An analysis of the complexities, challenges and vulnerabilities faced by EMEs in the conduct of exchange rate policy and managing volatilities in foreign exchange market reveal that the choice of a particular exchange rate regime alone cannot meet all the requirements. The emerging consensus is that for successful conduct of exchange rate policy, it is essential for countries to pursue sound and credible macroeconomic policies so as to avoid the build-up of major macro imbalances in the economy. Second, it is essential for EMEs to improve the flexibility of their product and factor markets in order to cope and adjust to shocks arising from the volatility of currency markets and swings in the terms of trade in world product markets. Third, it is crucial for EMEs to develop and strengthen their financial systems in order to enhance their resilience to shocks. In addition, a sound and efficient banking system together with deep and liquid capital market contributes to the efficient intermediation of financial flows. This could help prevent the emergence of vulnerabilities in the financial system by minimising unsound lending practices that lead to the build-up of excessive leveraging in the corporate sector and exposure to foreign currency borrowings. Fourth, countries would need to build regulatory and supervisory capabilities to keep pace with financial innovations and the emergence of new financial institutions’ activities, and new products and services, which have complicated the conduct of exchange rate policy. Fifth, policy makers need to promote greater disclosures and transparency.
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