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Depending on whom you ask,
China
is either on the verge of a big slowdown or an inflation
surge. Some worry Asia’s second-biggest economy faces
both risks.
China’s
situation suggests Asia is on the cusp of its worst
couple of years since 1997. From
Seoul
to Jakarta and from Beijing to New Delhi, officials are
grappling with a rapidly worsening inflation picture.
It would
be nice if there was less concern about the phenomenon
and more action to address it. Asia may be nearing the
point of no return—one where the region’s so-called
economic miracle goes off the rails anew.
Asia
isn’t about to revisit the darkest days of 1997 and
1998. It was then that speculators tested central banks’
resolve to defend currencies. Thailand’s devaluation in
July 1997 set in motion a crisis that suspended the
Asian miracle. It prompted investors to leave Asia and
sent contagion around the globe.
A decade
later, Asia faces the flip side of that experience. The
turmoil of the 1990s was about deflation and recession;
the situation today involves overheating. Central banks
may already be remiss in a different way than they were
during the last crisis: They are falling behind the
inflation curve.
“Inflation really has become THE issue,” says Richard
Grainger, a director at Barclays Capital in Hong Kong.
Surging
inflation is adding pressure on officials to raise
interest rates as record oil and food prices undermine
growth. That has created what central-bank heads such as
Amando Tetangco Jr. of the Philippines call a
“monetary-policy dilemma.”
Touchy
time
This is,
admittedly, a touchy time for central banks. They are
being asked to tame forces they can’t fully control as
“bond vigilantes” take matters into their own hands and
boost bond yields. Central banks also feel they must
tread carefully to protect hard-won gains in
independence. Politicians are already warning officials
not to go overboard raising interest rates.
Yet
negative real rates are more the norm than the exception
in Asia. Annual inflation rates are above benchmark
borrowing costs in China, Hong Kong, India, Indonesia,
Japan, Pakistan, the Philippines, Sri Lanka, Taiwan,
Thailand and Vietnam.
Bottom
line: Interest rates need to go higher in many
economies. With household expenses rising, Asia may very
well overheat unless central bankers do their jobs. The
longer they delay, the bigger the costs to long-term
prosperity and the bigger the risks of disappointing
investors.
Inflation scare
Asia has
thus far withstood the US credit-market debacle
remarkably well. If that was the only threat in the
global financial system, 2008 might have been a much
better year for the region. Oil at more than $135 a
barrel and record food prices have conspired to restrain
growth and worsen inflation.
That
balancing act is clear to anyone walking the streets of
Indonesia these days. Prices are hurting families
already close to the edge. Indonesia is but one
government in Asia—where about 600 million people exist
on less than $1 a day—that is divided between reining in
prices and supporting growth. What good is growth when
inflation eats up the gains?
“While
there are many investment opportunities, this won’t be
an easy year for Asian governments,” says Dessi
Natalegawa, a managing director at Lehman Brothers
Holdings Inc. in
Jakarta.
Headlines across the region explain why. There are
food-related protests in the Philippines; top-level
power struggles in Malaysia, the fastest inflation in
Singapore since 1982, public battles between politicians
and the Bank of Korea, a whiff of financial disaster in
Vietnam and talk of a coup in Thailand.
Avoiding
bust
Asia has
come a long way since its last crisis. Government debt
is down, living standards are up, corporate governance
has improved, currency reserves have been amassed and
central banks are more autonomous. Policymakers still
must keep Asia’s boom from becoming a bust.
For
central banks, that means openly and clearly declaring
the intention to attack inflation. Big, destabilizing
rate increases might do more harm than good. A gradual
yet steady campaign to tap on the brakes could both
soothe investors and avoid restraining consumption.
One
reason central bankers need to act carefully is the risk
of another flare-up in US markets. Standard & Poor’s
reminded investors of that on June 2 when it lowered
credit ratings for Morgan Stanley, Merrill Lynch & Co.
and Lehman Brothers, saying they may have to book more
writedowns on devalued assets.
It’s
impossible to generalize
Asia’s experience.
China’s
postearthquake rebuilding efforts, for example, may
boost growth and inflation. Wealthy Japan isn’t as
vulnerable to surging food costs as, say,
Indonesia
or the Philippines, where many families live on
poverty’s edge.
The key
commonality is a sense of caution. With credit markets
still in disarray, aggressive moves are a non-starter.
Yet, acting now means central banks can make headway on
an inflation problem that isn’t about to go away.
Hanging
in the balance is nothing less than the economic miracle
that investors are betting on in Asia. |
