Asia Needs Higher Interest Rates to Avert Bubbles, ADB Says

Bloomberg | April 12, 2010 | 22:00 EDT

Asia needs to start raising interest rates to prevent inflation from accelerating and avert the formation of asset bubbles as the region’s economies recover from the global crisis, the Asian Development Bank said. The region will probably expand 7.5 percent in 2010 after growing 5.2 percent in 2009, which was the slowest pace in eight years, the Manila-based lender said in its Asian Development Outlook report today. The 45 economies of developing Asia may grow 7.3 percent next year, the ADB predicts. Asia is leading a recovery from the deepest global recession since World War II after the region’s governments pumped more than $950 billion into their economies through increased investment, tax cuts and cash handouts to boost growth. Some central banks are already raising borrowing costs or taking steps to remove the excess cash in their banking system to fend off inflationary pressures.

“As recovery takes hold, inflation pressures, particularly in asset prices, may well start to mount in the region,” the ADB said. “Unusually easy monetary policy throughout the region cannot be kept for too long, and there is a need to revert to a normal stance.” Central banks in Malaysia, India and Vietnam have raised interest rates, while China has required banks to set aside more funds as reserves to drain money from the economy. Others, including Indonesia and South Korea, have left borrowing costs unchanged to buttress their recoveries.

Expansionary Stance

“While additional fiscal measures are unlikely to be implemented this year, monetary measures are expected to continue to support the recovery process by maintaining an expansionary stance,” the ADB said. “Authorities must choose the right timing to withdraw the exceptionally accommodative monetary stance. If 

the economy is susceptible to overheating, authorities should further tighten monetary policy.” Asian stock markets and property prices are rising as investors seek assets for their funds. Inflation in the region will accelerate to 4 percent this year from 1.5 percent in 2009, the ADB forecasts. “Because Asia is recovering more quickly and strongly than other parts of the world, the risk of an asset-price bubble is higher than elsewhere,” according to the report. “For developing Asian policy makers, asset price trends must be watched and preventive action taken before disruptive asset bubbles materialize.”

Capital Flows

Asia’s emergence from the global slump ahead of other regions is attracting large capital flows, which may have “serious” implications for exchange rates and money supply, the ADB said. More flexible currencies and some capital controls can help limit the impact of “volatile” investment flows, it said. “Surging capital inflows into several economies, especially those that have rebounded firmly and attracted investors with a rising risk appetite, are complicating macroeconomic management,” the ADB said. “In economies where recovery is firm, pursuing some fiscal tightening can ease pressures on rising interest rates. For others, accumulation of international reserves or allowing greater exchange-rate flexibility may be more appropriate.” Many Asian currencies have strengthened against the dollar this year, according to Bloomberg data. One exception is China, which has kept the yuan pegged at about 6.8 to the dollar since 2008 as part of efforts to help the economy weather the global recession.

China Growth

China’s economy will probably climb 9.6 percent this year, and extend the expansion with a growth rate of 9.1 percent in 2011, the ADB predicts. The central bank has kept benchmark interest rates unchanged even as inflation reached 2.7 percent in February. “Some moderation is expected in the highly stimulatory monetary policy, in light of the strengthening of economic activity and rising inflation and asset prices,” the lender said. “Forecasts assume the authorities may well tolerate some slight appreciation of the yuan this year, and more in 2011, in the context of sustained economic growth, a revival of inflation, and a rising current-account surplus.” A continuation of “highly stimulatory” monetary policy in China will likely produce higher growth rates that could lead to an overheating of the economy and increase speculation in stocks and property, according to the report. That may trigger a more severe monetary tightening later, it said.

India Rates

In India, where the economy may expand 8.2 percent in 2010 and accelerate to 8.7 percent next year, the ADB sees inflation as a concern. The Reserve Bank of India on March 19 raised borrowing costs for the first time since July 2008. “The outlook is for a return of high growth though this will require continued apt handling of macroeconomic policies,” the lender said. “Among the first wave of economies leading the recovery phase, it may have to contend with managing even much larger capital inflows, which would put upward pressure on the exchange rate, interest rates and growth of credit, replaying the difficult monetary policy mix of 2007 when capital inflows surged.”



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