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Central banks in line of fire as prices rise

Central banks in line of fire as prices rise
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First Published: Thu, May 22 2008. 12 17 AM IST
Updated: Thu, May 22 2008. 12 17 AM IST
Few central bankers would envy Lee Seong Tae’s dilemma in Seoul. Bank of Korea Governor Lee is under pressure to trim interest rates amid accelerating inflation. Lee refused to do so on 8 May, arguing that commodity prices and a declining currency are stoking inflation. The policy board next meets on 12 June.
That hasn’t stopped government officials from raising the volume. Vice finance minister Choi Joong Kyung has been making the argument that inflation gains are mainly due to rising oil and grain prices and that the central bank should be supporting an economy that has “entered a downturn”. While Choi’s concerns are well taken, Lee should beware. That goes for central bankers across Asia, too.
Imperfect arrangement
Central banks wield an uncomfortable amount of power in democracies. They are run by unelected economists who sometimes get interest-rate policies right and sometimes, get them wrong. It’s an imperfect arrangement, and central banks should be held accountable early and often.
Yet, in their desire to keep monetary policymakers honest, politicians risk interfering with the vital role they can play. Asia is at such a crossroads 10 years after the region’s financial crisis. Korea is no exception.
Consumer prices are advancing at 4.1% in Korea this year. The central bank aims to keep inflation between 2.5% and 3.5%. The closer it gets to 5%, the more investors will avoid Korea’s markets.
Until recently, investors dismissed Asian inflation because “core” prices were reasonably tame. There comes a time when rising energy and food costs can no longer be ignored or kept from boosting so-called headline inflation. At risk is nothing less than Asia’s progress over the last decade.
Central banks have spent the past 10 years becoming more independent and establishing credibility as inflation fighters. Now, officials from New Delhi to Beijing and from Jakarta to Manila are grappling with inflation that could spook investors and fan social instability. In Vietnam, for example, annual inflation is running at 20%.
Tough spot
Central bankers are in a very tough spot at a time when things are getting nasty in the global economy. Cutting rates too much will squander the last decade. Getting too stingy with monetary stimulus will unnerve politicians looking for a scapegoat. The Bank of Japan is now facing that balancing act.
Korea also is a case in point. “The economy is faced with a number of risks, including rising oil, a weaker currency and a global slowdown,” says Lee Sang Jae, an economist at Hyundai Securities Co. in Seoul. “Those risks are damping domestic demand, which may hamper jobs growth.”
Korea’s jobless rate rose to a five-month high of 3.2% in April. Yet, some perspective is needed. Governor Lee predicts growth of 4.5% or perhaps less this year, below the government’s target of 6%. The US would kill for 4% growth—or Korea’s low unemployment rate.
Korea has long since left the stable of poor Asian economies. Its problems are far more of the Organization for Economic Cooperation and Development, or OECD, variety. Korea needs to learn how to get by on 4% or so growth for a while.
‘Korean sandwich’
It’s at times like these that economies either shine or lose their lustre. “Korea has a world-class economy and financial system, but it’s one of many OECD economies and needs to work harder to get the world’s attention,” says Hank Morris, Seoul- based director of Industrial Research and Consulting Ltd.
At issue is what might be called the “Korean sandwich.” For all its merits—healthy growth, rising standard of living, educated workforce and world-class companies—Korea is sandwiched between wealthy Japan and low-cost China.
That partly explains why the nation’s stock market is undervalued relative to Asian peers, investors argue. Spotty corporate governance doesn’t help. Neither does the perception that family-run conglomerates dominate an economy that needs more start-up companies creating jobs.
It’s too soon to tell if last month’s resignation by Samsung Group chairman Lee Kun Hee marked the beginning of a new chapter for the Korea industry. Lee was charged with tax evasion and breach of duty, and his departure from Korea’s biggest business group shocked the nation of 50 million.
Boosting competitiveness
Policymakers have worked hard to control inflation and calm Korea’s business cycles. They should resist the temptation to boost growth with easier credit. All that would do at a time of surging global prices is inflate domestic asset values, further fuelling inflation.
Finance minister Kang Man Soo, for example, could step up efforts to cut taxes to spur demand and investment. Reducing the tax rate to 20% from last year’s 22.7% would do more to boost competitiveness than low interest rates.
If the economy truly needs more liquidity, the central bank can always act. Giving in to politicians looking for an easy way out would be a step backward for an economy that should be looking forward.
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First Published: Thu, May 22 2008. 12 17 AM IST