BIS warns of new debt, property risks in emerging markets

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Emerging economies are at risk of building up debt levels and property bubbles similar to those in advanced economies that triggered the recent financial crisis, the Bank for International Settlements warned Sunday.

"Emerging market economies managed to escape the worst of the crisis, but many now run the risk of building up imbalances very similar to those seen in advanced economies in the lead up to the crisis," said the bank for central banks.

"For example, property prices in a number of emerging market economies are advancing at staggeringly rapid rates, and private sector indebtedness is rising fast," it said.

"Emerging market policymakers should recognise that the lessons from the financial crisis do not appply only to advanced economies," it added.

The BIS warning echoed the International Monetary Fund's in mid-June. The IMF's research director Olivier Blanchard warned then that some emerging economies in Asia and Latin America were running the risk of overheating.

While the IMF did not cite specific countries, the BIS said that Brazil, China and India all recorded credit growth of more than 20 percent annually between 2006 and 2010.

Fuelled by rapid economic growth and urbanisation, China's property prices have also been defying cooling measures. The Asian giant is now racing to build subsidised housing in a bid to prevent a property bubble.

Beyond property prices, inflation is also rising in many emerging countries due to strong economic growth, and rising food and commodities prices.

As the central banks act to fight inflation by raising interest rates, the emerging markets are facing a new danger -- large capital inflows.

Investors are now "increasing their carry trade positions in emerging market fixed income instruments," said the BIS.

Carry trade is a practice where investors borrow sums of a currency that levies low interest rates, and then deposit the fund in another currency that pays higher interest rates. The investors therefore earn the difference of the two currencies interest rates.

But this capital shift to emerging markets carries "potentially damaging effects," noted the BIS.

It could potentially fuel "unsustainable credit expansions and asset price booms," said the bank.

"What begins as a response to strong fundamentals can become a serious threat to financial stability," it warned.

The recent financial crisis was triggered by US subprime home loans, which led to a collapse of the housing market.

As banks were heavily involved in issuing or investing in these loans, defaults in the subprime loans led to heavy writedowns in the financial institutions, some of which were international giants.

To prevent a financial meltdown, governments stepped in with state funds to prop up the banks.

In addition, they spent heavily on stimulus measures to keep economies churning, but this in turn brought about massive budget deficits, which the BIS said needed to be trimmed swiftly in order to prevent the next disaster.

© 2011 AFP

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