Asia is finally waking up to its inflation challenge. Recent weeks have seen a further round of monetary tightening, with a succession of central banks raising interest rates, or taking other measures to put a cap on rising prices. India, in particular, has taken tougher action than before, with a large rate hike, whilst others such as China have again pushed up reserve requirements.
The policy challenge is never easy. Is this a case of too little, too late: taking action after inflation has already taken off and when there are expectations of more to come? Or is it, too much, too soon — as there are tentative signs the world economy has started to slow, in turn taking the heat out of commodity markets, with food and energy prices easing off?
Dilemmas
The world is two years into an economic recovery. But in many places it doesn't feel that way. This recovery has been led by emerging economies and by policy easing in the West. But, it is a divided and disconnected world, as different growth prospects, high rates of unemployment and recent problems in North Africa and the Middle East testify. And it is a world of policy dilemmas.
In the West, where economies are fragile, a double-dip recession is the fear. Across Asia, and large parts of the emerging world, the risks are on the upside: inflation.
The inflation challenge is greater in Asia for many reasons. Last year the region grew strongly, and the slack in Asian economies is far less than in the West. Strong domestic demand allows retailers and producers the opportunity to pass on higher costs and to sustain or boost their margins by raising prices.
While this is a concern, rising wages and good labour market conditions are allowing people to pay higher prices. This is akin to a wage-price spiral, albeit in the early stages, but it can get out of hand if not addressed quickly enough. Then there is the very issue of food and energy prices itself.
Higher prices of these staples hit hard into spending and can cause problems, in particular for the poor and those on low incomes. Thus, in many countries, there are complex subsidies in place, on areas such as food, fertiliser and fuel. These subsidies need to be phased out, but it is difficult politically to do this.
To these domestic inflation drivers, there is the additional challenge for Asia and for many emerging regions of how to cope with capital inflows. This came to the fore as an issue last year, when money flooded in.
Often challenges are most apparent in property prices. When money flows in from overseas, it seeks out a home, and all too often this is in equities, or in real estate, adding to existing domestic pressures.
Lethal combination
A recent analysis by Standard Chartered of Asian property prices shows the pressure points. That study used the idea of traffic lights to put countries into green, amber and red categories. For those in red, prices are already too hot, and policy-makers must stop them. Singapore, Hong Kong and Beijing top this ‘property bubble-o-metre'.
Thus Asia faces inflation challenges on two fronts: in asset prices, especially in property and equities; and in general terms, across the whole economy, impacting everyone. Central banks across the emerging world need to avoid the lethal combination of cheap money, leverage, and one-way expectations. If they don't, inflation could take off, initially in property but then across the wider economy. This justifies recent policy tightening. It also supports the case for stronger Asian currencies, as economic fundamentals are good and as a way of curbing imported inflation.
While there are many reasons to be positive about emerging market prospects, nothing can, or should, be taken for granted. The business cycle exists. Setbacks can occur. One fear has been the setback from high oil prices.
Inclusive growth
Asia should not under-estimate the inflation risks from recent strong growth and the possible fall-out. Not surprisingly, high energy and food costs were a hot topic at the recent annual Asian Development Bank (ADB) meeting in Hanoi.
The three Asian economies that have witnessed the biggest improvement in Human Development Indices are Nepal, China and Bangladesh. Yet inclusive growth is also dependent upon credible macro-economic policies that help keep inflation in check and achieve sustainable growth.
For Asia, the message should be clear. The longer-term issues count for nothing if macro-economic policy does not confront the immediate challenges ahead: and the most important of those is the need to address inflation.
Although there is further to go, recent actions by central banks suggest Asia is moving in the right direction.
Source; gulfnews.com
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