UPDATE 1-ADB urges caution in Asia against withdrawing stimulus

* Raises growth forecasts for region, China view unchanged

* Sees quick rebound for Asia, but global recovery fragile

* Asia's risk is short-lived recovery in developed economies

* Capital flows a risk, urges against capital restrictions (Adds chief economist's quotes; byline)

By Karen Lema

MANILA, Dec 15 (Reuters) - The Asian Development Bank raised its growth forecasts for developing economies in Asia on Tuesday, but warned against any hasty withdrawal of stimulus packages, saying they were still needed to ensure a solid recovery.

It also cautioned governments that restricting the capital flooding Asia's emerging economies carried risks, suggesting that allowing more flexible exchange rates was one way to control the investment flows into the region.

The ADB raised its regional forecast to 4.5 percent on average in 2009 and 6.6 percent in 2010 from expectations in September of 3.9 percent and 6.4 percent, respectively.

"Global recovery is still fragile so Asian countries need to maintain current stimulus packages," ADB Chief economist Jong-Wha Lee said. "The Asian countries' monetary and fiscal policies should remain accommodative but they also need to design exit strategies from these stimulus packages."

Asian policymakers have put in place massive fiscal incentives and slashed interest rates to record lows to help their economies cope with the global economic crisis.

Many have paused to assess the impact of easier policy, while others have either begun or signalled they were ready to hike interest rates to keep a lid on infationary pressures as their economies gradually pick up.

Withdrawing stimulus too quickly is a risk, the ADB said.

"If done too soon, recovery may be at risk; if too late, fiscal deficits and monetary expansion could become unsustainable and inflationary," ADB said in a separate statement.

It said, however, that inflation remained muted for the moment and was likely to remain so, even while the recovery was taking hold. This had allowed authorities to maintain fiscal and monetary stimulus packages.

"In the medium-term, inflation could pick up in line with the general economic recovery and higher commodity prices," it said.

The report showed that the ADB maintained its growth forecasts for China at 8.2 percent in 2009 and 8.9 percent in 2010. It raised the 2009 growth forecast for India to 7.0 percent from 6.0 percent, but kept 2010 at 7.0 percent. [ID:nMNB002547]

"Recent data reinforces ADB's impression that developing Asia can expect a V-shaped recovery from the global economic downturn," the ADB said. "For many countries in the region, growth in the third quarter of 2009 has been higher than forecast."

CAPITAL INFLOWS

Risks to Asia's expansion included a short-lived recovery in developed economies and destabilising capital flows, it said.

"Faster recovery and higher growth in the region should attract more capital inflows, and limited exchange rate flexibility in the region could also encourage increased capital inflows, speculating on anticipated appreciation," it said.

"Yet, capital flows could destabilise the real economy. Changes in risk sentiment might lead to sudden capital flow reversals."

Both Brazil and Taiwan have imposed capital controls and other countries have suggested they are studying measures to restrict capital or redirect it to other economic sectors.

Lee cautioned against imposing capital controls, saying there were other ways by which policymakers could stem inflows.

"If you increase the flexibility of the exchange rate, if you improve the strength of financial market regulation, that will help manage more effectively these capital inflows.

"You also need to strengthen other regulatory measures to address possible bubbles in the domestic market. You don't need to necessarily prevent the capital inflows. You can strengthen your domestic capacity to minimise negative impact from hot money capital inflows."

Higher capital inflows have resulted in currency appreciation mainly in emerging markets in Asia and Latin America.

"If capital inflows become too messy and then the appreciation in asset price become excessive, some countries considering restricting capital inflows need to be very careful and they need to communicate with financial markets, otherwise it might create a negative impact on private sector," Lee said. (Editing by Raju Gopalakrishnan and Neil Fullick)