Capital flows pose E Asia asset bubble risk, warns World Bank

Written by Reuters | Tokyo | Updated: Oct 20 2010, 09:47am hrs
The World Bank warned that rising capital flows to East Asia are fanning fears of asset bubbles and authorities need to be careful not to repeat the mistakes of the Asian financial crisis more than a decade ago.

Asian currencies are appreciating as low yields in developed countries drive capital into the region, the development lender said on Tuesday. This could fan inflation, lead to asset bubbles and harm the banking sector.

Larger inflows combined with ample domestic liquidity and rising confidence have boosted stock markets, real estate prices and other asset valuations in some countries, precipitating fears of a new bubble, the report said. The authorities in East Asia need to take adequate precautions to ensure that they do not repeat the same mistake twice in slightly over a decade.

Intervention to slow currency gains has had limited success and uncoordinated intervention is only adding to global liquidity, the World Bank said.

It added that capital controls were not very effective in controlling long-term investment flows.

Group of 20 finance ministers, meeting in South Korea on Friday, will grapple with the global currency system as developed and emerging countries trade barbs over competitive devaluation.

Asian countries have a mix of instruments available to deal with rising inflows, such as adjusting monetary policy, withdrawing stimulus and regulating the banking sector to prevent careless borrowing and lending, Vikram Nehru, the World Banks chief economist for Asia-Pacific, said on Tuesday.

Mix of instruments

There is some evidence that capital flows to East Asia are becoming more short-term, Nehru said, but he was confident that Asian governments would not allow inflows to become so short-term that they could reverse quickly, as they did in the 1997 Asian financial crisis.

We are seeing an effort by developing East Asia to deal with the large amounts of liquidity driven in very large part by the monetary policy easing in the United States, Nehru said.

If this liquidity abundance is sustained and increases, I think they will have to take further action.

Policymakers need to be careful that unsterilised currency intervention does not lead to inflation, he added, as it would increase the money supply. The developing economies of East Asia will grow 8.9%in 2010, the World Bank said in its semi-annual East Asia and Pacific Economic Update report.

That was raised from 8.7% growth projected earlier, reflecting a recovery in trade and private consumption. Excluding China, developing East Asia will expand 6.7% this year, up from its previous forecast of 5.5%.

Encouragingly, the private sector is once again becoming the engine of growth, confidence is returning, and trade flows have returned to pre-crisis levels, the report said.

The return of large capital inflows to the region, combined with rising inflationary pressures and climbing asset prices, presents an emerging policy challenge and a growing risk to macroeconomic stability.

For 2011, East Asian growth will slow to 7.8%, less than an earlier forecast of 8% growth, because growth in the major economies is sluggish and emerging economies are withdrawing stimulus, the Washington-based lender said.

Strong expansion in private consumption and a recovery in external demand are supporting East Asian growth, the World Bank said in the report. But lacklustre growth in the developed world and tightening measures to slow inflation mean the pace of Asian growth will moderate, the report said.

For China, inflation is likely to rise in the short term, but wage growth is near historical averages and is unlikely to cause an inflationary spiral, the report said.

Since its economy is operating near full capacity and there are concerns about nonperforming loans in the banking sector, China needs to withdraw expansionary monetary policy, the report said.