To paint a benign picture of “core” inflation in Asia after stripping out soaring commodity costs is as pointless as it is morally repugnant.
Take Cambodia, for instance.Food accounts for as much as 59% of what a rural household in that country consumes. That compares with just 15% in the US.
For the Philippines as a whole, the share of food in the average consumption basket is as high as half; in Indonesia, it’s two-fifths. The importance of food drops to a still high 34% in China and 31% in Malaysia, according to the World Bank’s latest report on the economic outlook for East Asia.
Purists say any rise in the prices of energy or agricultural products need not, by themselves, be inflationary. If there’s no change in demand conditions, then households will merely spend less money on other things, such as clothes or entertainment. These goods will become cheaper and compensate for costlier food and fuel.
However, when a household consumes very little besides food and kerosene (for the stove), what does it cut back on?
In any case, prices of goods and services that aren’t freely traded can take a long time to adjust, allowing expectations about future inflation to get entrenched. That’s exactly what’s happening in Asia.
“Upward price pressures originating from food may be more permanent than many central banks anticipate,” says Lawrence Goodman, head of global emerging market currency strategy at Bank of America Corp. in New York. “Emerging market central banks should exercise caution in drifting to a de facto core inflation target.”
Thailand is the only emerging market nation out of 24 tracked by Bank of America to explicitly target core inflation.
Since the Bank of Thailand is trying to manage prices that are by definition more stable than volatile fresh food and fuel, it ought to be doing better than others. But it isn’t. Core inflation in Thailand accelerated to 1.7% in March from 0.7% in August.
Bond investors should, therefore, be sceptical of the “oh- it’s-just-food” argument. No policymaker in Asia can justify loose monetary policy on that basis.
Equally spurious is the idea that rising commodity prices may actually be good for poorer Asian countries because of the high shares of agricultural employment in their workforces.
The urban poor, the landless rural workers and small farmers with no surplus to sell on the market constitute the group that isn’t likely to benefit from food inflation. As the World Bank notes, these people make up 64% of Cambodia’s population; the figure for Vietnam is 66%.
It’s futile to expect that elevated food prices will self-correct if the urban poor went back to their villages.
Agriculture doesn’t need—and can’t use—more labour to produce bigger crops. It needs more land, more water, better technology and less of the current craze for biofuels.
None of that is forthcoming.
Nor should investors place much faith in the unusual strategies adopted by Asian governments thus far to respond to food price inflation.
China, India, Indonesia and Mongolia are experimenting with price controls, export bans, reduction in tariffs on agricultural imports, and subsidies.
In Pakistan, paramilitary troops have been stationed at flour mills in Baluchistan to prevent illegal exports to neighbouring Afghanistan.
In the Philippines, investigators are raiding rice warehouses to crack down on hoarding.
While these measures may be necessary, they won’t be enough to stabilize prices in the absence of strong monetary discipline, especially when the US Federal Reserve is stoking future inflationary expectations by slashing interest rates.
In those Asian nations where the economy is flush with funds, prices have been the hardest to tame. One such country is Vietnam where the money supply expanded 47% last year and the exchange rate was unchanged.
“Where inflation is highest, the common feature has been rapid monetary growth driven in large part by intervention to slow the appreciation of the local currency against the US dollar,” says the recent World Bank report on East Asia.
To use core inflation as an excuse to prematurely loosen monetary policy in the face of high commodity prices hurts investors. Already, in several emerging markets, “inflation is rapidly eroding real yields,” says Bank of America’s Goodman.
Local currency bond markets in Asia are both tiny and dominated by state-controlled financial institutions. It’s tough for private investors to play vigilante and demand compensation for inflation.
Luckily for them, in this particular battle, investors’ interests are aligned with those of the poor and the middle class. Bloomberg
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