Asia's inflationary winners and losers
By Shawn W Crispin
BANGKOK - As cost-push inflationary pressures course through Asia's oil-importing economies, some countries are better placed than others to meet the rising macroeconomic challenge presented by spiraling global oil prices, which hit a record high of US$147 per barrel this month.
How individual governments respond in the coming months will separate the region's economic winners from losers and likely determine whether the global economy is headed for a hard or soft landing in light of the US's mounting financial and economic troubles.
The region's economies have maintained strong growth momentum in the first half of this year, with several countries near peak economic growth levels. Accommodating monetary policy has played a significant role in many countries' growth, as has an unexpected surge in Japanese and European demand for Asian exports to offset the slump in the US.
That's expected to change in the months ahead, however, as external demand in the US, Europe and Japan is expected to weaken and the loss of export income begins to crimp local economies' growth. Investment bank UBS projected in a report this month that Asia's small open economies will likely see growth cut by half over the next four quarters, while the less externally geared China and India lose one to two percentage points of growth over the same period.
Across Asia, central bankers find themselves on the horns of a crucial policy dilemma in how to calibrate growth and stability. Hiking interest rates would help to re-anchor rising inflationary expectations, which are already coming unhinged in certain countries, but also will dampen domestic-led growth at a time global demand, including in the net-importing US, is expected to tail off.
Central banks in the region have so far been reluctant to appreciate exchange rates to mitigate inflationary risks, due partially to long-held concerns that a stronger currency will undermine export competitiveness via-a-vis their main regional competitors. Nor is it clear offshore interventions in foreign exchange markets are a viable way for regional countries to curb effectively cost-push inflation driven by rising global oil prices.
Investment bank Credit Suisse reckons monetary authorities would have to allow for double-digit currency appreciations to significantly dent local inflation rates.
Nearly all Asian central banks have historically endeavored to maintain their exchange rates - whether fixed or floating - within a steady level of the US dollar to anchor business expectations, particularly for their respective export sectors.
But with the US Federal Reserve now using loose monetary policy to stave off a possible financial collapse, many regional central banks are importing interest rates that are out of step with their own underlying economic conditions. In doing so, they risk pushing inflation higher than rising global oil prices alone would dictate.
The reflex to protect economic growth has so far limited the region's policy response to fight fast-rising inflation. In part that is because many monetary authorities view the recent spike in global oil prices as a one-off supply-side shock, influenced by US-led war and political instability in the Middle East, that will soon stabilize at a lower price level.
That view gained some currency last week when crude oil prices fell 11% before rising over 2% on Friday to close at around US$131 per barrel. Some economists in the region predict oil prices will dip further on slowing demand and stay steady at around $120 heading into 2009.
That is a shot-in-the-dark prediction, considering many of the same analysts thought $100 oil unfathomable just a year ago and with bearish commentators citing "peak oil" arguments still projecting average prices could rise as high as $200 by 2009.
Inflationary dominoes
So are Asia's central banks underestimating the risk of entrenching high inflation rates that will require drastic and growth-debilitating monetary measures to control in the future? It depends on where you look, economists say.
Doomsday comparisons to the run-up to the 1997-98 Asian financial crisis are in the main spurious considering few regional countries are plagued by the same overinvestment, credit bubbles, current account deficits and external debt profiles which characterized the region's previous meltdown. Nor is monetary policy equally loose across the region, as some commentators have suggested.
Countries such as China, India, South Korea and Indonesia fall into the lax monetary policy category, while Malaysia, Taiwan and Thailand have seen only modest money supply growth in recent months, according to Credit Suisse. The bank noted in a recent research report that "there are concrete differences in the conditions under which cost-push inflation is affecting the region and how each central bank should and may respond".
Investors and currency traders are thus taking a more sophisticated country-by-country view than the lump assessment they made during the 1997-98 financial crisis, when investor herd behavior meant capital fled wholesale the region's emerging economies despite significant differences in their underlying economic and financial fundamentals. Analysts are now looking towards individual countries' domestic demand, fiscal flexibility, central bank credibility, sovereign creditworthiness and exchange rate trends in making their risk assessments.
That also means those countries with widely perceived imbalances could take a disproportionate hit than when capital flight and currency selling was more evenly distributed across the region, as it was in the 1997-98 crisis among Thailand, Indonesia, South Korea, Malaysia and the Philippines.
Inflationary expectations are already coming unhinged in a number of regional economies and risk doing so in others without a prompt and firm policy response, economists say. While several Asian countries have the central bank credibility and fiscal flexibility to keep inflation expectations well anchored, including China, Japan and Taiwan, others lack the financial resources and monetary independence to prevent speculators who perceive they have moved too slowly from selling down their currencies.
That raises the risk of more debilitating second-round inflationary effects, including wage-price spirals, which if not contained could result in the sort of hyperinflation witnessed in Latin America in the 1980s. "There will be winners and losers, with some countries getting hit especially hard," said the head of research at one major investment bank in Bangkok, referring to rising regional inflation. "We're all waiting to see how badly this thing shakes out."
Clearly the first inflationary domino to fall was Vietnam, which has experienced double-digit inflation rates for eight consecutive months, hitting an annual rate of 26.8% in June and which, according to some analysts, is expected to rise to over 30% in August. Vietnam now runs the risk of entrenching high inflation rates as labor groups across the country demand higher wages from their factories and employers accede to their demands.
Many have attributed Vietnam's inflationary meltdown to poor regulatory oversight and haphazard economic policies that prioritized fast growth over stability. Excessively loose monetary policy caused Vietnam's money supply growth to more than double since the middle of 2006.
Meanwhile fuel price subsidies which until today accounted for around 5% of gross domestic product (GDP) masked underlying inflationary pressures and built up pricing distortions throughout the economy. On Monday, Vietnamese authorities rolled back fuel subsidies and raised domestic fuel prices by 36%, raising the risk of even faster inflation in the months ahead.
Indonesia and the Philippines, some economists reckon, could be the next inflationary dominoes to tumble. Both countries have witnessed recent surges in inflation, with Indonesian prices climbing 11% in June. They could rise higher if the government, as is expected, removes more fuel price subsidies later this year. Philippine prices spiraled up 11.4% the same month, marking a 14-year high.
Long-term bond yields in both countries have risen over 250 basis points in recent months, underscoring market perceptions both governments have moved too timidly in containing inflation. Both countries lack fiscal maneuverability while respective central banks are viewed skeptically by market watchers as prone to political interference.
Indonesia's monetary policy is widely viewed as exceptionally loose, even with the recent rise in the benchmark rate to 8.75%. Many analysts were thus surprised when Indonesian central bank governor Boediono told reporters this month that inflation would ease to 6.5-7.5% by the end of the year after warning previously it would hit between 11.5% and 12.5%. Philippine monetary authorities similarly have a storied history of fudging statistics and understating risks, economists say.
Thailand and South Korea, both of which have experienced heavy downward selling pressure on their currencies in recent months, represent the second line of potential inflationary dominoes. Both countries are among Asia's heaviest oil importers and are now spending billions of dollars every month to boost their exchange rates in offshore currency markets.
Thailand's economic picture is clouded by the country's tumultuous politics, which some fear has compromised the central bank's ability to tackle inflation more aggressively. Last week it raised interest rates by a mere 25 basis points to 3.5%, a move many viewed as inadequate considering prices rose to a 10-year high of 8.9% in June. UBS has estimated Thailand needs to raise rates by at least 125 basis points to restore market confidence in the central bank's policy direction.
South Korea stands out for its fast-rising debt-to-GDP ratio, which since 2005 stands in stark contrast to the region's post-1997-98 de-leveraging trend. Many economists believe South Korea is on the verge of another credit bubble, driven by short-term external debt, which has taken on a higher risk profile with rising inflationary expectations. Average Korean property prices have risen nearly 70% over the past decade, nearly on par with the 85% surge seen in the US, and way higher than the estimated 30% witnessed in Thailand and Singapore.
On the other side, China, Taiwan, Singapore and Malaysia have all maintained strong current account surpluses, helping them to offset the inflationary risks of potentially higher oil prices in the months ahead. Indeed, the market has bid up each country's currency against the US dollar this year, while the rest of the region's units have to varying degrees fallen, presaging perhaps the winners and the losers in Asia's new and uncertain inflationary age.
Shawn W Crispin is Asia Times Online's Southeast Asia Editor. He may be reached at swcrispin@atimes.com.
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