Capital volatility fears dominate ADB meeting
Officials try to put a brave face on it, but the threat of more capital inflows due to money-printing in the West looms large
A new round of easing in the US and Europe is set to increase the already heavy volumes of liquidity heading for Asian assets, fuelling concerns about the dangers of inflows into emerging markets.
The European Central Bank cut its headline interest rate by 25 basis points to just 0.5% on Thursday, while its president Mario Draghi said the bank had an open mind over introducing negative interest rates on deposits and was technically ready for them. If enacted this could prompt bank funding to enter the capital market to seek returns rather than resting in loss-making deposits.
A day earlier, the US Federal Reserve said it was willing to up the pace of its third quantitative easing programme and could increase the $85 billion it already spends per month on asset purchases.
These measures follow the aggressive monetary policy easing undertaken by Japan a move whose impact on Asia was defended yesterday by Japans finance minister, Taro Aso, to Emerging Markets.
Many people do not understand the reality of deflation, he said. This is the vital difficulty which we have faced for the last 15 to 20 years and the shrinking of the Japanese economy is not good for other parts of the world.
We have to expand our economy and [achieving] a certain one per cent or two per cent inflation rate is [essential] not only for Japan but also for our neighbours and the rest of the world.
But IMF deputy managing director Naoyuki Shinohara told Emerging Markets that developing countries would face challenges from rising capital inflows if they became volatile.
Monetary easing in advanced econ-omies including Japan tends to encourage the movement of capital to emerging and developing countries, he said.
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Capital inflow into this region itself is a good thing. It is good for growth in the region and it is good for investment. But volatility is the problem.
Countries receiving capital flows need to be careful in managing macro-economic policy as well as in taking necessary macro-prudential measures in order to cope with the situation, said Shinohara, who advised flexible exchange rates to help ameliorate the impact of flows.
Capital flows, and how to address them, have become a central theme of this meeting. The ADBs own Asian Bonds Monitor sounded a warning in its most recent edition, saying that inflows might put upward pressure on exchange rates, making exports less competitive. There are also concerns that higher levels of liquidity could lead to excessive credit growth, thus fuelling asset price bubbles in the region.
Finance ministers of the ASEAN+3 group meeting in Delhi last night expressed concern. We are well aware that continuing global levels of infusion could potentially induce risk-taking and leverage, credit expansion and asset bubbles, they said in their communiqué.
Zhu Guangyao, Chinas vice-minister of finance, said afterwards that the real debate is about spillover effects. China accepted that the first round of quantitative easing was needed to maintain financial stability, but, he suggested, China was not convinced that there was a necessity for subsequent rounds of QE.
Data from Haver Analytics suggests that quarterly net flows into Asian equity and bond funds had been higher in the last two quarters than during the peak of inflows in 2006-7, with well over $20 billion of net flows into equity mutual funds alone in both of those quarters.
Frances Cheung, senior strategist for ex-Japan Asia at Credit Agricole CIB, suggested central banks would discourage inflows into short-end instruments by reducing the return on them, or curbing inflows directly. More drastic measures risk backfiring and policymakers should learn from past experience.
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