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Surge in inflows puts capital controls back on Asian agenda
Asian policymakers are keener to intervene to tackle risks posed by rampant credit growth
Capital controls are back at the forefront of the Asian policy debate, as continuing inflows into the region’s assets raise growing concerns about volatility and risk, according to leading experts.
And in a marked shift in stance, the International Monetary Fund now appears to believe such controls are good for Asia.
The IMF used its annual report on Asia this week to warn of increasing risks posed by credit growth and rising asset prices, adding that “macro-prudential and capital flow measures will... have a role to play.”
It said measures to regulate capital inflows in Asia have generally been seen as a “useful addition to the authorities’ toolkit,” albeit with varied success.
“There’s clearly a marked shift in the thinking of the IMF about the usefulness of capital control measures,” said Frederic Neumann, co-head of Asian economic research at HSBC.
“It used to be the orthodoxy that such measures would always backfire. This was as clear an endorsement as we have ever had that in some instances, capital controls could work.”
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The report argued that portfolio equity flows had boosted private consumption and investment in Asia – with an increase of 1% of GDP in such flows translating into half a percentage point in private consumption growth.
But it added: “The impact of external risks on Asia remains substantial. In the event of a severe global slowdown, capital flow reversals and falling external demand would exert a powerful drag on Asia’s most open economies.”
DIFFERENT PRIORITIES
Approaches to capital flows have varied across the region. Many nations have prioritized stability in property prices, particularly Hong Kong, where asset prices have doubled in five years despite numerous attempts at state intervention.
Among macro-prudential measures taken to deal with the problem, China, Hong Kong and Singapore have all used loan-to-value caps for mortgage loans and debt-to-income limits. India has tightened provisioning rules, while China and India have changed reserve requirements.
In terms of capital controls, Korea and India have limited external borrowing by banks and corporates, Indonesia has set a minimum holding period for central bank bills, and Thailand and Korea have applied withholding taxes on foreign holdings of government securities.
However intervention has generally been modest and the trend in most Asian nations, particularly China, India and Malaysia, has been to loosen capital controls in recent years.
“If you look at the challenges facing Asian economies in the last few years, it’s surprising how few capital controls have been imposed,” Neumann said.
“But we’re reaching the point where, if capital inflows continue – and the likelihood is they will – then Asia will have to adopt some form of capital control measures as well.”
In his view the IMF report was designed to “set the stage for that nicely. It gives cover for policymakers who perhaps fear a backlash from people saying they are over-regulating their markets.”
Fund managers told Emerging Markets they saw little threat to Asia in terms of flow reversals.
“As domestic bond markets and domestic financial systems have matured, the risks from a capital flow perspective have dampened,” said Thanos Papasavvas, strategist on the fixed income and currency team at Investec Asset Management.
He said Asian nations’ high savings rates relative to investment had helped. “They hold relatively healthy FX reserves compared to the past and compared to foreign ownership of bonds, so in the event of a big outflow they can take the other side.”
He said countries were likely to consider using macro-prudential measures to stem inflows if currencies moved out of line with the rest of the region.
“But you can see that in the example of the Thai baht, rhetoric has been enough to contain appreciation pressures. We would expect further rate cuts as the most favoured measure generally, although the effectiveness of such a policy is questionable in a world of pretty much zero global rates,” Papasavvas said.
Robert Prior-Wandesforde at Credit Suisse saw “a low probability” of capital controls on foreign inflows in Asean this year, but said “some macro-prudential measures could well be announced,” such as property market curbs and restrictions on foreign currency borrowing in Indonesia, tougher limits on unsecured consumer credit in Thailand, measures to improve the quality of lending in Malaysia, and further caps on banking exposure to real estate in the Philippines.
“Judging by past experience, however, we probably shouldn’t get too excited about their likely longer-term impact,” he said.
One crucial influence on the decisions Asian central banks take this year will be the impact of the monetary easing underway in Japan.
“Outright capital controls will come into play only if the liquidity that a lot of people fear might come out of Japan and into Asia really comes,” Neumann said. “We’ll have to wait two or three quarters to see if that’s coming.”
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