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PR Newswire
23-10-2010, 06:27 AM
Oct 23, 2010
special report
Inflation: How afraid should we be?
Analysts red-flag food prices and massive cash inflows but don't see repeat of 2007 crisis
By Robin Chan
AFTER having sleepless nights in the past two years worrying about the economic meltdown, Asia's leaders have now turned their attention to inflation.
China stunned the market on Tuesday when it raised lending rates for the first time in three years, becoming the latest economy to hike interest rates to curb overheating.
With strong economic growth driving up demand for food and energy, and a tighter labour market pushing up wages, there is every reason to fear a scenario in which prices spiral higher.
The problem has been exacerbated by huge sums of cash pouring into Asia from the United States and other developed economies to buy stocks and property - and driving these asset prices up.
This has caused the spectre of the excessive inflation that took hold in 2007 and 2008 to loom large again. Back then, crude oil had hit a record US$140 a barrel and severe weather had caused a food shock in some countries, amid a surging global economy.
But while economists agree that inflation is starting to present a real risk to economic stability in Asia, they do not quite see a return to those days.
So far, the dominant driver of inflation has been food, they say. Droughts and floods have disrupted supply, driving up prices of items such as cereals, sugar and even cabbage. The food price index of the United Nations' Food and Agriculture Organisation is at its highest level since August 2008.
Dr Chua Hak Bin, director of global research at Bank of America-Merrill Lynch, said this could be especially serious in emerging Asia, where food makes up 40 to 60 per cent of consumption in countries such as India, Indonesia and the Philippines.
The Monetary Authority of Singapore (MAS) has also flagged food prices as a concern. Food is the second-largest item in the consumer price basket used to measure inflation, after housing.
'Inflation is a clear and present danger. It is showing up in a pretty material way and is being driven by commodity prices,' said Dr Chua.
Another factor: Costs of doing business are rising, as Asian economies run at close to full capacity after breathtaking growth in the first half of the year. Demand is outstripping supply, leading to a rise in wages and rents - with the consumer likely to end up paying the price.
'There is a real risk of inflation in emerging economies as many of them are quite close to full capacity, with little slack in the economy,' said Mr Manu Bhaskaran, chief executive of investment advisory firm Centennial Asia Advisors.
Beyond the usual inflation drivers, another cause for concern is emerging: Speculative cash is flowing into Asia as investors shun the low interest rates of the West and bring their excess funds to the fast-growing economies of the East.
This has created a problem of 'too much money chasing too few assets in this part of the world', said OCBC economist Selena Ling.
Investors now expect another round of money printing in the US - officially known as 'quantitative easing' - that will push down the weak greenback further. This is leading them to search for higher returns in Asia, not just in currencies but in property and stocks too, driving up these asset prices.
Stock markets in the region recently staged a six-week rally, before reversing some gains.
The World Bank has warned of a return of asset bubbles preceding the 1997 Asian financial crisis. Its average real estate property price index for eight East Asian countries is about 17 per cent above its level in early 2007.
Already, Singapore, Hong Kong and China have imposed a slew of measures to curb property bubbles, and they stand ready to intervene again.
The excess liquidity is also 'going into speculative positions in food, energy and basic commodities, pushing prices up', said Mr Bhaskaran. 'That means even a small supply disruption could lead to outsized rises in food and energy prices.'
Still, there is little reason to fear a recurrence of 2007 just yet. The notable difference is that three years ago, the whole world was growing. This year, Asia is growing, but the US, Europe and Japan are mired in a slowdown.
This means demand for food and commodities is not as strong as it was back then. The furious manufacturing activity in Asia seen in the first half of the year has also moderated to a more normal pace, easing pressure on capacity and costs.
Ms Ling said the inflation figures may look worse than they are as prices now are being measured against low prices in the recession last year.
Crude oil, for instance, is hovering at US$80 a barrel and is unlikely to go above US$100, let alone close to the US$140 level three years ago, she said.
Barclays Capital economist Leong Wai Ho said that in 2007 and 2008, inflation was much more broad-based, led by food, oil and metals.
'Core inflation, by all our measures, this time has been quite muted,' he said. He expects inflation to peak early next year before easing.
Central bankers also seem to be reacting much quicker this time, Dr Chua said.
MAS tightened its monetary policy when inflation hit 3.3 per cent in August. In 2007, it tightened only when inflation neared 6 per cent. Similarly, the People's Bank of China has moved earlier than expected with its quarter-point interest rate rise.
'In 2007 and 2008, the general reaction was fairly late. What is happening this time is policymakers are taking a pre-emptive stance,' Dr Chua said.
In fact, now that central banks have begun to raise rates, DBS economist Irvin Seah expects 20 more rate hikes across the region in the next six months, in countries like Indonesia and Thailand.
But although raising rates is the classic counter to inflation, the solution is not so simple this time, given the cash influx from the developed world.
Raising interest rates 'has lost its edge in a world of vast global financial flows', said HSBC economist Frederic Neumann. While higher rates may once have fought inflation, they also attract more funds - 'pouring oil on the fire of bubbles'.
This explains why central bankers in South Korea and Thailand postponed expected rate hikes this week amid inflationary pressures, he said.
The much bigger story, and one likely to persist for years to come as the US keeps borrowing rates near zero, is that careful balancing act of managing inflation, asset bubbles and capital inflows.
'It's not going to be a runaway inflation story like in 2007, but rather an anomaly because of the liquidity policies that are driving capital to the emerging world,' Ms Ling said.
Dr Chua said: 'The challenge for policymakers is to not just solve one problem and then aggravate the other one. It will be quite a balancing act.'
special report
Inflation: How afraid should we be?
Analysts red-flag food prices and massive cash inflows but don't see repeat of 2007 crisis
By Robin Chan
AFTER having sleepless nights in the past two years worrying about the economic meltdown, Asia's leaders have now turned their attention to inflation.
China stunned the market on Tuesday when it raised lending rates for the first time in three years, becoming the latest economy to hike interest rates to curb overheating.
With strong economic growth driving up demand for food and energy, and a tighter labour market pushing up wages, there is every reason to fear a scenario in which prices spiral higher.
The problem has been exacerbated by huge sums of cash pouring into Asia from the United States and other developed economies to buy stocks and property - and driving these asset prices up.
This has caused the spectre of the excessive inflation that took hold in 2007 and 2008 to loom large again. Back then, crude oil had hit a record US$140 a barrel and severe weather had caused a food shock in some countries, amid a surging global economy.
But while economists agree that inflation is starting to present a real risk to economic stability in Asia, they do not quite see a return to those days.
So far, the dominant driver of inflation has been food, they say. Droughts and floods have disrupted supply, driving up prices of items such as cereals, sugar and even cabbage. The food price index of the United Nations' Food and Agriculture Organisation is at its highest level since August 2008.
Dr Chua Hak Bin, director of global research at Bank of America-Merrill Lynch, said this could be especially serious in emerging Asia, where food makes up 40 to 60 per cent of consumption in countries such as India, Indonesia and the Philippines.
The Monetary Authority of Singapore (MAS) has also flagged food prices as a concern. Food is the second-largest item in the consumer price basket used to measure inflation, after housing.
'Inflation is a clear and present danger. It is showing up in a pretty material way and is being driven by commodity prices,' said Dr Chua.
Another factor: Costs of doing business are rising, as Asian economies run at close to full capacity after breathtaking growth in the first half of the year. Demand is outstripping supply, leading to a rise in wages and rents - with the consumer likely to end up paying the price.
'There is a real risk of inflation in emerging economies as many of them are quite close to full capacity, with little slack in the economy,' said Mr Manu Bhaskaran, chief executive of investment advisory firm Centennial Asia Advisors.
Beyond the usual inflation drivers, another cause for concern is emerging: Speculative cash is flowing into Asia as investors shun the low interest rates of the West and bring their excess funds to the fast-growing economies of the East.
This has created a problem of 'too much money chasing too few assets in this part of the world', said OCBC economist Selena Ling.
Investors now expect another round of money printing in the US - officially known as 'quantitative easing' - that will push down the weak greenback further. This is leading them to search for higher returns in Asia, not just in currencies but in property and stocks too, driving up these asset prices.
Stock markets in the region recently staged a six-week rally, before reversing some gains.
The World Bank has warned of a return of asset bubbles preceding the 1997 Asian financial crisis. Its average real estate property price index for eight East Asian countries is about 17 per cent above its level in early 2007.
Already, Singapore, Hong Kong and China have imposed a slew of measures to curb property bubbles, and they stand ready to intervene again.
The excess liquidity is also 'going into speculative positions in food, energy and basic commodities, pushing prices up', said Mr Bhaskaran. 'That means even a small supply disruption could lead to outsized rises in food and energy prices.'
Still, there is little reason to fear a recurrence of 2007 just yet. The notable difference is that three years ago, the whole world was growing. This year, Asia is growing, but the US, Europe and Japan are mired in a slowdown.
This means demand for food and commodities is not as strong as it was back then. The furious manufacturing activity in Asia seen in the first half of the year has also moderated to a more normal pace, easing pressure on capacity and costs.
Ms Ling said the inflation figures may look worse than they are as prices now are being measured against low prices in the recession last year.
Crude oil, for instance, is hovering at US$80 a barrel and is unlikely to go above US$100, let alone close to the US$140 level three years ago, she said.
Barclays Capital economist Leong Wai Ho said that in 2007 and 2008, inflation was much more broad-based, led by food, oil and metals.
'Core inflation, by all our measures, this time has been quite muted,' he said. He expects inflation to peak early next year before easing.
Central bankers also seem to be reacting much quicker this time, Dr Chua said.
MAS tightened its monetary policy when inflation hit 3.3 per cent in August. In 2007, it tightened only when inflation neared 6 per cent. Similarly, the People's Bank of China has moved earlier than expected with its quarter-point interest rate rise.
'In 2007 and 2008, the general reaction was fairly late. What is happening this time is policymakers are taking a pre-emptive stance,' Dr Chua said.
In fact, now that central banks have begun to raise rates, DBS economist Irvin Seah expects 20 more rate hikes across the region in the next six months, in countries like Indonesia and Thailand.
But although raising rates is the classic counter to inflation, the solution is not so simple this time, given the cash influx from the developed world.
Raising interest rates 'has lost its edge in a world of vast global financial flows', said HSBC economist Frederic Neumann. While higher rates may once have fought inflation, they also attract more funds - 'pouring oil on the fire of bubbles'.
This explains why central bankers in South Korea and Thailand postponed expected rate hikes this week amid inflationary pressures, he said.
The much bigger story, and one likely to persist for years to come as the US keeps borrowing rates near zero, is that careful balancing act of managing inflation, asset bubbles and capital inflows.
'It's not going to be a runaway inflation story like in 2007, but rather an anomaly because of the liquidity policies that are driving capital to the emerging world,' Ms Ling said.
Dr Chua said: 'The challenge for policymakers is to not just solve one problem and then aggravate the other one. It will be quite a balancing act.'
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