But Asian economic policy makers are also entering 2011 facing major policy challenges. Rising prices for food and oil worldwide have brought on a resurgence of inflationary pressures, especially in China, where inflation is at its highest level in two years. As central banks try to combat inflation by raising interest rates, they find themselves caught in a policy conundrum: Higher rates make their economies even more attractive to investors, raising the risk of hot money inflows.
“Even fixed-income in Asia is providing higher level of interest rates than in Europe or the U.S. Consequently, a lot of liquidity is working its way into Asia,” said Joseph Tan, chief Asian economist at Credit Suisse Private Banking. “But this poses the problem of asset-price inflation, which presents a real policy dilemma for a lot of central banks.”
In its “Global Economic Prospects” report released this month, the World Bank warned that strong capital inflows could “sow the seeds of asset bubbles” in the region. Yet, it also pointed out that though net capital from private sources flowing into the developing East Asia region surged 52 percent in 2010, carrying the total of portfolio-equity and foreign direct investment to $187 billion, that amount was still more than 10 percent below the previous peak of $212 billion invested entering the region in 2007.
So far, Asian central banks’ attention appears to be focused on fighting inflation.
China has increased its benchmark interest rates repeatedly after not increasing them for nearly three years. A January increase of 0.5 percentage point in the reserve requirement ratio was the fourth increase in a little more than two months.
The central banks in Korea and Thailand have also started raising their main interest rates to curb inflationary expectations. “The initial problem is too much money and liquidity in the system,” said David Carbon, head of economic and currency research at DBS Group Holdings in Singapore. “Central banks were reluctant to tighten policy as much as they should have in 2010; now, they are trying to drain liquidity out of the system by raising interest rates, but a lot of capital inflow into the region is nullifying those efforts. Capital flows in and pushes rates back down.”
Economists at HSBC warned recently that with interest rates in the developed world set to remain low, an aggressive increase of rates in China could heighten the risk of rising capital inflows that exacerbate excessive liquidity — which would be counterproductive for efforts to curb inflation. In a recent research note, Qu Hongbin, HSBC’s co-head of Asian economic research, wrote that raising reserve ratios could increasingly become Beijing’s tool of choice in its bid to check liquidity and inflationary pressure.
Sanjay Mathur, a senior economist at RBS Global Banking and Markets, said central banks in the region needed a more “holistic” policy response, encompassing both rate increases and currency appreciation. “If the policy response is focused only on rate hikes, then capital flows will accelerate,” he said. “However, if accompanied by currency appreciation, the risk of capital flows re-accelerating will moderate.”
Mr. Carbon said central banks would have “to filter or control” capital inflows if they wished to regain control over monetary policy.
Several Asian governments introduced at least mild controls in 2010 as they tried to slow the amount of hot money flowing into their economies. Korea introduced measures to curb equity derivatives trading, including a cap on the number of positions and a requirement to disclose large positions. Thailand imposed a 15 percent withholding tax on interest and capital gains earned by foreign investors on Thai bonds.
“If inflows continue, controls will get tighter and more onerous,” Mr. Carbon said.
In Singapore, the government set out this month to rein in the real estate market by raising to 16 percent from 3 percent the stamp duty charged to sellers who sell properties within a year of buying them. On top of a 3 percent stamp duty charged on the purchase, the action means that speculators must clear a profit hurdle of 19 percent to break even on a short-term Singapore real estate play.
[ NYTimes.com ]
