Capital Flows to Asia Revisited: Monetary Policy Options
IMF Blog, June 2, 2011
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- Authors: Anoop Singh
- Published: June 2, 2011
Capital flows: recent patterns and risks
- Capital flows into emerging Asia should be high on the ‘watch list’ for policymakers in the region.
- Timeline and speed:
- Twelve months ago our policy antennae were keenly attuned to the risks posed by the foreign capital that flooded into Asia from mid-2009 onwards.
- Within just 5 quarters, net inflows rose from their early 2009 trough to their mid-2010 peak—a mere one-fifth of the time that typically elapsed between troughs and peaks in the cycle of capital flows during the pre-Asian crisis period.
- Another twelve months on, what we’re seeing is not really all that “exceptional”.
- Historical perspective:
- Analysis in the Regional Economic Outlook confirms that, with the recent surge, net overall capital flows to emerging Asia (as a share of GDP) have not surpassed the peaks reached in past episodes of large inflows to the region.
- Signs of risks from asset valuations and corporate indicators remain largely muted, and external buffers are large.
- Change in composition and concentration of inflows:
- Net portfolio flows—bonds and equity—are now dominating inflows to Asia.
- For a few economies in the region—including India, Indonesia, Korea, the Philippines and Thailand—those inflows are large compared to what their domestic markets can absorb.
- Despite the slowdown since late 2010, portfolio inflows to emerging Asia are expected to continue over the next two years.
- Risks highlighted:
- The earlier rapid surge and continued concentration in potentially volatile portfolio flows raise concerns for a few Asian economies.
- Given relatively shallow markets in some countries, asset price bubbles can form quickly and sudden stops remain a real possibility.
- Risks to financial stability and asset market imbalances are present, with isolated pockets of overheating such as credit dynamics in some countries and certain segments of property markets around the region.
Monetary policy effectiveness
- Mechanism and influence:
- Capital flows can affect the monetary transmission mechanism as they can depress long term bond yields, which tend to be driven mainly by global factors.
- This in turn means that central banks have relatively limited influence on long-term interest rates.
- Despite the important role of long-term interest rates in monetary transmission in other parts of the world, our analysis find that monetary policy in Asia has a strong influence on economic activity, working mostly through short-term interest rates.
- A bulk of bank loans to businesses and mortgages in the region are priced relative to short-term interest rates.
- Policy implication:
- When capital inflows are large, conventional monetary policy still has a role to play in countering overheating pressures.
Safeguarding financial stability: macroprudential policy
- Lessons from the global financial crisis:
- Macroeconomic stability is not sufficient to guard against the risk of financial instability.
- Role and features of macroprudential measures:
- There has been increased attention to macroprudential measures, as have been introduced by several economies in Asia.
- These measures aim to reduce the risk of overheating in asset prices and of subsequent busts if capital flows reverse.
- Macroprudential measures can play a useful role in reducing economic and financial instability that could arise from surges in capital inflows.
- Comparison with monetary policy:
- Changes in both policy rates and macroprudential measures are likely to affect economic activity, as well as financial conditions.
- Changes in policy rates are “blunt” instruments that impact all lending activities.
- Macroprudential measures are aimed specifically at markets in which there is an excessive risk of financial instability.
- Accordingly, the two instruments are best seen as complements to, and not substitutes for, one another.
Policy recommendation: combine instruments
- Key recommendation:
- Asia’s economies are now well placed—and have the necessary ‘space’—to tackle overheating concerns with appropriate macroeconomic policies.
- Policymakers should be ready to tighten monetary policy together with, but not in place of, macroprudential measures.
- Rationale:
- Tightening monetary policy alone may be insufficient to limit leverage and address financial stability risks; macroprudential measures are needed to target specific market excesses.
IMF Blog post by Anoop Singh, June 2, 2011.
Content in this bundle
- Asia and Pacific -- Managing the Next Phase of Growth; April 2011