Source: The Wall Street Journal Asia                       Date: 27 October, 2010

Asian countries should allow their currencies to rise and withdraw stimulus measures as they grapple with surging capital inflows that threaten to fuel inflation, the International Monetary Fund said last week. Asia, including Japan, is likely to grow 8% this year, faster than the 7% estimated in April, but the region's economies need to rebalance their growth toward stronger domestic demand, as imports of goods and services by developed nations aren't likely to return to precrisis levels anytime soon, the IMF said in its latest Regional Economic Outlook for the Asia-Pacific.

"In view of the strong economic expansion that is under way, and emerging signs of inflationary pressure in some economies, Asia has reached the threshold to normalize policy stances across the region," the IMF said in the report. "Greater exchange-rate flexibility will be an important component of policy tightening."

Asian nations have been rushing to deal with rapid capital flows as investors shift away from the economic uncertainties of the U.S. and Europe. The shift has shaken currency markets and prompted several Asian nations to intervene to keep their currencies from rising in value. Meanwhile, China—which bears the brunt of global scrutiny over its currency controls—has let the renminbi rise but still faces pressure to let its currency float more freely.

Asian countries have comprehensive tools to tackle capital inflows, Mr. Anoop Singh, director of the IMF's Asia and Pacific Department, has said. "The challenge is to channel these inflows beyond the financial market, such as to infrastructure projects.".

The capital inflows haven't gone beyond their peak levels before the 2008 financial crisis and the IMF doesn't expect governments to erect capital controls, Mr. Singh said. Still, further tightening of monetary conditions in Asia may be needed, including increased exchange-rate appreciation, the IMF said in the report.

A faster withdrawal of fiscal stimulus would also help guard against the risks of overheating and a buildup of financial imbalances. "Despite the recent tightening, financial conditions generally remain accommodative in many emerging Asian economies compared with before the crisis (especially in China, the Philippines, and Thailand), as the policy easing of 2009 has not been completely unwound, equity valuations remain elevated, and bank credit continues to recover," the report said.

The IMF said managing capital inflows is another major policy challenge for Asia, as U.S. monetary conditions are likely to remain supportive for an extended period and global interest rates may stay low.

Currencies such as the Australian dollar, Thai baht, Indian rupee and Singapore dollar have racked up substantial gains in the past two months. The Chinese yuan has also appreciated but hasn't kept pace with its regional peers. The IMF said the yuan "remains substantially below the level consistent with medium-term fundamentals," citing China's rapid pace of foreign-exchange reserve accumulation, its large trade surplus and its productivity.