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NEWS UPDATES Asean Affairs  23 October 2010

Asean faces rate dilemma

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Asian countries are facing a difficult dilemma - if they increase interest rates to curb demand fuelled by foreign capital inflows, they risk inducing even more inflows, Anoop Singh, the IMF director for Asia-Pacific for the International Monetary Fund (IMF) says.

He said increasing the rates was a necessary policy choice unless regional economies want to see unsustainable economic growth and price increases.

"In the short run, capital inflows lead to excess liquidity and financial difficulty in the region. But Asia has a wise tool kit to deal with it," he said.

Asian economies can introduce financial supervision measures to curb excessive bank lending, said Mr. Singh. As well, most of them have room for further currency strengthening as central banks have opted to buy the US dollar forcefully in the past.

"Asia [should] exit from the political stimulus that they introduced earlier and move to greater flexibility in the foreign exchange rate. There is room for greater foreign exchange strengthening in Asia, as currencies just strengthened in the past 10 years," he said at the launch of the IMF's Regional Economic Outlook report on Thursday.

Regional currencies must inevitably strengthen, as countries can produce more output with decreasing resources, said Mr. Singh.

Regional policymakers should channel the funds to meet development necessities, partly to shift away from reliance on exports to focus more on domestic demand in the medium term.

"It is important to distinguish cyclical short-term effects from interest rate differentials between advanced and developing economies and a medium-term issue, as growth differentials in Asia and advanced economies will remain a structural problem. Fundamentally, Asia's output gap is being closed," said Mr. Singh.

The IMF expects upward pressure on prices to increase in the near future and has called on central banks in the region to tighten monetary policy. Regional countries have the option of introducing financial supervision measures to counter excessive lending, he said.

He said the People's Bank of China's quarter-point increase in its policy rate represents a shift from targeting bank credit to interest rates to curb inflation, which should boost confidence in Asia.

But some regional central banks, such as the Bank of Thailand, have held off increasing rates to assess the trend of inflows.

Mr. Singh said regional policymakers should carefully weigh any decision to impose capital controls.

"Capital controls need to be well defined in terms of circumstances and period. We don't see it as frontline measure in Asia," he said.

Inflows to the entire region remain well below the pre-crisis level in mid-2008, said Mr. Singh while noting that they had surged in recent months.

The IMF expects the regional economy to grow by 8 percent this year, one percentage point higher than April's forecast.

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