It is time to worry about inflation. Sure, Europe still looks wobbly, the US has seen a few false starts and even China continues to sputter. However, get ready for price pressures to resurface. First, there is oil. Second, liquidity is pouring back into Asia. Third, cost pressures continue to bubble away under the surface. It will take little to tickle inflation back to life — and Taiwan may be swept up in this.
Inflation across the region is a bigger risk than markets seem to believe. Asia has seen a cyclical deceleration of inflation during recent months, giving investors and policymakers false comfort. However, structurally, price pressures are still elevated: After years of strong growth, the region is bumping against its output potential. Even a slowdown in growth during the second half of last year has only taken off the pressure temporarily.
Therefore, even a slight acceleration in demand will lead to a rapid response in consumer price index readings. In fact, research shows that the tradeoff between growth and inflation has deteriorated in Asia during the past decade. This means that for a given level of growth, inflation is now higher than, say, six or seven years ago. Crucially, however, this also implies that for a given acceleration of growth, inflation snaps back more quickly today than the region has become accustomed to.
The reasons for this are structural. Demographics is becoming slowly, but perceptibly, more challenging. This puts upward pressure on wage costs. However, other factors are playing a role, too. The shift from export-led to domestic demand-focused growth is inherently inflationary. Crudely, it is easier to scale up the export of widgets, than it is to expand the provision of services or construction in the local economy.
Moreover, despite all the hype about Asia’s massive investment spending, it is not clear that this has really raised the productive potential of the region’s economies as much as often assumed: A big chunk of what is counted as investment relates to property construction.
With Asia wound tight as a coil, the liquidity pouring into the region could quickly push up price pressures. I am not discounting the financial risks that still hover menacingly above Europe and the world financial system. However, global central banks, from the Bank of England and the European Central Bank, all the way to the Bank of Japan, are evidently determined to keep all ships afloat. The trouble is that the outcome of such policy is binary. If it fails, worries about Asian inflation would clearly be misplaced, but if it succeeds, price pressures across the region will quickly resurface.
Oil is already perking up. Perhaps rising crude prices are not an imminent threat to inflation. Base effects will still be favorable through the middle of the second quarter across the region. However, the oil rally might have legs. Three factors appear to be behind it.
First, geopolitics. Iran foremost, but Sudan and Syria are not helping either. Second, liquidity. More money in the world and a weaker US dollar and, presto, oil goes pop. Third, demand. As Asia picks up, and it now consumes more than anyone else, more of the black stuff will be needed.
Fortunately, Taiwan faces less price pressure than others. In fact, in recent years, inflation has been remarkably well behaved, partly reflecting the central bank’s effectiveness in managing inflation expectations. This time around, price pressures, though rising, should remain broadly manageable. Therefore, for Taiwan the risk lies elsewhere: If inflation rebounds in the region, this might prompt officials to step on the brakes to cool growth. Exports to the rest of Asia might therefore suffer. Taiwan, in short, is not immune to the region’s growing inflation problem.
Frederic Neumann is cohead of Asian economic research at HSBC Holdings.
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