The current international financial crisis has generated instability incurrency and capital markets on a scale seldom seen in world economic history, raising thespectre of recession and global deflation. Should this threat materialise, it couldundermine many of the advances of recent decades, particularly the progress towards freertrade and the liberalisation of developing and transition economies.

In Latin America, the instability in international markets has generatedspeculative pressures that do not reflect the soundness of the underlying macro-economicvariables of the region's economies, or the speed and efficacy with which theirauthorities respond. The measures they have been obliged to adopt in reaction to externalspeculative movements are far more stringent than the economic fundamentals would warrantand entail high costs to the Latin American economies.

The recent financial instability has revealed a basic problem in theglobal economy: the great asymmetry between an increasingly sophisticated and dynamicinternational financial market and the existing institutional arrangements, which areinadequate to regulate it. The imperfections of financial markets and the rapid expansionof speculative funds require not only new prudential regulations and adequate supervisionarrangements, but also 'lenders of last resort'.

The lessons learned from past crises inspired the creation of nationalinstitutions to perform those functions, although not always effectively. But nocorresponding institutions exist in the global financial market. The InternationalMonetary Fund (IMF) has extremely limited resources for dealing with severe crises. TheBank of International Settlements has made progress in establishing uniform rules for theregulation and supervision of certain financial activities, but so far their scope islimited.

There is a great asymmetry between an increasingly sophisticated and dynamic international financial market and the existing institutional arrangements, which are inadequate to regulate it. Apart from negotiations towards the creation of a suitable institutionalframework for financial globalisation, other more immediate steps need to be taken. Thereis an urgent need, in particular, for the Group of Seven (G-7) countries to act in concertin giving out expansionary signals to counteract the threat of global deflation and inproviding resources to support developing countries experiencing temporary difficulties,thus raising the costs of speculative attacks on their currencies.

In a globalised world, it must be recognised that the economic policies ofthe industrialised countries have global implications. Institutional arrangementsconsistent with the new context of globalisation would entail co-ordination of themacro-economic policies of the industrial countries -a co-ordination not so far achieved-bearing in mind their effects on the less developed nations.

The debate on liberalisation of capital flows cannot be resolved withoutthe design of a new institutional framework to regulate financial globalisation. Thepossibility of expanding the IMF mandate to cover capital account convertibility dependson such mechanisms being in place. As long as the present situation persists, developingcountries will have to preserve greater autonomy in capital controls, while persisting intheir efforts to consolidate macro-economic stability and improve domestic financialregulation and supervision. They will have to develop new instruments to reduce theirvulnerability to international financial cycles and thus avoid situations that areultimately unsustainable.