BT: Capital flows fuelling Asia asset bubbles (27 Jul 2007)

Capital flows fuelling Asia asset bubbles

They're also driving up currency values in developing Asian countries, warns ADB

By ANTHONY ROWLEY
IN TOKYO

CAPITAL flows into developing Asia are driving up currency values and contributing to asset bubbles, the Asian Development Bank (ADB) said yesterday.

The warning comes at a time when outflows of funds from Japan in particular are pushing up Asian currencies to the point where the export competitiveness of some countries is being damaged, and when asset markets are becoming overheated.

The ADB's latest Asia Economic Monitor produced by the bank's Office of Regional Economic Integration says that, even so, strong growth in China and slightly slowing growth in the newly industrialised economies (South Korea, Hong Kong, Taiwan and Singapore) plus most of Asean should allow East Asian economies to grow by 8.1% this year and 7.9% in 2008.

Surging capital inflows - which reached a record US$269 billion in 2006 - brought with them increasing pressures for currency appreciation and fast-rising asset prices, leaving authorities with a new set of macroeconomic challenges to manage, the ADB report says .

'Already this year, the Thai baht is up over 17.6% and the Philippine peso over 9%, while equity markets have been rising fast and showing increasing signs of volatility. Authorities in the region are faced with a serious challenge as they look for the right policies to manage capital flows and keep economic expansion on a steady course.'

Although capital inflows can bring benefits, their danger lies in the potential for sudden reversal, with huge implications for asset prices and overall macro-economic conditions, the report argues. It breaks new ground for a multilateral financial institution in highlighting such dangers.

The report does not make specific reference to outflows of capital from Japan, via the so-called 'carry trades', whereby yen are used to fund purchases of other currencies and assets outside of Japan.

But these have been a major source of momentum for driving up the Korean won, the Thai baht and other Asian currencies while at the same time driving the yen down to record levels.

To counter the impact of surging capital inflows, the ADB says authorities in emerging Asia should consider a package that includes greater currency flexibility; a monetary policy that strikes a balance between domestic and external objectives; limiting the role of fiscal policy; further liberalising capital outflows; and developing more efficient financial market regulation and supervision.

Nevertheless, the region is in a far better position to manage potential financial shocks than it was at the time of the Asian financial crisis a decade ago, the ADB suggests.

Most of the economies in the region are running big current account surpluses and central banks are largely sterilising the capital inflows, resulting in huge foreign exchange reserves.

Potential risks to the economic outlook in East Asia include greater-than-expected inflation; increased financial market volatility; a sharper US economic slowdown; a disorderly adjustment of global payments imbalances; and non-economic events, such as geopolitical disruptions or further outbreaks of avian flu.

The ADB report includes a theme chapter looking at the region's banking sector, 10 years after the financial crisis, which notes that across much of the region, significant progress has been made in returning banks to robust health. Impaired assets have been cleaned up and risk management systems have been strengthened.

Yet, progress has been uneven and the challenges faced by banking systems continue to differ sharply. While financial systems in the region are now less exposed to changes in debt-related capital flows than a few years ago, new risks have emerged as banks have moved into activities such as household lending, securities and property.


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