Small emerging countries are innocent bystanders as advanced economies battle to recover from the financial crisis.

The response of the US Federal Reserve, Bank of England and European Central Bank has resulted in extraordinarily low interest rates and high levels of liquidity. The inevitable outcome has been a search for yield: investors have turned to the higher returns promised by assets in emerging markets. These capital flows are often good for emerging countries; they can finance growth when domestic saving is low. One can have too much of a good thing, however. It is time advanced economies did more to consider the effects of excessive and volatile inflows on emerging markets.

These inflows complicate macroeconomic policies in recipient countries through their impact on exchange rates and commodity prices. Resisting appreciation in the domestic currency is not easy. There is not enough foreign currency firepower to respond, given the size of the inflows relative to the small size of the domestic foreign exchange market. Excessive currency appreciation inevitably results in a loss of competitiveness for the domestic manufacturing sector.