how the successful strengthening of the supervisory and regulatory infrastructure for managing risk in these markets in recent years is continuing with a major initiative by the Basle Committee to reformulate capital requirements for international banking firms. It also briefly touches on some aspects of the resolution of banking difficulties in some major industrial countries. Chapter IV concludes by discussing various policy implications.

The report is followed by two groups of self-contained background papers. The first provides background material and analyses pertaining to the crisis in emerging markets and includes papers on recent trends in capital flows to developing countries, the evolution of the Mexican crisis, the Mexican peso crisis from the perspective of the speculative attacks literature, the macroeconomic policy responses to previous surges of capital flows, the experience with capital controls, and two sections on domestic financial sector issues in developing countries. The second group pertains to the supervisory and regulatory issues in the industrial countries, including capital adequacy and internal risk managment, initiatives relating to derivative markets, mechanisms for international cooperation in financial regulation, the regulatory implications of the Barings failure, the increasing importance of institutional investors, and a paper on bubbles and noise in speculative markets.

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