ADB warns of looming asset bubble

THE Asian Development Bank (ADB) warned the Philippines and other developing countries of a possible asset bubble due to a sharp rise in capital inflows and the appreciation of currencies in the region.

In a report, the Manila-based lender said the sharp rise in capital inflows along with the recent appreciation of the Malaysian ringgit, Indian rupee, Korean won, Indonesian rupiah, and the Philippine peso have raised concerns about overshooting exchange rates, potential asset bubbles, and capital flows’ overall impact on market stability.

“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 ADB’s Office of Regional Economic Integration, which prepared the report, said.

“More broadly, the region is holding up well in the face of the debt crisis in Greece and its potential contagion effect,” he added.

Emerging Asian equities yielded a 73 percent return in US dollar terms in 2009 while local currency bond issuance of $3.69 trillion was 41.4 percent higher than in 2008.

The hefty investment from overseas has put significant upward pressure on the region’s currencies, the ADB said.

Despite favorable 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,” the ADB said.

The report said the emerging Asian currencies have strengthened to varying degrees against the US dollar.

“Appreciation pressures are likely to intensify as capital inflows continue, which may fuel volatility in some currencies,” it said.

The report said 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.

The use of capital controls may be appropriate in circumstances where capital inflows are transitory and are adding undue pressure on exchange rates and where effectiveness of macroeconomic policy measures to counter the inflows and the exchange rate movements is uncertain, the report said.

“Managing capital flows requires a wide array of policy measures, sound macroeconomic management, a flexible exchange rate regime, a resilient financial system and sometimes the use of temporary and targeted capital controls,” Madhur said.

The strong economic turnaround has generated inflationary pressures in some of the region’s economies.

An uptick in inflation has been most visible in China, Hong Kong, India, Philippines, Singapore, Thailand and Viet Nam. –Darwin G. Amojelar, Manila Times