Emerging nations urged to impose capital controls

02/05/2010 | Sid Verma

Developing Asia must step up its surveillance of the financial sector and impose controls on capital inflows, experts warned this weekend, as surging foreign investment threatens to create asset bubbles and volatility in the region

Developing Asia must step up its surveillance of the financial sector and impose controls on capital inflows, experts warned yesterday, as surging foreign investment threatens to create asset bubbles and volatility in the region.

Masahiro Kawai, head of the Asian Development Bank Institute, told Emerging Markets in Tashkent yesterday: “Capital inflows will be very large in the coming years – which will pose a huge challenge for the region as the risk of asset bubbles has increased.”

Asia’s high growth prospects and low government debt has boosted the region’s appeal as a new safe haven, Kawai said. Meanwhile, historically-low US and eurozone interest rates will encourage investors to search for yield in Asia.

Kawai said Asian policymakers should “monitor the domestic financial sector for foreign debt and foreign currency exposures” as well as “the lending practices and liabilities of foreign financial firms operating in countries”.

He said Asian banking authorities should follow Brazil’s lead in ordering listed and non-listed companies to disclose and register derivatives transactions related to foreign loans. This would allow policymakers to assess the systemic risk of domestic companies.

Brazil imposed a 2% capital tax on foreign investments in the country’s stock and debt market last year, to ward off speculative inflows and curb currency strength.

Kawai said the positive market reaction to the Brazil move contrasts sharply with the December 2006 imposition of capital controls in Thailand that sparked a stock market slump in the country. “Asian countries should look at the success of the Brazil move and consider how to adopt that approach in their countries.”

Gerard Lyons, chief economist at Standard Chartered, said yesterday that larger countries such as India and China “could get away with strong capital controls without spooking markets”.

Although the IMF has signalled greater tolerance for capital controls, it has “failed to explain when governments should impose capital controls and what type of controls should be implemented”, Lyons said.

The IMF and ADB should draw up “a code of practice” on how and when to implement “targeted” controls depending on the type of capital inflows, Lyons argued. This would signal to the market the likelihood of greater capital controls and the form it might take – such the level of punitive taxes on foreign inflows.

The Institute for International Finance has said that emerging Asia will dominate private capital inflows in the coming years. The IIF calculated that net private flows to Asia rose from $171 billion in 2008 to $191 billion in 2009.

Asset bubbles are already taking shape in the high-end property markets in Hong Kong, Macau, Taiwan and mainland China, and in the Mumbai commercial property market, analysts said. And fears are growing that foreign investors could tip Indian and Indonesia stocks into bubble territory.

But despite the near-term move to impose capital controls in Asia, Kawai said that policymakers, in the long term, must liberalize capital accounts to boost returns on domestic savings – and ensure regional exchanges rates can be used for settlement purposes in cross-border trade.

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