Dec. 15 (Bloomberg) -- While a housing-led slump in the U.S. economy may indeed emerge as the biggest risk to Asian economies in 2007, a more immediate threat to investors will probably be posed by the region's central banks.

Policy makers in China, South Korea and India may have no option except to aggressively contain domestic liquidity and stamp out asset-price bubbles even as the U.S. Federal Reserve and the European Central Bank get closer to ending their monetary tightening cycles.

Relying on ``shock therapy,'' central banks in these countries might end up making overstretched securities -- such as Indian and Chinese equities -- more volatile than they have to be. A case in point was the bloodbath on Indian stock markets earlier this week.

In the absence of a full-blown U.S. recession, an intolerable surge in oil prices or a sudden aversion for financial risk, the global environment is likely to prove fairly stable in 2007.

After raising its key interest rate six times in the past year, the ECB has already cut its inflation forecast for 2007. And although the Fed still believes that ``some inflation risks remain,'' it would, according to bond traders' expectations, have switched to easing mode before June 2007.

While analysts expect the Bank of Japan to keep increasing interest rates next year, wages and consumer spending in the world's second-biggest economy still aren't robust enough to suggest the need for an overly aggressive monetary response.

In Asia outside of Japan, lax local financial conditions and the authorities' efforts to deal with them may have a greater bearing on investor sentiment than anything that the Big Three global central banks may or may not do.

Perils of Shock Therapy

Some evidence of that came this week when the benchmark Indian equity index plunged 5.8 percent following the central bank's surprise announcement that it would remove 135 billion rupees ($3 billion) from the banking system by raising the ratio of deposits banks are required to hold as cash.

The need for cooling the overheated Indian economy is undeniable. What investors can't take for granted is that it will be accomplished in a credible manner.

``The exaggerated response of the stock market is, in part, symptomatic of a failure to conduct effective monetary policy by guiding financial market expectations before taking appropriate policy actions,'' says Maya Bhandari, an economist at Lombard Street Research Ltd. in London. ``While the bewilderment of the Sensex will probably be temporary, the effect on the economy of opaque monetary policy could be severe.''

The Reserve Bank of India isn't the only Asian monetary authority to resort to shock therapy. In Korea, the reserve requirement on demand deposits is going up by 2 percentage points after Dec. 23 to deflate a housing bubble. The decision, announced by Bank of Korea last month, is the first increase in reserves in almost 17 years.

Fragile Korean Consumer

The question in Korea is whether monetary policy will achieve a soft landing in the housing market or cause it to crash.

According to Samsung Economic Research Institute in Seoul, housing prices nationwide rose more than 11 percent in the first 11 months of 2006, compared with less than 6 percent last year. In overheated pockets, price escalation is even more rapid.

With floating-rate mortgages accounting for 98 percent of the total, a sudden drop in home prices may further depress consumer sentiment, which has yet to recover from a credit-card bubble that burst in 2003.

Lee Seong Tae, the central bank governor, made it clear that he won't make a habit of manipulating reserve requirements. That's reassuring. Changes in reserves, because they have long- term effects on money supply and economic activity, are generally seen as a central bank's weapon of last resort. ``The change in required reserves won't come often,'' Lee said.

That, however, may not be the case in China.

`Heavy Dose of Medicine'

There are strong expectations that the People's Bank of China, which has already raised the reserve ratio by 2 percentage points in three steps since June, will be forced to act again to mop up the surfeit of liquidity being released by its massive trade surplus.

The gap between exports and imports came in at almost $23 billion in November, more than double the previous year's level.

People's Bank of China's third-quarter monetary policy statement released last month included 70 references to liquidity.

``Given the abundant liquidity, an increase in the reserve requirement ratio by a small margin is not a `heavy dose of medicine,' but rather a fine-tuning,'' the bank said.

Dearer Money

China's liquidity challenge is compounded by expectations of currency appreciation. The yuan, traders reckon, must strengthen substantially against the dollar to reduce the growing likelihood of the U.S. Congress passing punitive legislation against Chinese exports.

The one-way bet on yuan appreciation is drawing in overseas capital and pushing up equity prices in Shanghai and real-estate values in Beijing to dizzying heights.

While China's economy is plagued by overinvestment, India's is overheating. Economic activity in Korea, too, has been surprisingly strong, says Goldman Sachs Group Inc. analyst Kim Sun Bae in Hong Kong.

At least in these three Asian nations, investors may not find themselves worrying as much about a U.S.-induced growth slowdown next year as they may about the central banks suddenly turning off the money taps.

(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Andy Mukherjee in Singapore at amukherjee@bloomberg.net.

Last Updated: December 14, 2006 14:03 EST