Choking on the medicine

Capital will likely flee from western markets bloated with stimulus funds but mired in a weak recovery to Asia's relatively higher interest rates and surging growth.

Low interest rates and excess liquidity in Western economies could result in Asia's markets falling prey to asset bubbles and speculation throughout the coming year, leading international and regional financial experts say.

 A worker navigates girders at a building site in Beijing, where fear of a property bubble is rising. China is expected to raise interest rates in coming months to cool its economy. AFP Fundamental weaknesses in the US and European economies, surging unemployment and crippled consumer confidence will see a weak recovery in those territories, which could drag on the region's export-reliant markets. Relatively high interest rates and plentiful opportunities will increasingly spur western investors to look to Asia. The International Monetary Fund forecast the region will have the world's highest economic growth this year (8.4%) compared to the US (2.7%), Japan (1.4%) and the EU (1.0%), said Kobsak Pootrakul, an economist at the Bank of Thailand's Monetary Policy Strategy Division.

"The US is not in a position to raise interest rates; there is a lot of liquidity in the system earning 0.25% interest, so investors will look to Asia," he said, speaking to the Foreign Correspondent's Club of Thailand. "It is no wonder that money is flowing into Australia, China and South Korea. That is exactly why we have seen a change in exchange rates in the region and it is why Taiwan is fighting with speculators and Hong Kong and China are fighting asset bubbles."

Asia's central bankers will have an "exciting year" in 2010, when they will focus on "sweeping away" asset bubbles as they form, said Dr Kobsak. "There is a lot of fighting to do and it will be a difficult fight because there is an ocean of money flooding in [to Asia] and we only have a small pond," he said.

The region's economies learned the hard way from the 1997 Asian financial crisis. Central banks and financial institutions across the continent cleaned up their operations and took a much more cautious position on debt-to-equity levels, as well as implementing anti-speculation measures, which have enabled them to weather the current financial storm better than the West. While there has been much talk about the shape of the recovery, be it "L", "U" or "V-shaped", Dr Kobsak said it makes more sense to divide the world's economies into two groups: those with balance sheet problems and those without. The US, EU and some Eastern European countries have severe balance sheet problems. Asia is in relatively good health and their banks are lending which will drive confidence, investment and consumption, leading to a strong recovery, he said.

The situation in Anglo-Saxon economies is the opposite. Banks are refusing to lend, and debt and unemployment are rising while confidence continues to plummet, said John Sheehan, a former investment banker and founder of the research house Global Markets Asia, and Jeremy Charlesworth, founder and chief investment officer at UK-based Moonraker Fund Management. About 93% of the US$700 billion-plus stimulus capital pumped into US banks was still in the vaults with just 7% being loaned out, said Mr Sheehan. Real unemployment was about 22% in the US - more than double the official figures which do not count the long-term unemployed - and last year the US budget deficit hit $1.4 trillion, a 300% increase on the previous year.

"Industrial production in the US rebounded for two months in November, but it is already starting to fall because the effects of stimulus spending are fading," he said. "Bank lending is in freefall; the tipping point will be the moment when interest rates on US debt increase and that is very much on the horizon now. If interest rates on US debt increase by just 1% that is equivalent to the entire annual budget for energy and education combined".

Such a scenario could lead to foreign buyers of US government debt demanding that the bonds be issued in a currency other than the greenback, he said. Asia's central banks, particularly Thailand's, should reduce the proportion of their foreign reserves that are held in the US dollar because it is expected to weaken significantly, he said. No asset class would provide a safe haven for investors, he said.

"If the [US and EU] banks start to lend then entrepreneurs and consumers will be more confident and confidence makes an economy," said Mr Charlesworth. "The GDP numbers that will probably be issued this quarter will be relatively good because last year was so bad, but people may buy the numbers. The second quarter numbers will also be reasonably good, but the important figures will come in the third and fourth quarters.