Inflation is emerging as a growing risk across most of Asia except Japan. Given the situation just six months ago, when most Asian economies were experiencing deflation or much lower rates of inflation, the increase in price pressures in recent months highlights the region’s rapid economic turnaround since the depths of the global recession in early 2009. The pick-up in demand is in most respects a welcome phenomenon, but it is making it more difficult for policymakers to support growth without compromising price stability.
Inflation rates are picking up in most of Asia. Ignoring Japan, by late 2009 only two major economies in the region, Singapore and Taiwan, were still experiencing price falls in year-on-year terms. In India the year-on-year rate of consumer price inflation rate rose sharply to 13.9% in November. Wholesale price inflation (a more widely watched indicator in India) has also picked up sharply, to 7.3% year on year in December from 4.8% in November; this contrasts with falling wholesale prices in mid-2009. Consumer price in inflation has also recently picked up in Pakistan (to 10.5% in December) and Vietnam (8.5% in January), although in both countries such rates are still far below the alarming 20-plus levels recorded in 2008. The increase in inflationary pressures is also generating concern in China, after the consumer price index rose by 1.9 year on year in December, compared with a 0.5% fall as recently as October. Indeed, the country experienced nine successive months of deflation between February and October 2009.
The causes of stronger inflationary pressures vary from country to country, but there are a number of common factors. The biggest is the rebound in many commodity prices, which are now significantly higher than their depressed levels of one year ago, during the worst of the economic crisis. International oil prices, for example, touched US$80 a barrel in early January 2010, double their level at the same time last year. Other factors, such as poor monsoon rains in India, have caused significant disruption to the agriculture sector, causing food prices to rise. Vegetable prices are soaring in China in response to heavy snow, which has put supplies under pressure and made it difficult to get goods to market.
Another factor has been the strong economic recovery, which has eliminated problems of excess capacity across much of the region. Although most Asian countries do not provide decent capacity-utilisation figures, anecdotal evidence suggests that in a number of countries the output gap—the difference between an economy’s potential and actual growth—is narrowing fast or, in some cases(as in China), has been eliminated completely.
The rapid economic rebound may soon lead to upward pressure on wages, adding to inflationary risks. Wages fell sharply in most countries during the worst of the crisis in early 2009—suggesting that labour markets and wages in Asia are very flexible. However, this flexibility also suggests that wages can increase quickly in the event of a strong economic recovery. There are already reports of labour shortages in factories across southern China, as well as stories in Taiwan of bonuses in the electronics sector being paid early in order to retain key staff.
An additional concern relates to the potential effects of massive monetary-policy loosening and rapid credit growth. This is reflected in concerns that excessive liquidity could fuel inflation. This is not a problem everywhere in the region, but it is already of serious concern in both China and Hong Kong. It could emerge as a threat in other places if interest rates remain very low for a long time. It is not just the threat of high consumer price inflation that is causing concern. Policymakers also fear that low interest rates could lead to asset-price bubbles in stockmarkets and property markets. In addition, after falling sharply in 2009, producer prices are likely to grow strongly this year, owing to the rapid rebound in commodity prices.
Policy dilemma
In some respects the return of inflation to Asia is encouraging, since it shows that the region is not in danger of falling into a deflationary spiral of the kind that Japan experienced during its “lost decade”. However, managing inflation will create challenges for central banks, which remain wary of raising interest rates too quickly given the uncertain global outlook.
Policymakers are likely to be especially reluctant to tighten monetary policy quickly if the cause of rising inflation is seen to be a temporary one-off shock, such as a rebound in oil prices from the low levels of early last year, or the effects of a natural disaster (such as the floods in the Philippines in September 2009). However, if inflationary expectations become more entrenched, central banks may need to raise rates sooner than they would like, despite the continued fragility of the global economy.
Conversely, there also remains a danger that political pressure to keep interest rates low to support economic recovery will result in central banks being too slow to raise interest rates. This could allow inflation to emerge as a more serious problem later this year, necessitating even stronger tightening measures, with potentially harmful consequences for growth.
Forecast
The Economist Intelligence Unit has revised up its forecast for consumer price inflation in Asia and Australasia (excluding Japan). We now think the aggregate inflation rate will average 4.6% in 2010, and 4% in 2011-14, compared with just 2.7% in 2009. This is substantially higher than in our most recent global forecast, which envisaged inflation of 3.9% in Asia in 2010 and 3.7% in 2011-14.
Source: Viewswire