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Real exchange rate (RER) misalignment, which is the deviation between the actual real exchange rate from its equilibrium, occurs frequently among developing economies. Studies have shown that RER misalignment may have negative economic implications, such as a reduction in economic growth, exports and export diversification, and an increased risk of currency crises and political instability. Using quarterly data for 22 sample economies from 1990 to 2018, this paper investigates the impact of RER misalignment on business cycles in Asia and the Pacific by employing a panel vector autoregression involving consumer price index (CPI) inflation, output gap, short-term interest rate, and RER misalignment. We find that RER overvaluation may lead to a reduction in CPI inflation and short-term interest rate. We also find that Asia and the Pacific is highly heterogeneous wherein the output gaps of some economies, particularly those in Southeast Asia, are more susceptible to RER misalignment shocks.

More than 20 years after the Asian financial crisis, the region's continued high reliance on United States (US) dollar-denominated funding has significant implications for the transmission of global financial conditions to domestic financial and macroeconomic circumstances. Given limited domestic capital market-based financing solutions, a high reliance on funding denominated in US dollars renders countries vulnerable to changing global financial and liquidity conditions. Using a dynamic panel and a vector autoregression model to assess the exchange rate as a possible transmission channel, we find that changes in bilateral US dollar exchange rates can have a significant impact on sovereign credit risk. In particular, a depreciation of the domestic currency against the US dollar leads to a widening of the sovereign bond spread. This finding suggests a significant relationship between US dollar funding exposure, US dollar liquidity conditions, and domestic financial conditions in some emerging Asian economies, and thus highlights one source of structural vulnerability. Given that the magnitude of the effects varies across countries, policy makers need to monitor closely the interplay between the exchange rates and local financial market conditions with tailored prescriptions for domestic financial resilience.

In this study, we examine how public and private debt buildup is related to currency depreciation pressure. Our empirical analysis of a panel dataset of 59 advanced and emerging markets reveals that both private and public debt exacerbate currency vulnerability. However, the evidence of a significant effect on currency depreciation pressure is more robust and consistent for private debt than public debt. Furthermore, we find that excessive private debt buildup can be particularly harmful in emerging markets. In addition, our evidence suggests that greater dependence on external financing exacerbates the impact of debt buildup on currency stress. Overall, the evidence highlights the importance of a comprehensive debt surveillance framework which monitors both public and private debt buildup, especially in emerging markets.

This paper aims at identifying effective macroprudential policy (MPP) interventions and analysing the macroeconomic conditions that promote them. We define effective MPP interventions as those that stabilize its underlying target variable, such as credit growth, house price growth, etc. For our analysis, we construct a new database that documents the use of a large number of MPP instruments for 61 advanced and emerging market economies from 2000 to 2016. The new feature of the database is that it maps every recorded MPP intervention in these economies and over this period to stabilize a specific target variable category for banking, health, domestic loans, the exchange rate, foreign capital movements, and house prices. Using this dataset, we introduce a practical way for defining the macroprudential policy effectiveness. We find that MPP interventions are more likely to be effective when several prudential measures are taken together, but at the same time avoid the diminishing returns of repeated MPP tightening. Monetary tightening seems to override the effectiveness of MPP instruments. The output gap, credit cycle, external debt, current account, and global risk appetite also count for the likelihood of MPP successes. The paper provides a guideline for the effective conduct of MPPs.

There is mixed evidence for the impact of international capital flows on financial sector's stability. This paper investigates the relationship between components of gross capital flows and various financial stability indicators for 16 emerging and newly industrialized economies. Departing from panel data methods, for each financial stability proxy, we employ systems of seemingly unrelated regression estimators to allow variation in the estimated relationship across countries, while permitting crossequation restrictions to be imposed within a country. The findings suggest that, after controlling for macroeconomic factors, there are significant effects of different gross capital flow measures on the financial stability proxies. However, the effects are not homogeneous across our sample economies and across flows. Country-specific financial and macroeconomic characteristics help to explain some of these differences.

Contingent claims analysis applied to Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand shows no particular vulnerability to sovereign debt distress during recent years. However, the highly volatile "distance to distress" measure suggests that any of these countries may fall victim to a sudden loss in market confidence. For example, the value of Indonesia's sovereign assets dropped to just two standard deviations above its repayment obligations during the 2013 Fed taper tantrum, causing capital outflows and currency depreciation. Generally, we find that contingent claims analysis and market-based risk measures well complement conventional debt sustainability analysis for Asia.

Recent key challenges highlight the need to revisit Asia’s financial development. These include the region’s growth slowdown since the global crisis, compounded by a less benign external environment; internal structural challenges, such as population aging; and the maturing of much of the region into middle-income status. The evolving shift in the region’s growth paradigm from one based primarily on investment to one based on both investment and productivity growth also underscores the urgency for financial development. For economic growth to benefit more from a sound and efficient financial system, financial development should be complemented with structural and policy reforms in other areas. This means that financial development and inclusion work best in a policy environment that is conducive to growth and development.

We produce predictions of the current state of the Indonesian economy by estimating a Dynamic Factor Model on a dataset of 11 indicators (also followed closely by market operators) over the time period 2002 to 2014. Besides the standard difficulties associated with constructing timely indicators of current economic conditions, Indonesia presents additional challenges typical to emerging market economies where data are often scant and unreliable. By means of a pseudo-real-time forecasting exercise we show that our model outperforms univariate benchmarks, and it does comparably with predictions of market operators. Finally, we show that when quality of data is low, a careful selection of indicators is crucial for better forecast performance.

Recent key challenges highlight the need to revisit Asia's financial development. These include the region's growth slowdown since the global crisis, compounded by a less benign external environment; internal structural challenges, such as population aging; and the maturing of much of the region into middle-income status. The evolving shift in the region's growth paradigm from one based primarily on investment to one based on both investment and productivity growth also underscores the urgency for financial development. For economic growth to benefit more from a sound and efficient financial system, financial development should be complemented with structural and policy reforms in other areas. This means that financial development and inclusion work best in a policy environment that is conducive to growth and development.

Our previous assessment of debt sustainability in developing Asia, conducted in 2011, found that the region's fiscal outlook was mostly benign. In this study we update the debt sustainability assessment, taking stock of the latest data and including a larger number of countries. With the benefit of hindsight, we assess the accuracy of our earlier debt ratio forecasts and the underlying macroeconomic assumptions. By and large, we find that standard debt sustainability analysis (DSA) represents a valid forecasting tool, able to predict debt ratios fairly accurately under reasonable assumptions and circumstances. Further, our fan chart analysis confirms the importance for stochastic analysis to integrate standard DSA, in order to capture heightened macroeconomic volatility, which we observe for some countries in the region. Looking forward to 2020, debt ratio projections confirm that the outlook remains benign for the region as a whole, country heterogeneity notwithstanding. On the issue of DSA methods and implementation, we emphasize the importance of macroeconomic forecast accuracy and suggest that volatility be captured by risk analysis tools that would optimally flank the standard DSA framework.

In the postglobal financial crisis period, the central banks of the advanced economies pursued unconventional monetary policies, such as the United States (US) Federal Reserve's quantitative easing (QE). Those policies and their unwinding may significantly affect cross-border capital flows and thus destabilize the financial systems of emerging markets. For example, emerging markets experienced substantial financial instability during the taper tantrum triggered by the US Federal Reserve Chairman Ben Bernanke's May 2013 announcement of the potential unwinding of QE. In this paper, we examine the spillovers from the taper tantrum on emerging markets more rigorously by using econometric analysis to empirically assess the effect on equity markets in emerging markets. Our central finding that virtually all emerging market equity markets were affected by the taper tantrum highlights the need for emerging market authorities to remain vigilant about the effects of advanced economy monetary policies on their financial stability.

Events surrounding the global financial crisis have brought to light the potential role of monetary policy in precipitating the crisis. Numerous studies on advanced economies have documented a significant negative relationship between interest rates and bank risk-taking. This paper also finds the presence of the risk-taking channel based on a panel of publicly listed bank data in Asia. Using both annual and quarterly data, "too low" interest rates are found to lead to an increase in bank risk-taking.

This paper estimates the impact of monetary policy on exchange rates and stock markets for eight small open economies: Australia, Canada, the Republic of Korea, New Zealand, the United Kingdom, Indonesia, Malaysia and Thailand. On average across these countries, a one percentage point surprise rise in official interest rates leads to a 1% appreciation of the exchange rate and a 1% fall in stock market indices. The effect on exchange rates is notably weaker in the non-Organization for Economic Cooperation and Development (OECD) countries with a managed float. For the OECD countries, there is no robust evidence of a change in the effect of policy during the global financial crisis. For the non-OECD countries, there is some evidence of a stronger effect of policy on stock markets during the crisis, although further research is needed to investigate whether this is a result of measurement issues.

This paper simulates the impact of a short-term shock originating from the global financial system on small open economies in the Association of Southeast Asian Nations (ASEAN). The simulation uses empirically estimated general equilibrium models for Indonesia, Malaysia, the Philippines, and Thailand. The study finds that the impact of a pure international financial shock on aggregate domestic price inflation and on output gap for each of the four ASEAN countries tends to be relatively small but long-lasting, placing challenges in the medium- to long-term management of economic volatility.