beyondbrics

First it was Indonesia, then South Korea. Inspired by the strength of an Asian recovery that has left the western developed world standing, regional central bankers are challenging old Western orthodoxies, and are embracing once dreaded capital controls.

Is Thailand about to become the latest country to join them?  No. But that hasn’t stopped the new central bank governor from talking about it.

Tarisa Watanagase, the governor of Bank of Thailand, said yesterday that while the bank had no imminent plans to introduce capital controls, many were questioning the conventional thinking on the subject matter.

Capital controls were previously dismissed as something old fashioned, something that interferes with the market mechanism and should not be an acceptable tool of a central bank and I think that idea has changed.

It is no surprise this newest trend is gaining force in Asia, as global liquidity from developed countries sloshes into the region and central bankers, increasingly concerned about controlling rising inflation and looming asset bubbles, look for a policy toolkit to control these inflows. Thailand’s central bank governor is just the latest to publicly challenge the status quo.

For Tarisa, capital flows from western economies where interest rates are at record lows, “could attract de-stabilizing capital inflows that will put pressure on exchange rate, encourage a buildup of financial institutions’ short-term debt, and fuel bubbles in various sectors.”

And it’s not just Asian central bankers that see controls as a necessary evil. The International Monetary Fund is also cautiously supportive of the growing trend in Asia.

Managing director of the IMF, Dominique Strauss-Kahn, last week told the FT that he was “sympathetic” to emerging countries embracing controls as a last resort to counter foreign investors inflating asset bubbles, but warned,:

You have to be very pragmatic. Long-term capital controls are certainly not a good thing… But short-term capital controls may be necessary in some cases: it is a matter of balancing the costs of different options.

The latest data from the Asian Development Bank is likely to give governments further justification for consdering capital controls. ADB data released yesterday suggests 2010 growth in developing Asia is stronger it previously forecast in April. Regional GDP is now forecast 4 percentage points higher, at 7.9 per cent for 2010. This, according to the ADB, is due to better-than-expected results in the first quarter—driven by buoyant exports, strong private demand, and sustained stimulus policy effects.

But what Asian governments are most likely to focus on is the ADB’s caution of the downside risks to growth:

The economic outlook is subject to three major risks: (i) a disruption in the recovery in advanced economies; (ii) destabilizing capital flows; and (iii) unintended policy errors or an inappropriate policy mix when unwinding stimulus.

It’s exactly this ‘destabilizing capital flows’ that will give Asian central bankers justification for tighter controls.

Asian governments, as the victims of the 1997 financial crisis, had an inherent suspicion of the Greenspan-like faith in markets long before the latest crash, and the new orthodoxy on capital controls will suit them just fine.

Related reading:
Malaysian rates: to raise or not to raise, that is the question, FT beyondbrics