Asian central banks warn of risks from capital surge

Singapore (Reuters): Singapore’s Central Bank said on Wednesday that Asia was facing higher risks from a surge of capital inflows, a tide that could reverse in a disorderly fashion if inflationary pressures were not contained.

The Monetary Authority of Singapore (MAS) issued the warning in its latest macroeconomic review, echoing concerns expressed by policymakers in many emerging economies over hot money inflows that are pushing up regional currencies, stocks and other assets such as property.

The Bank of Korea’s Chief said on Wednesday that taxes on foreign bond investors may be re-considered, while India’s Central Bank said managing exchange rates in the face of volatile flows contained a cost.

Many emerging economies are concerned that the rush of speculative inflows in recent months could create potentially destabilising asset bubbles, making policymaking more difficult.

The surge of money into such economies, which is being partially fuelled by a weakening U.S. dollar, is also pushing up many regional currencies, denting their export competitiveness and threatening to stifle their economic recoveries.

“An upsurge in inflationary pressures that leads to a disorderly reversal of flows could occur if regional economies are not able to intermediate these flows efficiently,” the MAS said.

The World Bank warned last week that capital flows posed a rise to East Asian economies and said authorities needed to be careful not to repeat the mistakes of the Asian financial crisis more than a decade ago. Analysts agreed.

“If you draw in large amounts of capital there is a risk that hot money could flow out,” said Leong Wai Ho at Barclays Capital. “But whether that warrants putting up walls to block hot money coming in, the jury is still out on that.”

He said in Singapore’s case, the MAS’ recent move to allow exchange rate appreciation was relieving some of the pressure from rising flows, while other macroeconomic and prudential policies were tackling asset inflation.

DBS bank said in a research report on Tuesday that Asia’s foreign exchange reserves have been growing at a rate of $2.3 billion a day since April 2009, faster than at any time in history.

David Carbon, Head of Economic and Currency Research at the Bank, said currency appreciation and capital controls would be among the ways Asia could tackle these inflows.

“Will it all end in tears? That seems unlikely,” Carbon noted. “If Asia’s policymakers have any fault, it is that they are too afraid of revisiting the 1990s.”

Singapore’s Central Bank said banks, companies and households are in a healthy position in Asia, but it was closely monitoring credit and asset markets.

MAS also said the risks of another round of financial contagion arising from sovereign defaults and a sharper-than-expected economic downturn in the developed economies had ebbed somewhat.

The MAS – which tightened monetary policy further this month by widening the trading band for the Singapore dollar – said inflation in the city-state would remain high until the first half of 2011 before moderating.

Singapore’s economy will hit a slow patch in the immediate quarters ahead due to a fragile global economy before recovering in 2011 on strong Asian growth prospects, as well as continued expansion in financial services and tourism, the MAS said.

Despite the impending slowdown, the economy will grow at by 13 per cent to 15 per cent in 2010, the fastest annual growth ever, and would expand at a more sustainable pace in 2011, it said.

The services sector could account for two-third of gross domestic product in 2011, up from 50 per cent this year, fuelled by the opening of two casino-complexes.

Fitch on emerging Asia risks importing inflation via US$ links

Fitch Ratings (Hong Kong): Emerging Asia’s strong economic and sovereign-credit performance through the global financial crisis could come under pressure in the medium term from inappropriately loose monetary policy imported from advanced economies, Fitch Ratings says in a Special Report published today, with the ranking of exposures across the region indicating lower-rated sovereigns would be more at risk.

With at least nine of 11 Emerging Asian countries on some form of currency link to the USD, and the US Federal Reserve widely considered to be moving towards further quantitative easing (QE), Fitch argues countries with poorer track records of price stability, already-loose domestic monetary conditions and weaker financial systems would be more exposed to the risks of a further global monetary easing.

On that basis, the report draws up a ranking of regional sovereign vulnerability based on ten selected indicators. Lower-rated sovereigns such as Mongolia (‘B’) and Vietnam (‘B+’) emerge at the riskier end of the range, while Taiwan (‘A+’) comes out as least vulnerable under both specifications considered.

Indonesia (‘BB+’) and China (‘A+’) look relatively more exposed than their rating levels would suggest, reflecting in Indonesia’s case high and volatile inflation and shallow financial markets, and in China’s case, exceptionally strong real credit growth implemented as part of economic policy stimulus since the onset of the global financial crisis.

China’s capital controls insulate it from global monetary conditions to some extent, allowing the PBoC to hike rates by 25bps in October in response to a pick-up in inflation. Enhanced capital controls are on the agenda in other countries including Thailand and Korea, indicating the pressure on policy frameworks, although controls carry costs of their own and Fitch does not expect them to play a significant role in addressing the risks discussed in the report.

The report offers a snapshot of Emerging Asian sovereign vulnerability to risks associated with further QE, and the simple framework adopted cannot substitute for Fitch’s country-level sovereign credit analysis. For example, important risk mitigants such as sovereign balance sheet strengthening arising from ongoing official reserve accumulation are not considered.

Overall, the strong relationship between the rankings and the order of sovereign ratings in the region suggests limited likely rating impact from this area of risk, although Fitch’s Asia-Pacific Sovereigns team will continue to monitor developments closely.