Asia: The Challenge of Capital Inflows
IMF Blog, May 18, 2010
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- Authors: Anoop Singh
- Published: May 18, 2010
Context and near-term outlook
- Author: Anoop Singh
- Date: May 18, 2010
- Asia has been leading the global recovery and is expected to continue doing so in the near term.
- Asia’s rapid growth helped output return to pre-crisis levels relatively quickly and has attracted large capital inflows into the region.
- Portfolio and cross border banking flows have rebounded sharply as financial conditions normalized.
- Growth projections suggest Asia is expected to outperform advanced countries, implying continued attraction of significant capital inflows, conditional on:
- fallout from the euro zone sovereign debt crisis being contained, and
- the recent spike in global risk aversion abating.
Benefits and downside risks of large capital inflows
- Benefits:
- Can help boost much needed infrastructure development.
- Can help develop service sectors.
- Can support increased foreign and domestic investment when combined with reforms.
- Risks and policy dilemmas:
- Persistent and large capital inflows can be a double edged sword.
- Risks of overheating and runups in asset prices that may leave the region vulnerable to outflows and asset price busts.
- Excess liquidity has been rising across Asia, in part fueled by strong inflows and resistance in many countries to letting exchange rates appreciate.
- Inflationary pressures have emerged in some countries, and inflation expectations have increased.
Asset price developments and evidence
- Stock markets:
- So far, stock price runups appear generally contained.
- Stock prices are not out of line with historical norms in most countries, based on price-to-earnings ratios.
- Concern: equity analysts may be overly optimistic regarding future earnings growth.
- Property markets:
- Lingering concerns that property prices have been rising too fast, especially in China and Hong Kong SAR.
- These property price trends have been seen in localized pockets in specific countries and don’t appear to be a nationwide phenomenon.
- Bubble formation timing:
- Analysis in the Regional Economic Outlook finds that it can take 11 quarters for a stock price bubble to develop and burst and even longer for a property price bubble.
Policy responses and recommendations
- Prudential measures:
- Policymakers in the region have already put in place prudential measures to slow the runup in asset prices, particularly in the property market.
- These measures are already beginning to work.
- Other policy tools:
- Allowing more exchange rate flexibility to slow down capital inflows.
- Structural reforms to mobilize inflows productively and support rebalancing:
- Increase product and labor market competition.
- Level the playing field for foreign investors.
- Ensure contract enforcement.
- Reduce administrative bottlenecks.
- Medium-term objective:
- Use capital inflows, along with reforms, to increase investment in key sectors and support rebalancing the economy toward domestic demand to maintain medium-term growth momentum.
Source: Asia: The Challenge of Capital Inflows, Anoop Singh, May 18, 2010.