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Asia Has the Answer From the Wall Street Journal, June 20, 2010; By Peter Stein |
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One unintended consequence of China's move to loosen its currency policy may be a flood of new funds into the region that prompts a wider embrace of capital controls. Last week, South Korea and Indonesia announced modest restrictions on foreign capital aimed at grappling with a common problem: an overwhelming flow of money shifting away from the developed world to the developing one, particularly in Asia. Some parts of the world might envy such a headache, but these funds have become a concern in a region fearful of asset bubbles, inflation and instability. In the wake of the yuan move, investors are likely to pour even more money into the currencies of China's neighbors, which have become a proxy for Chinese growth. The result is that "controls will have to tighten," says Russell Napier, a strategist with CLSA Asia-Pacific Markets. On Wednesday, Indonesia announced a number of measures aimed at damping speculative inflows, including the introduction of central-bank bills with longer maturities and a one-month holding period on inflows of foreign capital. That followed regulations South Korea announced on June 13 limiting the currency-derivative positions that foreign banks will be able to take based on the size of their capital. While domestic banks are affected, too, they currently operate within the proposed limits; foreign banks, which generally don't, will need to reduce theirs over time. Markets, which have viewed the measures as moderate, reacted calmly in both countries. In fact, the new regulations are probably more reassuring than worrying to many investors, says Catherine Yeung, investment director at Fidelity International in Hong Kong. Too rapid an inflow of foreign capital can overwhelm less developed financial markets, she says, which is ultimately not good for longer-term investors. The recent measures in Asia haven't caused alarm in part because they aren't lowering the gate on capital already invested. Instead, they are changing the rules going forward, giving investors a chance to position themselves. Nor are they considered draconian, as when Thai shares plunged after the government instituted rules in 2006 forcing foreigners to deposit 30% of their investments with the central bank - a move rolled back some 15 months later. Behind the moves, however, lies a major change in thinking about the use of capital controls, long criticized by Western policy makers for hindering the efficient allocation of capital. Those views were already challenged in Asia by some governments - Malaysia imposed severe capital controls in 1998 that flew directly in the face of International Monetary Fund guidance, calling them a success even as some foreign investors wrote the country off - but they took a much bigger beating among a broader audience during the recent global credit crisis. "Governments across the world have seen a sea change in attitude," says Mr. Napier, who says the credit crisis showed that "enlightened self-interest can't determine the appropriate amount of credit for the system." In other words, markets don't always work. Even the IMF, long a vocal opponent of capital controls, published a "staff position note" in February arguing that capital controls in certain circumstances are "justified as part of the policy tool kit to manage inflows." One milestone marking the acceptance of limited capital controls was Brazil's decision last year to impose a 2% tax on foreign portfolio investments into fixed-income and equity accounts in a bid to stem appreciation of its currency. "Initially, it caused a stir in financial markets, but then the currency continued to rally," giving people a measure of reassurance, says Frederic Neumann, senior economist at HSBC in Hong Kong. He says that in conversations he and colleagues have with policy makers in Asia, capital controls are now often a topic of interest. Not that they are always effective. Despite having some of the most restrictive currency regulations anywhere, China suffered from huge "hot money" inflows after the central bank began a controlled appreciation of the yuan against the dollar in mid-2005. Beijing could opt to tighten the restrictions further in an effort to avoid a repeat of that experience now that the yuan is likely back on the rise, or it may rely on credit controls and other regulatory moves already under way to cool the economy and achieve the same effect. |