Post date: Oct 24, 2010 12:45:1 AM
Saturday October 23, 2010
HOT money will continue to find the emerging markets of Asia increasingly attractive, as the macroeconomic outlook continues to favour them over developed markets.
By and large, the growth stories of Asia’s emerging markets remain intact, backed by a solid and healthy financial system in the region, as developed markets continue to struggle to find its way to a sustainable recovery path.
“Asia remains firmly in the lead of the global economic recovery and strong growth in the region is set to continue, led by large domestic-demand-driven economies such as China, India and Indonesia,” the International Monetary Fund (IMF) said in its latest regional economic outlook for Asia-Pacific.
The IMF has raised its growth projections for Asia’s gross domestic product (GDP) for 2010 and 2011 by nearly one percentage point from its April estimates for both years. According to its latest estimates, Asia’s GDP this year is expected to grow 8%, before moderating slightly to 7% in 2011.
The strong economic rebound of Asia was already evident in the middle of 2009, prompting several countries in the region to start the process of normalising their monetary policies and raising interest rates early this year, while developed markets remained confined to their loose monetary policies and depressed interest rate regimes because of still-sluggish economic conditions.
As the interest rate differentials between Asia’s emerging markets and developed economies widened, foreign capital began to flow into this region in search of higher returns for their assets.
Economists say this wave of speculative capital inflow will not likely abate anytime soon as signs are pointing to the United States preparing for another round of quantitative easing – the printing of money by the US Federal Reserve to buy bonds – amid an “extended period” of super-low interest rates to support its weak economy.
The IMF has warned that while Asian economies remain healthy and strong, the continued inflow of short-term speculative capital is posing risks to the region’s financial stability; hence, the necessity for governments in the region to implement capital-control measures to contain such risks.
“What we’re seeing now is that the region continues to attract this bulk of speculative financial flows that could cause disruptive volatility if and when these monies pull out, and this could undermine the region’s currency and financial stability,” a fund manager with a foreign research house tells StarBizWeek.
“Capital control measures may be very unpopular to foreign investors because of their highly restrictive nature but may be necessary at some point in time to maintain stability,” he adds.
Thailand, Indonesia, South Korea and Taiwan are among the countries in the region that have recently implemented some form of measures to manage the influx of hot money into their countries.
But economists see the imposition of such measures would only drive the investment flows to other countries in the region with perceivably lower levels of hindrances.
“It’s more effective if all countries in the region are in this together and have a coordinated policy,” the fund manager opines.
Pressure to appreciate
Meanwhile, the massive influx of capital has also been contributing to the sharp appreciation of Asian currencies over the past one year.
Appreciation of Asian currencies may be a welcomed development for Western developed economies, which have long accused the region’s currencies of being undervalued. But for Asia, it is a threat to their export-dependent economies as higher currencies will only make their products relatively more expensive to their trading partners and hence dampen foreign demand for their goods and services.
To maintain their export competitiveness, countries such as South Korea and Thailand recently devalued their currencies.
Such measures have raised concerns of what some policymakers call a currency war.
“Aggressively depreciating one’s currency is not a sound macro policy to pursue in the long run as it may cause serious global imbalances and trading partners may retaliate in various forms,” RAM Holdings Bhd senior economist Kristina Fong explains.
IMF chief economist Olivier Blanchard over the week urged emerging-market economies to accept the appreciation of their currencies, stating that such process was part of a much-needed readjustment to help get the global economy back on track.
For instance, China’s management of its yuan remains under harsh scrutiny, particularly by developed economies such as the United States, European Union and Japan as they continue to pressure China to allow for a faster appreciation of its currency.
When China surprisingly raised its benchmark interest rates over the week to contain rising inflation and asset bubble risks in its economy, some might have thought the measure was also partly to appease the political pressure on its currency. Typically, a higher interest rate would cause the country’s currency to appreciate as it attracts foreign capital inflows. But this was not the case for China as its central bank intervened by setting the yuan’s mid-point weaker to prevent foreign capital inflows.
So, instead of appreciating, the yuan weakened by at least 0.13% against the US dollar between Tuesday and Friday.
Some economists now believe China will continue to intervene to pause the yuan rise for the interim period, much to the displeasure of developed economies, especially the United States, which have long held that the currency is significantly undervalued.
US Treasury Secretary Timothy Geithner claimed that if the pace of China’s yuan appreciation since September were sustained, the currency would have corrected its under-valuation.
As the meeting of the Group of 20 finance ministers convened yesterday in Seoul, Geithner continued to urge for the establishment of a “fair” exchange policy globally. But economists believe this will not be an easy process, and it’s going to be a long time before countries can reach a consensus and come up an ideal framework on a fair policy.