Asia is finally waking up to its inflation challenge. Recent weeks have seen a further round of monetary tightening, with a succession of central banks raising interest rates or taking other measures to put a cap on rising prices. India, in particular, has taken tougher action than before, with a large rate hike, while others, such as China, have again pushed up reserve requirements.
The policy challenge is never easy. Is this a case of too little, too late: taking action after inflation has already taken off and when there are expectations of more to come? Or is it too much, too soon — because there are tentative signs the world economy has started to slow, in turn taking the heat out of commodity markets, with food and energy prices easing off?
The world is two years into an economic recovery, but in many places it doesn’t feel that way. This recovery has been led by emerging economies and by policy easing in the West. However, it is a divided and disconnected world, as different growth prospects, high rates of unemployment and recent problems in North Africa and the Middle East testify. It is also a world of policy dilemmas. In the West, where economies are fragile, a double-dip recession is the fear. Across Asia, and large parts of the emerging world, the risks are on the upside: inflation.
The inflation challenge is greater in Asia for many reasons. Last year, the region grew strongly, and the slack in Asian economies is far less than in the West. Strong domestic demand allows retailers and producers the opportunity to pass on higher costs and to sustain or boost their margins by raising prices. While this is a concern, rising wages and good labor market conditions are allowing people to pay higher prices. This is akin to a wage-price spiral, albeit in the early stages, but it can get out of hand if not addressed quickly enough.
Then there is the very issue of food and energy prices itself. Higher prices of these staples hit hard into spending and can cause problems, in particular for the poor. Thus, in many countries, there are complex subsidies in place, in areas such as food, fertilizer and fuel. These subsidies need to be phased out, but it is difficult politically to do this. Although subsidies may ease the pain for some, they complicate the inflation picture and often add to it.
To these domestic inflation drivers, there is the additional challenge for Asia and for many emerging regions of how to cope with capital inflows. This came to the fore as an issue last year, when money flooded in. Although less of a concern this year, this may soon change. This has been called “America’s year” by some investors, as the third year of a presidential term is often good for the US equity market. That optimism has been enhanced by the additional stimulus measures the US received at the start of this year, but now, as policy stimulus wears off, and as debt still needs to be repaid, greater challenges lie ahead. Add in the debt crisis overhanging parts of Europe, and it is easy to see why capital may start flowing back to emerging economies. This suggests that the problem of how to absorb capital inflows will again become a key concern for Asian countries.
Often challenges are most apparent in property prices. When money flows in from overseas, it seeks out a home, and all too often this is in equities, or in real estate, adding to existing domestic pressures.