Some emerging markets like Brazil, Chile, Israel and Poland recently adopted the flexible regime for exchange rate management (ERM). In spite of benefits like better protection against external shocks, greater monetary policy independence, etc., many developing countries are hesitating to adopt it. An orderly exit from the peg system needs advance preparation and good timing. The question is whether these countries shift before or after liberalizing their capital account convertibility. they need sound macroeconomic and structural economies to adopt a flexible system. this article tries to alleviate the fears about the floating rate.
Although a majority of the world's countries maintain pegged exchange rate regimes, a growing number of economiessuch as Brazil, Chile, Israel and Polandhave adopted flexible regimes over the past decade. This trend will likely continue, because deepening cross-border linkages have increased the exposure of countries with pegged regimes to volatile capital flows. And flexible regimes usually offer better protection against external shocks and greater monetary policy independence.
First, it is essential for countries to develop a deep and liquid foreign exchange market for priceexchange ratediscovery and determination. Foreign exchange markets of most developing and emerging market economies are shallow and inefficient, partly because they rely extensively on foreign exchange regulations. Exchange rate rigidity also hinders the development of the foreign exchange market because market participants have less incentive to form views on exchange rate trends, take positions or manage risks.
Countries that have managed orderly exits from pegs have, thus, generally adopted inflation targeting as an alternative nominal anchor over long-time horizons. The lengthy transition periods have reflected, in part, the time required to fulfill the necessary institutional requirements and macroeconomic conditions. |
