Tuesday, April 5, 2011

The Spectre of Inflation in Asia

It isn't just China and India – most of Southeast Asia will be hit

Almost all of Asia is behind the inflation curve. And blaming US quantitative easing makes little sense when most of these countries – not just China – have been continuing to mop up US treasuries and other low-yield western debt, rather than follow policies which would damp inflation but might harm exports.

Consumer price inflation hit 5 percent in Singapore in February. Given the city's tight fiscal policy and rising currency – the US dollar has declined from S$1.40 to S$1.26 over the past year – one can expect that inflation in Asia is becoming ever more deeply ingrained. For sure, Singapore's inflation spike may prove a partly temporary, driven by one-off local factors as much as international ones. Still, for the full year it now looks sure to be at the top end of the 3-4 percent official forecast range. Meanwhile savers continue to lose out thanks to interest rates of just 0.3 percent on savings deposits and with a 10-year government bond yield just under 3 percent.

With Singapore continuing to enjoy a current account surplus of 17 percent of GDP, one might think that higher interest rates and another 10 percent currency gain would put the economy on a sounder footing for the long term. But Singapore still seems to focus on growth numbers, even if that means having to continually increase the import of labor, and a huge external surplus, even if invested in low yielding assets, rather than encourage either consumption or reward savers.

To find Singapore's CPI figures well above those of Malaysia may be a surprise – until one takes a closer look. For a start many doubt the accuracy of Malaysia's claim for the figure to be around 2.5 percent, noting actual increases in many basic food and energy prices. Malaysia has one important trend that counters inflation, notably a steadily rising currency, which has appreciated roughly at the same pace as Singapore's. But important factors also include slowed reduction in oil and some food subsidies, import duty cuts announced in the last budget and a government-ordered freeze on expressway tolls.

Malaysia keeps the CPI down partly by keeping the government deficit up, this year likely to be around 5.4 percent of GDP, a small reduction on last year. In addition government-linked companies have been raising money for projects of dubious economic merit. While such spending may seem innocuous when export commodity prices are booming they may prove hard to sustain under less buoyant circumstances. Meanwhile the long-term driver of growth – private investment – remains very weak as capital flows to less discriminatory destinations.

Complacency about inflation also seems to be infecting Indonesia, putting at risk a well-earned post-Asian crisis reputation for fiscal and monetary prudence. Inflation at 6.6 percent is still modest by local standards but the rate has been kept down by subsidies – much of them to high-income car owners – which would be much better spent on the nation's creaking infrastructure. Meanwhile monetary growth has revived to around 15 percent and private sector credit to over 20 percent, which looks too much. Bond yields have been kept down partly by the eagerness of foreign investors to buy into the Indonesian success story and accept rupiah interest – 7.2 percent on two-year bonds – which is barely abreast of inflation. The currency has also gained 4 percent against the weak US dollar over the past year so for now rupiah debt looks attractive. But the current account surplus has been eroding even as commodity prices remain very favorable. Watch for some big losses when commodities turn south.

Complacency continues to reign in Vietnam. Its counter-inflation measures again look like too little too late. Another 100 basis-point rise in interest rates and cuts in government spending might just be enough to halt the vicious cycle of excessive monetary growth, currency devaluation and inflation which has been running at close to 20 percent. But there have been too many false dawns before as the government seems to lack the political will to squeeze inflation back to single digits.

But much of developed Asian has been behind the inflation curve too. The Bank of Korea has raised interest rates several times but from a low level and with the base lending rate now at 3 percent it remains well below the actual rate of CPI – 4.7 percent – and merely abreast of the 3 percent inflation target rate. As ever, Korea has focused more on keeping its currency cheap to boost exports, which have gained dramatically, partly at the expense of Japan because of the huge advance of the yen against a relatively weak won. Korea's currency manipulation may not be as obvious as China's but it has been at least as effective.

Hong Kong meanwhile has so far shown surprisingly mild inflation considering that its currency is stuck with its US dollar peg-derived inflation. It is also dependent on China which has a rising currency and domestic inflation, for many basic imports. The latest CPI increase is only 3.7 percent. But it has been inching up steadily and inflation may well prove more entrenched than elsewhere because of this currency and because of the delayed manner in which property price increases work their way into the index. The CPI is also being artificially reduced by one-off measures such as temporary property tax concessions.

Ludicrously, the government likes to believe that it can have some impact on inflation by influencing marginal demand through its fiscal surplus. The government is forecasting 4.5 percent for the full year but other estimates put it at 5 percent and some see it peaking at 7 percent.

The region's inflation champion is Taiwan, where the CPI increase is running at around 1.5 percent even though the economy has been booming on the back of technology exports. Currency appreciation of about 10 percent over the past year against the US dollar has helped. However that news is not all good. The domestic economy remains sluggish which accounts for the fact that although unemployment has declined it is still over 4 percent. Hence wages have barely moved and credit demand has been modest. The CPI is also helped by Taiwan's high self-reliance on protected, locally-produced food and by some price controls.

All told the trend in Asia is helping asset values but retarding the growth in disposable incomes.

Asia Sentinel

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