Hot money flows to Asia

As the economies of Europe and the US wallow in a sea of debt, Asia’s high interest rates and economic stability continue to attract strong capital inflows pushing up stock markets and local currency exchange rates to levels not seen for years.

Already a number of regional central banks have intervened to slow the flow of so-called “hot money”.

The Asian Development Bank (ADB) warns that the majority of inflows are “short-term portfolio investments that could create volatility during a reversal”.

One of the problems facing governments in the region is that hot money can be destabilizing to the economy because as quickly as it flows in, it can be just as quickly pulled out.

In the latest edition of Asia Capital Market Monitor, the ADB said Asia has attracted around 80 percent of total portfolio capital flows to emerging markets since 2000 – much of it going to China.

The Manila-based bank warns, however, that “if a local stock or bond market is integrated globally (or regionally), its sensitivity to a global (or regional) shock will increase”.

“Global factors explain a large part of emerging Asian equity market volatility, suggesting the region’s stock markets are well integrated globally. The trend underscores the need for the regional economy to ensure strong macroeconomic fundamentals,” it said.

“Improved transparency, regional integration and breadth in the capital markets are imperative if Asia is to ease the impacts of volatility,” the ADB said.

“What we have observed in the past two days is panic, but we are of the opinion that as the dust settles, capital flows to emerging Asia will continue,” said Iwan Azis, head of the ADB’s office of regional economic integration. “If anything distinguished the region from the rest of the world it is its strong macro-fundamentals.”

Recently, the International Monetary Fund (IMF) warned that the influx of capital into emerging Asian economies remained a “major concern” for governments in the region.

These capital flows are “extraordinarily important” in some countries, including China, Indonesia and the Philippines, the IMF said in its latest report on economic prospects for the Asia-Pacific.

It noted that several countries – including South Korea, Indonesia and India – have already taken steps to curb the sudden influx of capital from investors seeking higher returns than those offered by Europe or the US.

“Shareholders should continue to arrive in Asia in 2011 and 2012, lured by prospects of strong growth and fed by abundant liquidity,” said the IMF.

These flows remain “a major concern for politicians,” the IMF said but they are well below the levels seen just before the Asian financial crisis of 1997.

The US debt crisis that culminated in the Standard & Poor’s (S&P) downgrade of its sovereign rating to AA+ would induce more foreign capital flows in the near future, strengthening regional currencies, Azis of the ADB said.

“I don’t think there will be a flood of money out of US Treasuries. Asia will remain a safe haven. It is not the amount of the flows, but the volatility that is the number one enemy,” he said.

Azis added that eroding growth prospects in the US and Europe could become an increasing concern for Asian economies.

“The downgrade by S&P showed thinning trust in US and European policymakers and the market’s impatience. The S&P downgrade was also about US politics hampering policy efforts,” said ADB’s Principal Economist Cyn-Young Park.

Unlike the US and European economies, many developing Asian nations boast manageable levels of public debts and trade surpluses, said the ADB report that covered 11 emerging economies in Asia – the Chinese mainland, Hong Kong, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan, Thailand and Vietnam.

The report, which was written before the latest bout of financial turbulence, projected emerging Asia’s economy to grow an average of 7.9 percent this year and 7.8 percent in 2012, down from 9.2 percent in 2010.

Stock markets around the world saw steep declines on Aug 8 and 9 following the unprecedented S&P downgrade.

According to the Philippine central bank, Bangko Sentral ng Pilipinas, foreign portfolio investments continued to surge into the Philippines with net inflows in July at $2.655 billion, nearly four times the $713.11 million recorded the previous year.

The Macquarie Group in a research note on Aug 6 said Singapore and Malaysia will be the main beneficiaries of capital inflows.
International investors will add to holdings of Singapore bonds, the only economy in Southeast Asia with a top rating from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, Australia’s biggest investment bank said.

The report added that Malaysia, which has the world’s largest Islamic debt market, will become more attractive to investors in the Middle East.

S&P cut its rating on the US by one level to AA+ on Aug 5, with a negative outlook, saying this month’s agreement among lawmakers in the world’s largest economy to raise a $14.3 trillion debt limit and spending cuts fell short of what would be necessary to stabilizing the government’s medium-term debt dynamics.

“The downgrade solidifies Singapore as the new safe-haven in Asia,” Singapore-based strategist Matt Huang wrote in his report. “Despite offering a lower yield to the US, expected currency appreciation will likely more than compensate investors,” he told The Straits Times.

“The Middle East is becoming increasingly comfortable with Malaysia’s capital markets, which may lead to increasing their global bond allocations into the ringgit,” Huang said. “It is a natural investment destination as part of a portfolio re-allocation away from the US.”