Recent experience in emerging markets has led to a greater realization of the dangers posed to countries by premature capital account liberalization. even the IMF's views of the efficacy of capital controls have shifted in recent months. In its September 1998 report on international financial markets, the Fund said: "The combination of a weak banking system and an open capital account was an accident waiting to happen." In the same report and in subsequent public pronouncements the IMF has also suggested that as the strengthening of financial systems takes time, temporary controls on short term capital inflows could be a useful tool to buy time for rectifying weaknesses in the banking sector. It then follows that in the absence of a lender of last resort, countries contemplating capital account liberalization need to have strongly capitalized banks, strict prudential control over foreign currency assets and liabilities, access to substantial international reserves, a strong fiscal position and exchange rate stability.

However, even with strong fundamentals in these areas, emerging markets have found it difficult to cope with the volatility of international capital flows. Countries should, therefore, have the right to reverse liberalization measures if a change in domestic or international events should call for it. Although there should be  a preference for market based measures, countries should not be precluded from applying capital controls of an administrative character in times of emergency.

The East asian crisis has led to much discussion as to what constitutes an appropriate exchange rate regime to avoid financial crises. While the costs and benefits of different exchange rate regimes have been discussed elsewhere, suffice it to say that no regime is likely to provide fool-proof guarantee against such crises. Experience has shown that a great variety of exchange rate regimes have been successful in the past in bringing stability to financial systems, at least for a period. Such regimes range from currency boards to freely floating exchange rates, including intermediate regimes such as crawling pegs, exchange rate bands and dirty floats. The important point is that whatever exchange rate regime is adopted, it needs to be consistent with the fiscal and monetary policies of the country and may require complementary measures. Thus, fixed exchange rate regimes require a large amount of reserves to be viable, while intermediate regimes generally require more active intervention in the management of the capital account, including capital controls.

The turmoil that has wrecked so much havoc in emerging markets over the past two years seems, at least temporarily, to have died down. This has given policy makers the chance to consider fundamental reform of the international financial system, while they remember the urgency of the task. The issues involved in designing a new financial architecture for the 21st century are complex and difficult. Given the substantial political dimension underpinning some of these issues, the more ambitious ideas have features that are obstacles to their adoption. Imperfections and compromises will then be inevitable. Clearly what is needed is to consider all feasible options for change and to proceed incrementally on a broad front with immediate pragmatic steps. Within this context there is a crucial role for the IMF in preventing and managing financial crises, and the goal should be to improve its ability to do so. While the ultimate challenge must be to maintain sufficient stability in international capital markets so as to make capital controls unnecessary, in the absence of a genuine lender of last resort countries should retain the right to impose disincentives or controls on inflows, particularly in times of capital surges, and on outflows during severe crises. With order returning to financial markets and the crisis hit Asian economies beginning their slow return to health, there is area need to guard against a return to complacency. Recent experience has shown that the option of doing nothing is too costly.