A clerk helps customers at Woori Bank headquarters in Seoul, South Korea on May 4, 2009.

South Korea, Australia and India will raise interest rates ahead of China, the nation that is driving the region’s economic recovery, Bank of America-Merrill Lynch said.

Central banks in the region face risks in switching from “emergency” to “supportive” monetary stances, Merrill Lynch economists led by Hong Kong-based T.J. Bond said in an e-mail.

“Reversing unprecedented monetary easing could have unexpected effects on growth and financial markets,” the economists said. “Failing to reverse it could spark an outbreak of inflation.”

The first Asian nation to raise interest rates may be Vietnam, Merrill said, without saying when.

China’s economy, the world’s third biggest, rebounded to 7.9 percent growth in the second quarter from a year earlier on stimulus spending and a surge in bank lending.

Asia’s recovery “is in decent shape and emergency monetary stimulus needs to be removed well before the Fed hikes rates, which we currently expect in 2011,” the report said.

India’s inflation risks

The Bank of Korea “would be prepared to raise rates ahead of the Fed if necessary, although it would probably be reluctant to be the region’s first central bank to hike rates,” the economists said.

In India, “inflation risks are rising” and the central bank has said it may need to consider exiting from expansionary policies, the Merrill report said.

In China, additional reasons for keeping rates on hold are to avoid attracting inflows of speculative capital and because restrictions on loan growth are a “more effective” tool, the economists said.

The Shanghai Composite Index has fallen 16 percent from this year’s peak on August 4 because of investors’ concern that lending will slump in the second half after record gains in the first six months.

China plans to tighten capital requirements for banks to curb record lending, three people familiar with the matter told Bloomberg News.

The China Banking Regulatory Commission sent a draft of rule changes to banks on August 19 requiring them to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital, said the people, who have seen the document.

Source: Bloomberg