The Asian Development Bank has taken the unusual step to warn investors that many Asian bond and stock markets may be near their peaks after “massive” inflows of capital into Asia during the global financial crisis since 2008.
Capital controls are among the policy options required to temper capital inflows that could promote asset bubbles and create more general inflationary pressure, as well as leading to instability, suggested by ADB.
According to the latest Asia Capital Markets Monitor presented by ADB, emerging equities in the region has yielded a stunning 73 percent return overall terms of US dollar last year. But this strong performance “limits the room for further gains.”
The report covers the 11 markets in Vietnam, Thailand, Taiwan, Singapore, Philippines, Malaysia, South Korea, Indonesia, India, Hong Kong and China.
Local currency bonds and equities in Asia have found favour with foreign investors in 2009 or more, leading to a 41-percent increase in the amount of bond issuance – mainly by governments – last year.
“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,” it added.
After the Lehman Brothers crisis last September of 2008, there were fears that Asia and other developing regions across the world would experience a serious capital drought. Its reverse has proved to be correct and instead Asia experienced a capital glut.
ADB said that the region seems to have escaped unaffected from the crisis in Greece with few signs showing that buoyant capital inflows into Asia are being adversely affected. But the bank warned that there are still threats posed by this windfall in the region.
“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 Senior Director Srinivasa Madhur of the ADB’s Office of Regional Economic Integration.
Emerging currencies in Asia have also shown improvement against the US dollar due to the impact of increasing 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,” it added.