Last week, the Bank of Thailand decided to leave its policy rate unchanged at 3.25%. It shows that the central bank did not succumb to political pressures to lower the interest rate. It is not that the Bank of Thailand proactively raised interest rates as the Reserve Bank of Australia did recently. After all, on a headline basis, the inflation rate is more than 4% in Thailand and, hence, the real rate is negative.
A policy of accommodating inflation eventually extracts a heavy toll of the economy as we saw in the 1970s in America. That question would be uppermost in the minds of central bankers in Asia this week. This is a week for central banks in Asia-Pacific. Interest rate decisions are due from Indonesia, Korea, Japan, Australia and New Zealand. Barring Australia, interest rates are not expected to go up anywhere. Under the circumstances, that is the most prudent step they would be willing to take. Expecting them to push rates higher in response to rising inflation pressures would be asking too much, given that they fear a delayed impact of the US slowdown on their economies. But, they have to ask themselves—given that they are not politicians facing elections—if they could sustain growth by ignoring inflation. They thought they could do so but have now discovered that the consequences of strong demand on inflation are eventually felt.
Asian central banks could have done a lot more to allow their currencies to appreciate in 2003-04 when inflation was low and tame. That would have smoothed the process of currency appreciation and built up defences against inflation now.
But, to be fair to Thailand, in 2006, the Thai baht saw a substantive gain against the US dollar and continued to remain stable in 2007. Further, in mitigation, one could argue that Asian central banks could not have anticipated that the prices of commodities would continue to surge into 2008 when they allowed their currencies to remain relatively weak or less strong in the last few years. The reference to the boom in commodities brings China into the picture.
As long as the yuan appreciated at a snail’s pace against global currencies, East Asian governments had to preserve whatever little export competitiveness was left with them. Hence, they were usually reluctant to let the currency appreciate in the recent past—coming out of the Asian crisis, the collapse of the technology cycle and a US recession that followed. It is important to reiterate that the Chinese yuan has depreciated more than 14% against the euro in the last two-and-a-half years. Yuan appreciation has been more pyrrhic than real. That is one of the reasons why China’s trade surplus with the euro zone is bigger than it is with America.
China’s emergence as a low-cost, industrialization and export-led growth powerhouse is exposing the lack of growth drivers in East Asia. These weaknesses remained hidden in the last five years as the world economy powered ahead after the series of shocks from 1998-2002. As the pie grew in size, it did not matter if the share of the pie shrunk. Now, the fault lines of East Asian economic growth are becoming more visible.
The real answer to inflation now in the world is a collapse in economic growth in their economies or better, in China. That is a sentiment that one may not hear in public often, if at all. But, China’s growth slowdown would be a godsend to the rest of Asia and to other nations outside of Asia, too. There may be some losers and that would include Australia notably and New Zealand to some extent. But, the winners would far exceed the losers in both number and magnitude. China’s growth slowdown would drastically lower commodity prices and, thus, create a windfall tax cut for many economies in the world.
While some of the factors behind the rise in commodity prices are structural (e.g., climate change, secular decline in supply in the case of crude oil), there is a substantial role for China’s industrial production and excess capacity creation in explaining the boom in commodities. This growth model has been sustained at considerable cost to China’s economy and environment with low interest rates (in nominal and real terms) and a competitive exchange rate.
Thus, China’s current growth model has been largely parasitic until now. Once it achieves the long-overdue rebalancing in favour of domestic consumption, its economy will support growth in its neighbours. But, we are quite a way off from that situation. In fact, China may need to experience a hard landing with its current model for changes to be brought about, although the changes have been talked about for more than three years. To put it bluntly, sustaining non-inflationary growth in Asia requires China to experience an economic hard landing.
(V. Anantha Nageswaran is head, investment research, Bank Julius Baer and Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org)