Overheating Of Asian Economies Likely: Lehman

Source : The Business Times, January 23, 2008

Better growth rate will attract massive capital inflows

GOOD economic news now could lead to tough times later, an American investment bank is warning. The bank, Lehman Brothers, says that a soft landing for the global economy could lead Asia ex-Japan economies to overheat later this year or into next year.

Lehman's chief economist Asia ex-Japan, Robert Subbaraman, says the bank expects the region to 'attract massive capital inflows' because of its better growth rate than those of other regions, higher interest rates, and stronger economic fundamentals.

'So our core view of the region is that the aggregate GDP growth for the Asia ex-Japan economies will weaken by about one percentage point this year to about 7.5 per cent,' he said. 'The weakening will be because of weakening exports; however, because of the strong capital inflows, the domestic economies are going to be red-hot.'

He also expects that, with the region's exports weakening, Asian central banks will intervene heavily to slow currency appreciation, even more so than before.

This may result in the dilemma of the 'impossible trinity', which holds that a country can have only two of the three economic options of a fixed exchange rate, control over interest rates, and an open capital account.

'We doubt that countries will impose Draconian capital controls,' he said. 'Thus it will become harder for central banks to raise interest rates, because to do so would attract even stronger capital inflows and put greater upward pressure on their currency.

'In our view, that is a recipe for an overheating economy.'

On the other hand, the bank predicted that if there is a global recession, Asia ex-Japan economies will be severely hit - falling by as much as 4.5 percentage points. This would be nowhere near as bad as during 1997's Asian financial crisis, because of 'sound economic fundamentals' and 'plenty of room for macro policy to respond'.

However, Lehman Brothers has not gone out with a full-blown recession prediction for the United States, forecasting only a 40 per cent risk of a recession this year, slightly higher than its predicted one-in-three chance at the beginning of this year.