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Denial, then depression

Denial, then depression
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First Published: Mon, Nov 26 2007. 10 54 PM IST
Updated: Mon, Nov 26 2007. 10 54 PM IST
In June, Bare Talk had said that the inflation genie was out of the bottle. In November, this column upgraded the warning to include the risk of economic stagnation. In other words, stagflation is likely to cast its shadow over the global economic landscape in the next two years.
Last week, this columnist was in Dubai. He stayed in a hotel that stood in the middle of panoply of cranes, concrete pillars and steel rods. That was almost surreal.
However, the stories of inflation in Dubai were neither surreal nor unreal. Last week itself, bread prices increased by 20%. Cooking gas prices were to go up this week. Fees in private schools are set to double next year. As rents went up by 50% in the last three years, the government put a cap on the rental increase percentage for next year. Landlords decided to increase the parking fees, instead. The official inflation rate is around 7-8%.
The public believes that the inflation rate is somewhere between 15% and 20%. With the interest rate around 5%, that translates into a real interest rate of -10% to -15%. A negative real rate means that borrowers are paid to borrow. It must be of no surprise that asset prices are going through the roof. This is not sustainable. The government knows that and, in recent days, speculation is rife that the United Arab Emirates (UAE) dirham would be revalued and repegged against a basket of currencies rather than being pegged against the US dollar (as it currently is). The Gulf Cooperation Council countries—UAE, Saudi Arabia, Qatar, Bahrain, Kuwait and Oman—meet on 3-4 December to decide on their countries’ exchange rate regimes. Kuwait has already stopped pegging its currency to the declining US dollar. Other countries have been inexplicably reluctant. This has cost them in terms of a rapidly accelerating inflation rate.
That is pretty much the unfolding story in Asia as well. Macquarie Bank now expects a double-digit inflation rate in Indonesia next year. Singapore reports an official consumer price index (CPI) inflation rate of 3.6%, the highest in 16 years. Here, too, the public feels that the official CPI statistic understates the true inflation rate that households contend with. Surprisingly, the government appears to hope that the spike in inflation would be a one-off matter and that it is resulting mainly from the hike in the goods and services tax to 7% from 5%. That optimism is a bit strange considering that utility rates, transport costs and rents have gone up substantially in recent times. In addition, labour force growth and wage growth are strong. It is almost inevitable that inflation would not only be higher but will persist at high levels next year.
Recent inflation data have surprised on the upside in places such as South Korea and Taiwan. Chinese Premier Wen Jiabao has begun the arduous task of preparing his country for inflation persisting at more than 6% in 2008. Of course, whether it would mean more tightening measures from China is an altogether different?matter.
Of course, growth data have been strong in Asia. Thai exports and imports are both growing briskly and Taiwan exports were vigorous, too, in October. However, it is a matter of time before Asia feels the impact of slowing growth in the US, Japan and the European Union (the G-3 countries). Japanese banks are slowly disclosing the amount of US mortgage- backed securities that they are carrying in their books. They hold yen 1.2 trillion of the riskiest portions of mortgage-backed securities (MBS), according to the Financial Services Agency. But, today, even the best rated AAA rated portions of the MBS are risky. This can only mean that instead of clambering out of the growth hole dug by the woes of the construction sector, Japan could yet again be dragged down by its financial sector next year.
In the euro zone, German manufacturing has already begun its decline and French consumer spending has declined for two consecutive months. Inflation remains well above the euro zone’s target of 2%. The price of crude oil is still edging towards $100 per barrel.
In the final analysis, whether the G-3, which has collectively nearly $30 trillion of GDP, enters into a recession or not, there is a high chance that their growth rates slow appreciably in the coming years. Together with high inflation and strains in the financial system, the world will have to contend with problems that besieged Japan in the 1990s and the US in the 1970s, and that too simultaneously.
At some point in time, assets might become screamingly attractive to buy. When that happens, investors must have cash to do so. As John Kay observed recently in Financial Times, that means having the courage to buy when others are in depression. That is later. But now, it requires courage to sell when others are still in denial, about Asia that is.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at baretalk@livemint.com
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First Published: Mon, Nov 26 2007. 10 54 PM IST