Capital controls back at forefront of Asian policy

Emerging Markets, ADB editions, May 2 2013

Capital controls are back at the forefront of Asian policy as inflows continue into the region’s assets, raising concerns about volatility and risk.

On Monday the International Monetary Fund used its annual report on Asia to warn of increasing risks posed by credit growth and rising asset prices, while it also spoke positively about the use of capital controls in the region.

The IMF said “capital inflows to emerging Asia are likely to remain buoyant”, through a combination of easy monetary conditions in the developed world, growth and return expectations in Asia, and easing financial conditions worldwide. While the report argued that portfolio equity flows 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 – it also said: “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.”

In a contradiction of previous advice from western multilaterals, the IMF spoke positively about capital controls, saying “macroprudential and capital flow measures will… have a role to play” and saying that measures to regulate capital inflows “have generally been seen as a useful addition to the authorities’ toolkit”, albeit with varied success.

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 despite numerous attempts at stte intervention. China, Hong Kong and Singapore have all used LTV caps for mortgage loans and debt to income limits. India has tightened provisioning rules, China and India have changed reserve requirements, 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.

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,” says 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, “so 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 macro-prudential measures would likely be considered to stem inflows if currencies moved out of line with the rest of the region, “but you can see that in the example of 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.”

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.”