Capital Inflows Across Asia

A new IMF working paper looks at capital inflows and what can be done about them (abstract):

Surging Capital Flows to Emerging Asia: Facts, Impacts, and Responses
Balakrishnan, Ravi and Sylwia Nowak; Sanjaya Panth & Wu Yiqun

Summary: Net capital flows to emerging Asia rebounded at a record pace following the global financial crisis, raising concerns about overheating and financial stability. This paper documents the size and composition of the most recent surge to Asian emerging markets from a historical perspective and compares developments in the broader economy, asset prices, and corporate variables across the different episodes of strong inflows. We find little evidence of a significant build-up of imbalances and resource misallocation during the most recent surge. We also review country experiences in managing the risks associated with inflows and argue that Asian countries have used regulatory measures during past surges, although there is not strong evidence of their efficacy without supporting monetary and fiscal policies.

There’s some interesting differences in experiences between different categories of Asian emerging markets.

Why should we be concerned? Because massive inflows run the risk of “sudden stop” episodes where capital inflows either stop, or worse reverse course entirely in a very short period. That could potentially put extreme pressure on exchange rates, and financial market and banking liquidity.

In short, it’s not good for macroeconomic stability or business confidence. The study actually identifies that approximately 60% of capital inflow episodes for emerging Asia in their sample range (1987-2011) ended in a sudden stop – which is an uncomfortably high percentage.

Moreover, we’re also looking at inflows that have become shorter in duration over time i.e. greater volatility, which isn’t good either as it limits the policy response menu (i.e. you can’t put in place medium-to-long term policies). The flip side to that is it also means that there’s less likelihood of high capital inflows changing long term investment and borrowing behaviour, or causing asset price bubbles.

The NIEs (Hong Kong, Korea, Singapore and Taiwan) appear to be most highly exposed to capital flow volatility in recent time – as of 2011, their volatility is double that of ASEAN, and 5 times that of China.

Specific to Malaysia, there are two points of vulnerability identified, both relating to asset prices: house prices  which continue to remain elevated relative to incomes, and foreign holdings of government bonds. While the former is somewhat ameliorated by low price appreciation prior to the Great Recession, the latter is real enough (ratio of foreign holdings to total government debt):

MGS is a pretty big and liquid market, and has been preferred over equities by foreign investors. There’s no doubt that foreign investment in Malaysian bonds have helped keep government borrowing costs perhaps artificially lower than it should be. Of the other major Asian economies, only Indonesia is more vulnerable this way, with the ratio is exceeding 30%.

In any case, the paper is a nice, quick and digestible survey of capital inflows and outflows in Asia over the last 25 years.

Technical Notes:

Balakrishnan, Ravi and Sylwia Nowak; Sanjaya Panth & Wu Yiqun , "Surging Capital Flows to Emerging Asia: Facts, Impacts, and Responses", IMF Working Paper No. 12/130, May 2012