The capital inflow problem revisited

This is the right time for developing countries to recognize the perils of gauging monetary action merely in terms of aggregate inflation-targeting
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First Published: Thu, Apr 11 2013. 07 23 PM IST
Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint
Updated: Thu, Apr 11 2013. 07 53 PM IST
The Asian Development Bank in its recent annual economic publication, Asian Development Outlook 2013, has predicted that growth in Asian economies will improve to 6.6% in 2013, up from 6% in 2012. The bank, however, has also warned that economies in Asia may have to pay the price of adopting vastly expansionary monetary policies in the wake of the 2008 crisis. ADB also brought into particular attention the threat of looming asset bubbles in various Asian economies.
Chief economist Changyong Rhee, in an interview with The Wall Street Journal, has rightly expressed concern over strong capital inflows into Asia, thanks to profligate western central banks. It is likely that such flows will be eventually unsustainable once western central banks, like the US Federal Reserve, which is a major source of liquidity, tighten their monetary stance after they realize the inflationary effect of such loose policies.
The bank’s warning may well have substance in the light of recent history that suggests a strong causal relationship between expansionary monetary policy and the creation of unsustainable asset bubbles. Contrary to the belief among central bankers, expansionary monetary policy does not merely stimulate aggregate demand—which may seem favourable with revival of growth being the desired end—but also influences the relative prices of assets. Such mispricing of assets, unfortunately, may prove unsustainable once monetary expansion ceases and real economic fundamentals correct asset prices.
Blaming western central banks, however, should not deflect attention from the actions of their Asian counterparts, who too have expanded balance sheets aggressively after 2008, blowing domestic asset bubbles. China’s realty bubble that the government is now trying to rein in through ad hoc measures that are unlikely to work, offers the best example of the ill-effects of aggressive credit expansion.
Corporate debt, which serves as a signal of easy credit policy, is already at alarming levels in many of Asia’s vibrant economies. In the case of China, Hong Kong, Singapore and Taiwan, such borrowing is already over the gross domestic products of their respective nations. India’s corporate debt levels look much more manageable at about half the country’s GDP, something that might be attributed to the Reserve Bank of India’s relatively conservative stance since 2008.
With developing countries all set on the course to experiencing the downside of the bust, this is probably the right time for them to recognize the perils of gauging monetary action merely in terms of aggregate inflation-targeting. With the real effects of monetary action being on individual asset prices, they may well be missing the woods for the trees.
Is the danger from a capital inflow surge in Asian economies an overblown fear? Tell us at
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First Published: Thu, Apr 11 2013. 07 23 PM IST
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