Emerging economies should make exchange rates flexible - IMF official

By Martin Dokoupil

RIYADH (Reuters) - Emerging economies need to make sure their exchange rates are flexible enough to deal with volatile capital flows, a senior International Monetary Fund official said.

Billions of dollars have left emerging markets since May, when the U.S. Federal Reserve first said it may need to begin reducing its $85 billion monthly bond-buying programme, which would deal a blow to emerging economies saddled with large current account deficits.

But capital flows switched direction again in November as the Fed delayed its exit plan, IMF deputy managing director Min Zhu told Reuters, giving emerging economies breathing space to prepare defences for when the Fed decides to act.

"Exchange rate flexibility is really the first front line to go against this capital flow volatility," Zhu said on the sidelines of a financial conference in the Saudi capital.

"That's the most important line against the cross-border shocks. So make sure that exchange rates are flexible," he said without giving details.

The IMF has urged China in the past to adopt a more market-based currency exchange rate with less intervention. Last month, China's central bank governor dangled the prospect of speeding up currency reform and giving markets more room to set the yuan's exchange rate.

Developing countries called on the IMF in October to help them deal with heightened market volatility caused by the Fed's taper plan.

According to the IMF, emerging economies have been working hard since the Fed's May warning signal to improve fundamentals through tightening fiscal policies and tackling inflation, which is a key issue in India, he said.

Some emerging economies have also embarked on policies to encourage trade in order to slash their large current account deficits and raised interest rates to counter depreciation of their currencies, Zhu said without giving specifics.

Last month, Indonesia's central bank raised its policy rate by 25 basis points to help reduce its large current account deficit and bolster the rupiah, Asia's weakest currency this year.

Zhu also said that China may need several years to switch its economy from investment to consumption-driven growth.

"China is moving in the right direction but it is not an easy job. Investments account for 47 percent of GDP (gross domestic product), which is way high, and consumption is way low," he said.

The world's second-largest economy will need time to implement reforms such as opening up the services sector to help reduce investment as a proportion of GDP, he said.

"It will be a medium-term adjustment process. The government set a goal by 2020 that they want to double per capita income, change the growth model. We think it is reasonable," he said in the Fund's first comments on China's reform plans.

Beijing's leadership last month unveiled its boldest set of economic and social reforms in nearly three decades to unleash fresh drivers of growth over the next decade.

On Tuesday, China's leaders pledged to quicken economic reforms in 2014 while keeping policy stability and continuity at a meeting of the decision-making Politburo.

According to the World Bank, China's per capita GDP was just $6,188 last year, compared with $22,590 in South Korea, $36,796 in Hong Kong and $51,709 in Singapore - Asian peers that have succeeded in making such a transition.

A Reuters poll showed annual economic growth this year could slow to 7.6 percent - the weakest in 14 years - but ahead of the government's target of 7.5 percent.

(Editing by Hugh Lawson)