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A surge of capital is flowing into emerging markets as money flees the U.S., Europe, and Japan in the hope of higher returns.

The perception is that emerging markets offer stronger profit growth for their stocks, higher interest rates for their deposits, and the potential for currency appreciation.

Yet it's not all roses for the emerging economies involved.

That's because the surge of money seeking emerging markets is an example of how easy monetary policy in the developed world spills over into the developing one. Emerging markets nations try to tighten monetary policy... but are then beset by waves of foreign capital entering their countries. This negates the domestic tightening effort since foreign money is sloshing around their economies, and it's how Ben Bernanke is actually the entire world's central banker.

One risk is excessive loan growth, despite a nations' efforts to restrict lending, and this could be happening as we speak according to Deutsche Bank's Peter Hooper:

Deutsche Bank:

This surge in capital inflows raises a number of concerns. First, it could generate excessive credit growth; and credit growth has risen sharply in recent months. This complicates monetary policy in a region where most central banks are trying to at least “normalize” monetary conditions if not actually tighten credit.

Chart

Credit growth is soaring in places such as Hong Kong (HK), Indonesia (ID), Singapore (SG), South Korea (SK), the Philippines (PH), Taiwan (TW), Malaysia (MY), and Thailand (TH).

Thailand just the other day slapped a 15% tax on bond investments in response to capital flows. More Asian measures are likely on the way.

(Via Deutsche Bank, Capital controls in emerging markets, Peter Hooper, 13 October 2010)

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Source: Deutsche Bank: Look How the Fed Is Fueling a Credit Bubble in Asia