ANALYSIS – Emerging Asia to tread lightly with capital controls

By Reuters Staff
July 6, 2010

By Kevin Plumberg

HONG KONG, July 5 (Reuters) – Having learned lessons from the past, emerging Asia is showing caution about adopting heavy-handed capital controls to curb heavy investment inflows and is focusing instead on closing economically disruptive loopholes.

Measures announced by Indonesia and South Korea last month targetted particular areas of their markets, unlike Thailand in 2006 which effectively imposed a blanket tax on foreign investment. A Reuters poll suggests further targetted measures can be expected from the region.

That is inspiring confidence among investors and economists that any measures in coming months to prevent hot money from becoming inflationary or economically destabilising will be narrowly targeted and flagged well in advance.

“The bottom line is policymakers want to curb volatility, not necessarily where their currencies move over the longer term,” said Kevin Grice, senior international economist with Capital Economics in Singapore.

“It’s a sign the region is getting more sophisticated with regard to the application of these measures.”

The developed world is flush with cheaply borrowed money that is searching for higher returns in markets globally than the paltry ones available in the West.

Asia will be a big recipient. Balance sheets are clean and growth prospects strong as the region leads the rest of the world out of the global downturn.

Ironically, multi-lateral lending agencies have endorsed calibrated capital controls for emerging economies to deal with the wall of money they face, unlike the strong opposition to capital controls during the Asian financial crisis of 1997/98 when the region was trying to prevent capital flight.

There is a risk more countries in Asia will impose further capital controls to prevent inflows from stoking inflation, said Donald Amstad, director of Asian fixed income for Aberdeen Asset Management in Singapore.

However, he characterised policy responses so far as “reasonable” and was still optimistic about his exposure to Indonesia and South Korea.

Amstad, who oversees the firm’s Asian bond fund, which had $5.3 billion in assets under management as of May, is comfortable with his positions in short-maturity Indonesian government bonds and inflation-linked Korean debt that he added to two months ago before the latest round of measures.


Thailand in December 2006 surprised financial markets by instituting an unremunerated reserve requirement, effectively a tax on foreign investors.

The 30-day volatility of Thai stocks surged in the days after the rules were implemented to 70 percent from 10 percent.

Investors also hit the exits. The stock market dropped 15 percent the day after the Thai measures were announced, showing to other governments the reaction they could expect if they also wanted to impose such a broad capital control.

So Asia’s policymakers are now opting for more effective action that will not cause investor confidence to evaporate, such as prudential measures.

The International Monetary Fund found that between 2003 and 2009, prudential measures enacted by economies around the world and aimed at foreign capital reduced inflows by 2 percentage points of GDP.

General prudential rules actually had an effectiveness rate of 1.6 percentage points of GDP when it came specifically to portfolio inflows, as opposed to direct investment or loans.

Asian officials will also probably allow more exchange rate flexibility and use administrative measures to manage capital flow volatility rather than outright controls. Administrative controls, not always transparent, restrict capital flows through prohibitions or set limits.

Capital flight almost brought Indonesia to its knees in 1997/98, so any discussion of capital controls in the country gets investors jittery.

But since Indonesia three weeks ago announced rules to push money out of the short-term central bank debt market, preferred by foreign speculators, markets have actually reacted favourably.

JPMorgan’s Indonesian bond index has returned around 4 percent since the measures, which Indonesia’s central bank stressed should not be seen as capital controls, were introduced.

“They are very aware that they need capital and that’s why they are very careful about what they do,” Milan Zavadjil, the IMF’s senior resident representative in Indonesia, said.

“At the same time, they want much more long-term capital to be coming in, either into the private sector or to finance the government budget,” he said.


The Reuters poll showed South Korea is the most likely country in the region to add more capital curbs this year because of its volatile exchange rate and exposure to short-term foreign debt. Korea could become a test case for how much tolerance foreign investors have for capital curbs.

Asia’s fourth-largest economy has been one of the most active countries in imposing macro-prudential measures to ease capital volatility. The poll also identified Taiwan, China and India as likely to add controls this year.

Seoul’s plans unveiled last month to clamp down on foreign leverage puzzled some investors who had been cheering on the country to open its markets further.

Last year a rule change allowed Korea’s government bonds to be settled on Euroclear, the world’s largest settlement system, and a withholding tax on foreign investment in Korean debt was exempted, boosting Seoul’s ambitions to become a regional financial centre.

“At some stage, officials will see that either you open the market and then you have to cope with volatility in the currency… or you close the market and don’t speak of a financial hub,” said Patrick Mange, deputy chief executive of Shinhan BNP Paribas Asset Management in Seoul.

In another irony, Asian policymakers are these days being viewed generally as supporters of freer markets. That contrasts with officials in advanced economies who are aggressively intervening in markets following the financial crisis.

“Three or four years ago, Asia was considered a standout in terms of interventionist behaviour by policymakers, arbitrary decisions and arbitrary policies,” Peter Redward, head of emerging Asia research with Barclays Capital in Hong Kong, said.

“Asia is seen as being on a general path back toward liberalisation, despite a few steps back in the last couple of months.”

(Editing by Neil Fullick) ((Reuters Messaging: Email:; 852-2843-6370))

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