Managing the Effects of Southeast Asia's Capital Inflows

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THIS year is likely to be another challenging one for South-east Asia’s monetary managers. Capital inflows have been rising for some time, triggered by low interest rate regimes in the US and Europe. They are likely to rise even further this year after a fresh round of monetary easing in Japan results in yet more capital finding its way into South-east Asia’s fast-growing economies.

By pushing down the cost of borrowing, such inflows help finance corporate expansion and urgently needed infrastructure projects. But large capital inflows also bring with them the prospect of higher inflation and an increased risk that speculative investments will produce potentially damaging bubbles in regional property and stock markets.

South-east Asian currencies are already strengthening, threatening export competitiveness.

“Growth is good. But growth in this environment also has its problems,” notes CIMB’s regional economist Song Seng Wun. Foreign ownership of Malaysian bonds rose by US$8.4 billion (S$10.4 billion) in the first 11 months of last year. Indonesia registered a full-year increase of US$4.9 billion, while Thailand reported a US$6.6 billion rise.

Not surprisingly, yields have also been falling. In the Philippines, for example, the yield on three-year peso bonds fell to 3.29 per cent last month, the lowest since September 2011.

Even more money is likely to flow into regional bond markets this year as ratings agencies issue upgrades. Indonesia was awarded an investment grade rating by Moody’s last year. The Philippines may well secure a similar rating this year thanks to improved governance and public finances. Malaysian government bonds are already regarded as investment grade.

Strengthening currencies are, however, also threatening exports. In the six months to end- January, the Malaysian ringgit appreciated by 3.3 per cent against the US dollar. In the same period, the Thai baht rose by 5.3 per cent. And on Jan 14, the Philippine peso climbed to a record 40.55 to the greenback, its highest level since March 2008.

The monetary authorities are likely to react to these market forces by imposing regulations.

Last year, the Philippine central bank banned overseas funds from special deposit accounts. Philippine officials have so far ruled out imposing a holding period on investments in stocks, but it remains an option considered seriously by many in Manila. Last month, the Philippine stock market hit a record high.

Professor emeritus Ammar Siamwalla from the Thailand Development Research Institute has urged his nation’s monetary authorities to respond by imposing capital controls. “The government could announce that foreign funds brought in since Jan 1 be kept in the country for some time,” he suggested last month.

The Federation of Thai Industries has suggested ways to limit the baht’s rise. These include forcing foreign investors to separate their investment accounts so it is easier to identify “hot money”; relaxing foreign currency holding rules; and making overseas direct investment easier.

Indonesia, where yields on two-year government bonds have reached their lowest level since February last year, has so far been spared rapid currency appreciation. As a result, the debate about the dangers posed by the inflow of speculative capital has been more muted.

Last October, when Fitch Ratings warned in a report that Indonesia’s external finances were “exposed to shifts in risk sentiment associated with short-term capital flows”, many local economists disagreed. Indonesia’s external finances came mostly in the form of foreign direct investments rather than short-term investments in the capital market, they pointed out. And while property prices were indeed rising, credit disbursement did not appear to be concentrated in any single economic sector. This, they argued, made Indonesia more resilient to external shocks than other regional economies.

Although there have been some moves in Indonesia and Malaysia, few countries have followed Singapore by introducing wide-ranging property cooling measures. Indeed, observers in Malaysia are now beginning to argue that the property boom in that country may have peaked.

But a similar property boom in the Philippines, described as the strongest in two decades, shows no sign of easing. In Thailand, the central bank is paying particular attention to property loans.

But it is the potential for inflation where monetary managers may yet face their greatest challenge even if current inflation levels remain manageable. Should they become a concern, conventional market mechanisms are unlikely to resolve the situation. Raising interest rates – the traditional response of central banks when faced with an overheating economy – risks attracting yet more speculative capital.

So far, capital inflows have had more positive than negative effects on South-east Asia’s economies. The challenge facing monetary regulators this year is finding ways to ensure it stays that way.

(C) Singapore Press Holdings Limited 

Key Political Risks

Asia is the fastest growing region in the world, and is likely to remain so in 2013. However, a number of risks cloud the picture.

The good news is that domestic demand in the region remains strong and should continue to cushion the impact of weaker external demand on overall economic growth. The completion of national elections in Japan and South Korea in December 2012 should also help reduce political uncertainties. 

But Asian governments will need to guard against the adverse impact of prolonged easy financial conditions on inflation.

Rising inequality also continues to threaten social stability. Ethnic and religious rivalries remain just below the surface in many countries. When combined with government corruption and (in some countries) high youth unemployment, this could become a deadly mix. This seems particularly true of China.

Territorial disputes also require close monitoring. Much diplomatic activity in the new year is likely to be centered on finding ways to reduce tensions over resource-rich islands in the South China Sea, where Beijing's claims overlap with those of Japan, Vietnam and other Southeast Asian states. South Korea and Japan also have rival territorial claims.

North Korea remains the wild card. Inclined to believe its own propaganda, Pyongyang's new leadership could miscalculate, making belligerent moves that plunge the region into a military conflict that nobody wants.

About Me

My name is Dr Bruce Gale and I am a senior writer with the Singapore Straits Times. I studied at  LaTrobe University (BA Hons) in Melbourne and later at the Centre for Southeast Asian Studies at Monash University (MA). My PhD thesis, which focussed on Malaysian political economy, was completed at the Malaysian National University (Universiti Kebangsaan Malaysia) in 1987.

From 1988 to 2003 I was Singapore Regional Manager for the Hong Kong based Political and Economic Risk Consultancy (PERC). 

I have written several books and articles on Southeast Asian affairs, including Political Risk and International Business: Case Studies in Southeast Asia (Pelanduk Publications, 2007). Books on language include Mastering Indonesian: a guide to reading Indonesian language newspapers (Pelanduk Publications, 2008)

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