Inflation risis with Asia's recovery (Asia Times Online)

Written for and published by February 25, 2010. Click here for original article

Inflation rises with Asia's recovery
By Jennee Grace U Rubrico

MANILA - Asian economies, buoyed by fiscal pump-priming, loose monetary policies and growing intra-regional trade, have generally rebounded from recession faster and in better financial shape than other regions around the world. But as economic recovery comes quicker to Asia than in Europe and the United States, inflationary threats are rising as regional governments remain reluctant to rein in their crisis-induced stimulus measures, including, in many countries, record low interest rates.
Asia's economies are on the upswing, with China leading the way. The International Monetary Fund (IMF), in its World Economic Outlook, in January adjusted up its previous gross domestic product (GDP) forecast for China this year to 10% from 9% after the country reported 8.7% growth in 2009. It also raised its projections for India and the Association of Southeast Asian Nations' (ASEAN) top five economies - Indonesia, Thailand, Malaysia, Singapore and the Philippines.
As fast economic growth resumes, so too are pricing pressures that some say could undermine the medium-term effectiveness of government stimulus measures and, if poorly managed, open a new Pandora's box of economic troubles. Food and energy are major components of Asia's consumer price indices - accounting for as much as 60% and 15% respectively in certain economies - and are where new pricing pressures are expected to be most acutely felt.
In 2008, regional food prices rose to crisis levels and raised fears of severe shortages. The numerous factors involved included low levels of cereal stock, crop failures in exporting countries, demand for biofuel, rising oil prices, export restrictions, a weakening US dollar, price speculation, and enormous liquidity in the global financial system, according to the United Nations' Food and Agriculture Organization (FAO).
Current market conditions lack that same confluence, yet food prices are now approaching levels last seen in 2008, when a record spike in global oil prices contributed to a surge in cost-push inflation across various commodities. Oil prices collapsed with the global economic downturn, falling from a record high of US$147 per barrel in July 2008 to below $35 in February 2009. They are now again on an upward trajectory.
Market prices were just below $80 per barrel at the start of 2010 and are expected by many analysts to rise higher as economic recovery among Asian importers pushes up global demand. The countries seen by economists as most vulnerable to escalating food and energy prices are Vietnam, India and Sri Lanka, with the Philippines, Hong Kong and Korea representing the second tier of those most at risk.
Vietnam is a case in point, with inflation on course to return to double-digit levels by the second quarter of this year. Rising inflation expectations pushed the Vietnamese government into devaluing the currency this month for the second time since last November. Its not clear that Vietnam's rising inflation will have a contagion effect on other regional countries, but economists are closely tracking the situation.
In the FAO's price situation report released on January 25, the United Nations-affiliated agency reported that its Food Price Index had hit its highest level in November since the 2008 surge in inflation. The upward trend, it said, was driven by higher prices of rice, sugar, oil seeds and dairy products.
"Prices of rice are rising in several [Asian] countries, mainly in Vietnam, where they are 50% higher than two years ago; in Sri Lanka, where they have been at record levels in January; and in Bangladesh, where they have increased 30% in the past three months," the FAO report noted.
In India, the world's second-largest rice producer, the crop's price was well above the inflationary levels of two years ago and drought conditions have caused the government to scrap import taxes it maintained on the commodity through 2010. The need for more Indian imports is expected to push rice prices up across the entire region, according to the FAO.
Multinational bank HSBC noted in a recent research report that "Even in China, which has enjoyed a relatively good harvest over the past year and maintains ample stocks, food prices have risen 11.8% [quarter on quarter] in November."
Pricing pressures
What worries some economists is that unlike in 2008, commodity prices and core inflation are now pushing prices up in tandem. The HSBC report said that core inflation is no longer as "well-behaved" as previously, indicating "structural changes" in the behavior of inflation in the region driven by labor shortages and flexible wage policies.
Indeed, the bank's Asian Business Index (ABI) points to soaring input and output costs, with the latter "well correlated with core price inflation in most Asian economies". While Asia's flexible wage policies allowed many countries to avoid the massive lay-offs seen in some Western countries at the height of the global financial crisis, those same policies with recovery are increasing wages and in cycle putting more pressure on core prices.
There is growing evidence of labor shortages across the region, with Chinese firms in the country's export-oriented southern regions complaining of insufficient skilled workers and Taiwanese technology companies reportedly advancing New Year bonuses to avoid staff from being poached by competition. Increasing consumer spending power, too, is contributing to inflationary pressures.
While property prices have approached bubble territory in some markets in the region, particularly in China, Hong Kong and Singapore, many economists believe governments and their affiliated central banks understand the inflationary risks of maintaining overly loose monetary policies implemented against the global crisis and that most will begin tightening in the second half of this year as recoveries take hold.
"We expect monetary tightening will be a key feature of 2010, with higher interest rates and stronger currencies sharing the burden about equally," said Singaporean bank DBS in its first-quarter report on Asian economies. The bank expects monetary tightening to begin in the middle of the year, except in a handful of countries, including India and South Korea, which it expects will start to raise rates earlier.
That will require Asia's central banks to break their historical tendency to shadow movements of the US Federal Reserve and devise monetary policies better calibrated to the region's now dramatically different economic and financial fundamentals.
Noting that central banks may hesitate to adjust monetary policies because of political considerations, HSBC says it is best for monetary authorities to act sooner rather than later. It warned that any substantial delay in raising interest rates "inevitably involves a more aggressive subsequent move [and] may then introduce considerable volatility into financial markets".
If central banks are hesitant to raise interest rates, HSBC suggests alternatively that they withdraw fiscal stimuli; tighten banking supervision, including by beefing up capital requirements or the application stricter lending guidelines, most notably for mortgages; cap aggregate credit growth; or allow exchange rates to appreciate more rapidly. Few of the region's export-oriented countries have taken on board the advice to appreciate their currencies due to fears they will lose market share to regional competitors, including vis-a-vis China and its fixed exchange rate regime.
The IMF, for one, does not support the rapid withdrawal of Asia's fiscal stimulus measures, warning that while economies have recovered they may not be strong enough yet to stand alone. "Due to the still-fragile nature of the recovery, fiscal policies need to remain supportive of economic activity in the near term. The fiscal stimulus planned for 2010 should be fully implemented," the IMF said in a statement.
At the same time, the IMF said "countries that are already enjoying a relatively robust rebound of activity and credit will have to tighten monetary conditions earlier and faster than their counterparts elsewhere". Whether Asia's central banks do so in a timely and effective manner will determine whether Asia's recovering economies sustain growth or set the macroeconomic stage for the region's next bust.
Jennee Grace U Rubrico has been a journalist for over 10 years.
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