THE latest Asian Business Cycle Indicators reveal that the ASEAN economies are likely to maintain the growth momentum in the first quarter of 2011. In particular, relatively positive developments in Indonesia, the Philippines and Thailand are associated not only with strong export demand but also sound domestic demand and improved business sentiment. The recovery of China’s economy is driven by robust investment. Activity is showing some signs of slowing in India.

Growing confidence in the ASEAN economies, coupled with economic uncertainties still lingering in most OECD countries, has boosted capital inflows in the region. Policy makers in Southeast Asia are concerned about such inflows and potential reversals which might jeopardize the region’s macroeconomic stability. Countries are reacting differently; for instance, Indonesia considers tightening capital controls, while Thailand has introduced a withholding tax on foreign investment in Thai bonds.

Inflationary pressures are posing another important challenge to policy makers in the region. Geo-political tensions in the Middle East and North Africa have pushed up oil prices once again. In addition, droughts in China might add to the already significant pressures on food prices. Countries in the region are considering a broad range of options, including subsidies and price caps and likely to tighten their monetary stance as inflationary pressures feed into core inflation expectations.

In sum, ASEAN economies in the first half of 2011 (and beyond) are facing the double policy challenges of tightening interest rate policy to quell inflationary pressures, while avoiding additional capital inflows and maintaining competitiveness.

Inflationary pressures are also mounting in China and India stemming from different sources: soaring real estate prices in China and food prices in India.