A guard stands before a Thai bank |
This article is a guest contribution from Dr. Robert Horrocks, Matthews International Capital Management LLC.
It seems that every week we hear that the worldās economy is unbalancedāEuropean and American economies face, among other things, fiscal austerity, weak housing markets and the threat of deflation. In contrast, China and India are booming. Western central banks are trying to stimulate demand through low interest rates while central banks in Asia are trying to cool demand amid private capital inflows.
While the West pushes for more growth from the East, Asia's governments fear that speculative inflows of āhot moneyā could cause economic overheating and price volatility. Recently, China raised reserve requirements and India raised interest rates. China also implemented a series of administrative controls to sharply decrease property speculation by making it harder and more expensive to buy a second or third home. One tool policymakers might use to quell speculative investors is currency appreciationābut many countries in Asia have preferred to peg their currencies to provide a predictable value for the exchange of goods in their most important overseas markets.
Another tool for policymakers in discouraging asset bubbles is capital controls. However, capital controls are a double-edged sword. They help governments retain control over their exchange rate and domestic monetary policies but they are also coercive measures that bring into question a countryās commitment to free markets. Asia has had a checkered history with capital controls. Most notably, Malaysia imposed harsh controls to prevent capital from fleeing the country during the Asian financial crisis of 1997ā1998. Malaysia had a difficult choice to make: it imposed its controls at the height of the crisis in order to stop a panic and buy time for the economy to recover. Nevertheless, it left foreign investors feeling bitter for years afterward.
The situation is different now. Asiaās economies are not in crisis. They seek to dampen the influx of capital for fear that it will be suddenly withdrawn at the first sign of volatility. Capital controls are perhaps both a blunt tool (determined investors can circumvent them) and a controversial one. So, recent moves to impose controls have been modest compared to Malaysia's experience: KoreaĀ has imposed limits on its banksā positions in currency derivatives; Taiwan banned foreigners from holding time deposits as a way to speculate on its currency; and Indonesia announced controls on sales of central bank paper. All countries have downplayed the idea that they would impose stricter capital controls. In addition, inflows of portfolio equity investments are probably less concerning to policymakers than inflows of credit, particularly bank loans. The withdrawal of equity investments, while damaging to sentiment, should not cause a credit crunch. Harsh controls on equity investments at this stage would appear unlikely.
Policymakers are clearly wary of imposing further controls on capital. However, they cannot prevent the bubbles they fear by using monetary policy aloneāuntil they allow their currencies to appreciate. Otherwise, they are simply allowing international investors to enjoy the high interest rates that tighter policy brings at the existing cheap exchange rate and capital will flow in. Investors should keep this in the back of their minds. As enticing as the current economic climate is for Asian investment, any ārebalancingā in the world economy will be managed at a pace with which Asia feels comfortable. Controlling the pace will require Asian economies to follow a pro-active monetary policy, allow currencies to appreciateāor, yes, even consider capital controls. Even more reason for investors to maintain a long-term time horizon when considering investment in Asia.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC
Copyright (c) Matthews Asia
