Asia should guard against volatile capital inflows

SEOUL: Emerging Asian economies should stay on guard and ready to act if volatile capital inflows threaten to destablise the region's financial markets, the Asian Development Bank (ADB) warned Tuesday.

Emerging Asia's capital markets have posted rapid gains as economic recovery in the region has gathered pace, drawing massive investment from overseas, the bank said in a report released in Seoul Tuesday.

Foreign investors have rushed back into emerging Asian markets, attracted by the region's swift recovery from the global crisis, a return of risk appetite and very low returns on assets in developed economies, it said. "While the return of capital flows is welcome, surges in short-term capital inflows could potentially leave countries vulnerable to a sudden reversal in portfolio investment and to sharp currency movements," Srinivasa Madhur, Senior Director of the ADB's Office of Regional Economic Integration, said in the report.

Recent surges of capital have been driven by equity flows as investors take advantage of widening earnings potential between emerging Asian and mature markets, the report said. The ADB said managing the hefty inflows was "the key challenge." Emerging Asian equities yielded a 73 percent return in US dollar terms in 2009 while local currency bond issuance of 3.69 trillion dollars was 41.4 percent higher than in 2008, the report said.

"The hefty investment from overseas has put significant upward pressure on the region's currencies," it said.

Madhur said managing capital flows required a wide array of policy measures, including sound macroeconomic management, a flexible exchange rate regime, a resilient financial system and "sometimes the use of temporary and targeted capital controls."

Speaking at the press conference co-organised by the ADB and the Korea Capital Market Institute, Seoul's Vice Finance Minister Yim Jong-yong said emerging nations need to take "proactive steps" to stave off short-term risks.

"I think (emerging economies) need to take appropriate and preemptive measures, if necessary, to prevent volatile capital inflows and outflows from posing a systemic risk," he was quoted as saying by Yonhap news agency.

"From the global financial crisis two years ago, South Korea has learned the importance of strengthening the country's system to deal with rapid capital inflows and outflows," he said.