As a result of capital account liberalization and financial globalization, the average daily turnover of global foreign exchange transactions now stands at US$3.98 trillion. Only US$68.8 billion of this total, or 1.73%, is related to trade.
Currently in Taiwan, around 6,000 foreign institutional investor (FINI) accounts are active. Among them, only 20 are responsible for over 40% of all FINI foreign exchange transactions. As a group, FINIs account for 63% of the Taipei inter-bank foreign exchange market turnover.
The above information shows how short-term capital flows have become the key determinant of exchange rates. Large and volatile capital movements can undermine economic and financial stability. This is especially true for small but highly open economies like Taiwan.
As have been seen recently in emerging economies, including Taiwan, massive capital inflows have led to heightened exchange rate volatility.
Flexible exchange rates could absorb external shocks, just like the willows swaying in strong wind without breaking off their branches. Greater exchange rate flexibility may help mitigate adverse impacts attendant with volatile foreign capital movements.