Sun, Dec 14, 2008 - Page 8 News List

EDITORIAL: The real specter is deflation

The central bank has cut interest rates again, but it was the size of the cuts that surprised the market. The monetary policymaker clearly thinks the domestic economy is in even worse shape than first thought.

Caution over the possibility of deflation would be prudent, with the latest economic data suggesting the return of the first deflationary environment since 2003.

On Thursday, the central bank announced it would cut interest rates for the fifth time since late September — the larger-than-expected 75 basis-point cut being the largest in 26 years.

The market had expected a cut after last month’s exports registered a decline of 23.3 percent, the biggest in seven years. Exports have been contracting every month since September, according to figures released by the Ministry of Finance on Monday.

But the central bank’s aggression on this occasion has raised concerns about just how bad the domestic economic situation could become. If exports continue falling, it would force companies to cut jobs as a weakening economy prompts consumers to lower spending, triggering a return to the deflation that plagued the nation five years ago.

Despite mixed forecasts for Taiwan next year, economists here and abroad generally agree that the global slowdown will have a bigger impact on Taiwan’s export-oriented economy than its Asian peers because Taiwan relies too much on export growth and has too heavy a dependence on cross-strait trade.

Declining exports could be one of Taiwan’s biggest challenges next year. The latest government figures show that shipments to major destinations last month, excluding Japan, were disappointing, with Taiwan-made goods bound for China/Hong Kong suffering the hardest hit: a record 38.5 percent year-on-year contraction.

On the other hand, China — Taiwan’s biggest export market, taking around 40 percent of the nation’s total shipments — said on Thursday that exports last month dropped for the first time in seven years.

Granted, a severe slowdown in the economy and a recession look unavoidable, and the central bank is likely to offer further rate cuts next year to boost the economy. But what the nation should pay extra attention to is not the specter of recession but whether a deepening recession becomes deflationary.

The government agencies, including the central bank and the Directorate-General of Budget, Accounting and Statistics, have dismissed concerns about deflation, saying that the consumer price index (CPI) is likely to grow 0.37 percent next year, following an increase of 3.64 percent this year.

But with exports steadily declining, industrial output contracting since September and real estate investment still slowing, the domestic economy is decelerating fast. With CPI growth slowing to 1.88 percent last month, the lowest since September last year, and the wholesale price index posting its first decline in three years, the data suggest that the risk of deflation is increasing. Academia Sinica warned on Friday that this was the case, and it urged the government to do what it could to avoid this happening.

Deflation usually starts with subdued wage growth and rising unemployment amid an economic downturn, which then prompts consumers to spend less. Producers try to lower prices to drive sales but consumers tend to resist spending in anticipation of more price cuts, a process that generates a vicious downward spiral in which domestic demand and business activity weaken dramatically.

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