Volatile inflows may hit capital markets

ISLAMABAD: Governments in emerging Asia should stay on guard and be ready to act if volatile capital inflows threaten to destabilise the region’s financial markets, the Asian Development Bank (ADB) said in a report.

Emerging Asia’s capital markets have posted rapid gains as economic recovery in the region has gathered pace, drawing massive investment from overseas, the report titled ‘The Asia Capital Markets Monitor’ said. The impact of the escalating debt problems in Europe has been limited, the report said. However, economies and markets face a number of other risks with inflation, though manageable, edging up and as governments prepare exits from economic stimulus packages.

The report, ADB’s annual assessment of the performance and outlook for the region’s equity, bond and currency markets, said that managing the hefty capital inflows into the region’s markets is the key challenge. Foreign investors have rushed back into emerging Asian markets, attracted by the region’s swift recovery from the global crisis and because of a return of risk appetite and very low returns on assets in developed economies.

Emerging Asian equities yielded a 73 per cent return in US dollar terms in 2009 while local currency bond issuance of $3.69 trillion was 41.4 per cent higher than in 2008. The hefty investment from overseas has put significant upward pressure on the region’s currencies, it added. Despite favourable cyclical developments, the strong performance of emerging Asian equities in 2009 limits the room for further gains, the report said. The yield curve in local government bonds has already steepened and that may continue on rising inflationary expectations and as monetary authorities increase official interest rates.

Emerging Asian currencies have strengthened to varying degrees against the US dollar and appreciation pressures are likely to intensify as capital inflows continue, which may fuel volatility in some currencies. The report said that recent surges in capital inflows have been driven by portfolio equity flows as investors take advantage of widening earnings potential between emerging Asian and mature markets.

Published in the Express Tribune, May 19th, 2010.