Large Capital Inflows Present New Policy Challenge

Robust Recovery, Rising Risks: Large Capital Inflows Present New Policy Challenges, Says World Bank East Asia And Pacific Economic Update

Tokyo, October 19, 2010 – The economic recovery in East Asia and the Pacific is robust, but attention must now turn to managing emerging risks which may pose challenges to macroeconomic stability, says the World Bank in its latest East Asia and Pacific Economic Update released today.

Titled Robust Recovery, Rising Risks, the Update notes that output has recovered to above pre-crisis levels throughout developing East Asia, and is expanding at near pre-crisis rates in some countries. Real GDP growth is likely to rise to 8.9 percent in the region in 2010 (6.7 percent excluding China), up from 7.3 percent in 2009 and in line with the average growth rate during 2000-2008. Private sector investment is once again driving growth, confidence is on the rise, and trade flows have returned to pre-crisis levels.

Yet, greater confidence in the region’s growth prospects and concerns about tepid economic expansion in advanced economies is creating the need for policy makers to perform a delicate balancing act – in particular, around the return of large capital inflows and appreciating currencies.

Driven by abundant global liquidity in search of yield, combined with expectations of stronger growth in the region than abroad, capital inflows have risen sharply this year. Larger inflows have helped exchange rates appreciate substantially despite exchange market interventions by central banks. Inflows have also contributed to large increases in asset prices. Most monetary authorities have refrained from introducing capital controls so far.

“Should inflows remain strong, especially against a background of weak global growth, the authorities will be faced with the challenge of balancing the need for large capital inflows – especially foreign direct investment -- with ensuring competitiveness, financial sector stability, and low inflation,” said Vikram Nehru, World Bank Chief Economist for the East Asia and Pacific region.

With economic recovery on firmer footing, the authorities in most East Asian countries are cautiously unwinding their stimulus measures. Fiscal deficits will remain higher than before the crisis, at least for a while, as governments address infrastructure gaps and maintain social safety nets to protect the poor, providing an appropriate defense against subdued prospects for advanced economies.

Many countries in the region are also focusing on addressing medium-term growth challenges. Increasingly, the need for China to rebalance the economy by altering the pattern of growth and investment is becoming critical for sustainability. Commodity exporters such as Mongolia, Timor Leste, PNG and Lao PDR must ensure a transparent framework to use resource-related revenues for development. The middle-income countries of the region, excluding China, need to raise investment in physical and human capital and encourage innovation if they are to eventually attain high-income status.

ENDS