Depending on whom you ask, China is either on the verge of a big slowdown or an inflation surge. Some worry that Asia’s second biggest economy faces both risks.
China’s situation suggests Asia is on the cusp of its worst couple of years since 1997. From Seoul to Jakarta and from Beijing to New Delhi, officials are grappling with a rapidly worsening inflation picture.
It would be nice if there was less concern about the phenomenon and more action to address it. Asia may be nearing the point of no return—one where the region’s so-called economic miracle goes off the rails anew.
Asia isn’t about to revisit the darkest days of 1997 and 1998. It was then that speculators tested central banks’ resolve to defend currencies. Thailand’s devaluation in July 1997 set in motion a crisis that suspended the Asian miracle. It prompted investors to leave Asia and sent contagion around the globe.
A decade later, Asia faces the flip side of that experience. The turmoil of the 1990s was about deflation and recession; the situation today involves overheating. Central banks may already be remiss in a different way than they were during the last crisis: They are falling behind the inflation curve.
“Inflation really has become the issue,” says Richard Grainger, a director at Barclays Capital in Hong Kong.
Surging inflation is adding pressure on officials to raise interest rates as record oil and food prices undermine growth. That has created what central bank heads such as Amando Tetangco of the Philippines call a “monetary-policy dilemma”.
This is, admittedly, a touchy time for central banks. They are being asked to tame forces they can’t fully control as “bond vigilantes” take matters into their own hands and boost bond yields. Central banks also feel they must tread carefully to protect hard-won gains in independence. Politicians are already warning officials not to go overboard raising interest rates.
Yet, negative real rates are more the norm than the exception in Asia. Annual inflation rates are above benchmark borrowing costs in China, Hong Kong, India, Indonesia, Japan, Pakistan, the Philippines, Sri Lanka, Taiwan, Thailand and Vietnam.
Bottom line: Interest rates need to go higher in many economies. With household expenses rising, Asia may very well overheat unless central bankers do their jobs. The longer they delay, the bigger the costs to long-term prosperity and the bigger the risks of disappointing investors.
Asia has thus far withstood the US credit market debacle remarkably well. If that was the only threat in the global financial system, 2008 might have been a much better year for the region. Oil at more than $135 (Rs5,751) a barrel and record food prices have conspired to restrain growth and worsen inflation.
That balancing act is clear to anyone walking the streets of Indonesia these days. Prices are hurting families already close to the edge. Indonesia is but one government in Asia—where about 600 million people exist on less than $1 a day—that is divided between reining in prices and supporting growth. What good is growth when inflation eats up the gains?
“While there are many investment opportunities, this won’t be an easy year for Asian governments,” says Dessi Natalegawa, a managing director at Lehman Brothers Holdings Inc. in Jakarta.
Headlines across the region explain why. There are food- related protests in the Philippines; top-level power struggles in Malaysia; the fastest inflation in Singapore since 1982; public battles between politicians and the Bank of Korea; a whiff of financial disaster in Vietnam; and talk of a coup in Thailand.
Asia has come a long way since its last crisis. Government debt is down, living standards are up, corporate governance has improved, currency reserves have been amassed and central banks are more autonomous. Policymakers still must keep Asia’s boom from becoming a bust.
For central banks, that means openly and clearly declaring the intention to attack inflation. Big, destabilizing rate increases might do more harm than good. A gradual yet steady campaign to tap on the brakes could both soothe investors and avoid restraining consumption.
One reason central bankers need to act carefully is the risk of another flare-up in US markets. Standard and Poor’s reminded investors of that on 2 June when it lowered credit ratings for Morgan Stanley, Merrill Lynch and Co. and Lehman Brothers, saying they may have to book more writedowns on devalued assets.
It’s impossible to generalize Asia’s experience. China’s post-earthquake rebuilding efforts, for example, may boost growth and inflation. Wealthy Japan isn’t as vulnerable to surging food costs as, say, Indonesia or the Philippines, where many families live on poverty’s edge.
The key commonality is a sense of caution. With credit markets still in disarray, aggressive moves are a non-starter. Yet, acting now means central banks can make headway on an inflation problem that isn’t about to go away.
Hanging in the balance is nothing less than the economic miracle that investors are betting on in Asia.