ECONOMIC OUTLOOK: Robert Zoellick, President of the World Bank, speaks at the opening ceremony of the annual meeting of the International Monetary Fund and the World Bank in Washington, D.C. on October 8 (ZHANG JUN)

A huge influx of hot money has inflated asset bubbles in emerging markets. This has led to more inflationary pressure, increased the difficulty of economic decision making and damaged the effect of exit strategies. In India, for example, the inflation rate has surpassed 10 percent. Capital surplus resulting from the influx of hot money is a key reason for this.

In order to contain inflation and limit asset bubbles, many emerging economies began to adopt tight monetary policies. Against the sustained low interest rates of the United States, Europe and Japan, emerging economies can only increase interest rates to curb inflation. This increases the appreciation pressure of their currencies, and leads to the influx of even more hot money.

As the Institute of International Finance predicted, the capital flowing to emerging economies will reach $825 billion in 2010, up 42 percent from 2009.

Both the IMF and the World Bank have cautioned the emerging economies to pay attention to the huge influx of international capital, and to prevent it from harming economic stability.

U.S. economist Nouriel Roubini warned the current monetary policies of the United States and Europe are producing huge asset bubbles, and may trigger a second financial catastrophe.

The continual depreciation of the U.S. dollar forces other currencies—especially the currencies of emerging countries—to continue appreciating and interrupts these countries' recoveries. Currently, many people are worried the weakening dollar may force the monetary policies of emerging economies off track.

Recently, IMF Managing Director Dominique Strauss-Kahn suggested for the first time that Asian countries implement capital controls to prevent asset bubbles and financial turbulence. Some countries have heeded this advice. Brazil, for instance, raised the financial transaction tax on foreign investors buying its bonds from 4 percent to 6 percent. Thailand also announced a 15-percent tax on foreign investors' profits from purchasing local bonds.

Another noteworthy fact is that organizations like the Organization of the Petroleum Exporting Countries (OPEC) have also begun to worry. OPEC is afraid the depreciation of the U.S. dollar may lead to a surge in oil prices, which is bad news for a sustained global economic recovery. In addition to oil prices, the prices of grain, minerals and precious metals will also be affected.

Sovereign debts

The financial crisis, coupled with the economic recession, has forced developed countries into financial deficits and increased sovereign debts.

Unlike similar historical cases, the current sovereign debts were caused by the financial crisis and the debtor countries are mostly developed countries. In the post-crisis era, the world is facing the severe challenge of dealing with Western countries' sovereign debts.

Europe's debt is only a small part of that of the whole Western world. The fiscal deficits and government debts of developed countries have climbed to the highest levels since World War II. According to the IMF, the ratio of government debts to GDP in developed countries will reach 100 percent by the end of 2010.

Such huge debts will be difficult to sustain. Worse still, all developed countries are facing the problem of aging populations. Increasing pensions and health expenditures will create a burden on future economic growth.

The bad news is the peak of the debts has not yet arrived. The most difficult time should come between 2011 and 2018. The IMF estimates the proportion of developed countries' government debts in GDP can be reduced to only 80 percent by 2023. Only if they can cut government spending to 8.8 percent of GDP, can government debts return to pre-crisis levels—below 60 percent of GDP.

Along with the heavy debts of developed countries, emerging economies are facing rising risks in financial security. In other words, huge fiscal deficits and government debts have not only affected the sustained economic development of developed countries, but also threatened the asset security of their creditor countries, that is, emerging countries.

The risks for emerging countries not only come from developed countries' weak debt-paying ability, but also lie in their declining repaying willingness. The currencies of debtor countries are mostly hard currencies. As long as their central banks issue notes, they can dilute their debts through inflation. The United States is the most likely one to adopt this practice. Its attempts to transfer its own crisis to other countries will greatly increase the risks of emerging creditor countries.

The author is director of the Institute of World Economic Studies of the China Institutes of Contemporary International Relations