Last week, central banks on both sides of the Taiwan Strait moved against excessive liquidity, particularly hot money, in a pre-emptive campaign targeting asset bubbles.
On Monday, Taiwan’s central bank issued a statement highlighting the necessity of capital controls. The statement, which the central bank dubbed “reference materials,” listed dozens of commentaries by international agencies and leading economists relating to Asia’s potential asset bubbles and controls on international capital flows.
Since early October, the central bank has on several occasions expressed its dislike of short-term foreign capital inflows in financial markets. It even joined the Financial Supervisory Commission in warning foreign investors to leave the country within the week if they had not put their money into Taiwanese shares or bonds as they promised to do.
This time, however, in the context of a cross-strait financial memorandum of understanding that took effect yesterday, the central bank seems to be worried about the entry of Chinese capital in the form of qualified domestic institutional investor (QDII) funds. The concerns arise from the possibility that speculators will target Taiwan via the Chinese funds.
The central bank’s concern eventually led to a compromise at the Financial Supervisory Commission. On Friday, the commission announced that it would allow Chinese QDII funds to invest up to US$500 million in Taiwanese stocks — half of the planned ceiling of US$1 billion that the commission initially proposed to the Cabinet.
In China, the threat of hot money, coupled with excessive liquidity in the banking system, also forced that country’s central bank to unexpectedly announce on Tuesday a 0.5 percentage point increase in the reserve requirement ratio for commercial banks, effective tomorrow.
By forcing commercial banks to deposit more money in the central bank, Beijing hopes the move will lower the amount that commercial banks will lend out amid an overheating economy. It was also aimed to help curb stock and property speculation.
Clearly, China is becoming more wary of excessive liquidity and hot money inflows. The government has recently acted to impose taxes on certain property transactions, encourage tighter scrutiny of loans and more closely monitor foreign fund inflows to prevent speculative investment.
The problem is how effective these measures are likely to be — and whether more aggressive measures should be waiting in the wings. The irony is that if the central banks have to raise interest rates ahead of similar moves by the US Federal Reserve, the European Central Bank and other major central banks, then Taiwan and China may risk attracting more speculative capital, thus aggravating the asset bubble threat.
The most important challenge for the two governments is how to respond if investors take a different attitude from a year ago, when the whole world was hit by a disorientating financial crisis, and swarm around currency, stock and property investments.
It is the nature of investors to seek opportunities for profit, short term or long term.
Governments, however, have the responsibility to guide excessive liquidity into spending and production in the real economy instead of allowing such funds to flow exclusively to markets dealing in equities, real estate and commodities. The alternative is rising asset prices, one of the most enduring effects of loose credit policy in the post-crisis period.
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