Column Food for thought from pricey Asia

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: and quality of prospects between North American and Asian markets. Fund flow to Asian markets might remain limited to a few till investors acquire firmer perceptions.

In addition to monetary and exchange rate measures, most of the Asian economies have been forced to rationalise fuel subsidies. China has been the latest to increase fuel prices. The moves have led to political backlashes and public discontent. Realignment of domestic prices with global crude prices has been much easier in economies like Singapore, Hong Kong and Korea, which do not have a tradition of fuel subsidies. But it hasn’t been so in India, Indonesia and Malaysia. For these economies, supply-side responses in the form of revision of domestic fuel prices have aggravated the already-high inflation, leaving precious little room for further policy manoeuvre.

So, what should be the most effective policy response? The Asian experience seems to indicate that there is no unambiguous choice. Countries are reacting to inflation in line with their specific circumstances and priorities. Monetary policy may not be the most virtuous of measures to adopt, given that the genesis of the problem is essentially on the supply side. Many would argue in favour of the exchange rate being used as a more direct policy instrument. India, however, appears to have lost the policy space to leverage exchange rates given the sharp depreciation. That leaves only specific supply-side responses like cutting subsidies by revising fuel prices. Almost all Asian economies have done so. However, the problem with such a measure is that it might aggravate inflation and necessitate interest rate hikes. This is exactly what’s happening in India.

The trade-off between policies and their outcomes needs to be assessed carefully in economies like India where inflation has reached disturbing levels. It is evident that policy responses aiming to achieve short-term objectives are unlikely to yield results. Oil prices are not showing signs of softening. More revisions in domestic fuel prices will be required sooner or later. But interest rate hikes should not follow automatically. A careful combination of interest and exchange rates aiming to increase capital flows can be helpful. At the same time, there is little point in fighting shy of cheaper imports. Indian consumers won’t mind eating cheaper Thai rice as long as it tastes as good as home-grown varieties!