MNI POLICY: EM FX Intervention Counterproductive, Paper Argues

By Alexandra Kelley

     WASHINGTON (MNI) - Attempts by emerging-market central banks to limit

swings in the value of their currencies when the Federal Reserve adjusts

interest rates can be counterproductive and sap growth, according to research to

be presented at Friday's Jackson Hole Economic Symposium.

     The best way for emerging markets to reduce their exposure to changes in

Fed policy is to improve institutional quality, cutting risk premia and reducing

capital flow volatility by improving governance, transparency and accountability

and fighting corruption, University of Maryland Professor Sebnew Kalemli-Ozcan

wrote in the paper.

     "The case for flexible exchange rates is stronger in a world of

international risk spillovers since exchange rate adjustment can smooth out

shocks to risk sentiments," she wrote, adding that attempts to defend currencies

by raising local interest rates hit gross domestic product.

     As investors require relatively higher returns from emerging-market assets

in order to compensate for their perceived higher risks, local central banks

tend to be forced to make a much larger increase in their domestic policy rate

than any Fed tightening in order to maintain currency stability. Limiting

exchange rate volatility can also prompt more companies to borrow in foreign

currency, increasing balance sheet vulnerability.

     "In order to achieve higher GDP growth and mitigate volatility related to

monetary policy spillovers, countries need to decrease the risk-sensitivity of

capital flows through reducing inherent country risk by improving institutional

quality," wrote Kalemli-Ozcan.

--MNI Washington Bureau; +1 202 371 2121; email: alexandra.kelley@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MGU$$$]