The subprime turmoil of the past few weeks has failed to dethrone inflation as the biggest challenge facing Asian policymakers this year. Risks in Asia remain just as tilted towards higher prices (and away from lower growth) as they were before the worldwide credit crunch.
Unlike in the US, where the Federal Reserve appears to have been forced to retreat from its fight against inflation with its 17 August cut in the discount rate, lower interest rates in Asia are not on the menu, at least not anytime soon.
From China to Singapore and Sri Lanka, consumer prices are accelerating almost everywhere in Asia. And now that financial-market volatility has at least temporarily eased, an excess of money and credit, rather than a shortage, looks like the big concern for the region’s monetary authorities.
South Korea unexpectedly raised its benchmark interest rate earlier this month, after the liquidity of financial institutions grew 10.4% from a year earlier in June, the quickest pace of monetary expansion in more than four years.
In India, where a soft landing in bank credit is currently under way and inflation appears to be under control, domestic demand is still expanding strongly. Price pressures may have ebbed, though they certainly haven’t gone away.
A return of appetite for emerging-market risk, leading to a fresh surge in capital inflows from overseas, may once again cause a money glut of the kind that saw overnight interbank call-money rates in India crash to almost zero late last month.
The 2.9% increase in the Bombay Stock Exchange Sensitive Index on Monday coincided with the first gain by the rupee in three days against the US dollar. It’s too early to say if this marks the beginning of renewed pressure on the Indian currency to appreciate, though if that turns out to be the case, the central bank will be under pressure from the exporters’ lobby to buy dollars and keep the rupee competitive.
And that means more cash in the banking system, with the attendant risk of an inflationary surge in credit, especially loans, to individuals.
Excess liquidity is an even bigger headache for China where loose monetary conditions are causing food shortages to become entrenched in inflationary expectations. At the same time, negative returns on bank deposits are diverting household savings into stock markets, leading to an asset-price bubble.
People’s Bank of China assistant governor Yi Gang last week warned of “drastic changes” in the economy if the money glut isn’t dealt with effectively.
Even a small, open economy such as Singapore is less exposed at present to the US subprime meltdown than it is to the risk of intolerable price gains, especially in property values and rents.
The Monetary Authority of Singapore on Monday raised its inflation forecast for this year. The fresh assessment followed a government report last week that showed the city-state’s consumer prices had risen 2.6% from a year earlier in July, the biggest jump in more than a decade.
Although inflation last month was exaggerated by a one-time increase in the goods-and-services tax, analysts say soaring domestic demand will continue to spur prices higher.
“We do not believe that price pressures will fade over the coming months,” says Nicholas Bibby, a Barclays Capital strategist in Singapore.
The Singapore economy will expand 7.3% this year, faster than its potential rate of 5.5%, Bibby says.
Office rents, which climbed 46% from a year earlier in the second quarter, are adding to business costs. Given buoyant demand, these cost pressures will get passed on to consumers. Similarly, soaring residential rents will feed into wage increases.
Singapore’s monetary authority may allow the trade-weighted average of the local dollar, the island’s main policy tool, to start moving towards the upper end of its trading band over the next couple of months, Bibby says.
As for Asian policymakers who explicitly target a short-term interest rate to manage inflation, they will find it difficult to make a case for rate cuts.
Unless the subprime mess gets a lot worse and ensnares the US consumer, Asian interest rates will have to continue to rise. With inflation still untamed and domestic liquidity still in abundance, there is very little scope for rates to fall.