Many Asian markets near their peaks, warns ADB

It suggests capital controls to temper volatile fund inflows into region

THE Asian Development Bank took the unusual step yesterday of warning investors that many Asian stock and bond markets may be near their top following 'massive' inflows of capital into the region in the wake of the global financial crisis that erupted at the end of 2008.

Capital controls could be among the policy options needed to temper volatile capital inflows that could lead to instability and promote asset bubbles as well as creating more general inflationary pressure, the ADB suggested.

Emerging Asian equities yielded a stunning 73 per cent return overall in US dollar terms in 2009, the ADB said in its latest Asia Capital Markets Monitor. However, this strong performance 'limits the room for further gains', it added.

The report covers the 11 markets of China, Hong Kong, India, Indonesia, South Korea, Malaysia, the Philippines, Singapore,Taiwan, Thailand and Vietnam.

Asian local-currency bonds as well as equities have found favour with foreign investors over the past year or more, leading to a 41 per cent jump in the amount of such bond issuance (mainly by governments) in 2009.

'The yield curve in local government bonds has steepened and that may continue on rising inflationary expectations and as monetary authorities increase official interest rates,' the ADB said.

'Foreign investors have rushed back into emerging Asian markets, attracted by the region's swift recovery from the global crisis, a return of risk appetite and very low returns on assets in developed economies.'

Following the Lehman Brothers crisis in September 2008 there were fears that Asia, along with other developing regions of the world, would suffer a serious capital drought. The reverse has proved to be true and instead Asia has enjoyed a capital glut.

Asia appears to have escaped relatively unscathed from the Greek crisis with few signs that buoyant capital inflows into the region are being adversely affected, the ADB said. However, it warned that there are downside threats posed by this windfall for Asia.

'While the return of capital flows is welcome, surges in short-term capital inflows could potentially leave countries vulnerable to a sudden reversal in portfolio investment and to sharp currency movements,' said Srinivasa Madhur, senior director of the ADB's Office of Regional Economic Integration.

Emerging Asian currencies have also strengthened against the US dollar under the impact of surging capital inflows. 'Appreciation pressures are likely to intensify as capital inflows continue, which may fuel volatility in some currencies,' the ADB report said.

'The use of capital controls may be appropriate in circumstances where capital inflows are transitory and are adding undue pressure on exchange rates and where effectiveness of macroeconomic policy measures to counter the inflows and the exchange rate movements is uncertain.

'Managing capital flows requires a wide array of policy measures; sound macroeconomic management, a flexible exchange rate regime, a resilient financial system and sometimes the use of temporary and targeted capital controls.'

Source: Business Times, 19 May 2010