Asian inflation comeback throws up policy dilemma

Singapore, Aug 5 | Updated: Aug 6 2005, 05:30am hrs
For the first time since the Asian financial crisis, inflation is haunting Asian policy makers, forcing some to reluctantly raise interest rates even as their economies cope with a soft patch.

Core inflation in many parts of Asia is at multi-year highs, and hitting the upper end of policy makers comfort zones.

Central banks are, for the first time in quite a long time, faced with the decision should we follow the Fed should we tighten rates can our domestic economies handle that said Jan Lambregts, head of Asia-Pacific research at Rabobank in Singapore.

It was a fine line between reining in inflation and hurting domestic demand, Lambregts said, although he added inflation was unlikely to spiral out of control.

A big part of the rise in inflation has come from higher oil prices as governments in Thailand, Malaysia and Indonesia have cut subsidies that sheltered consumers from dearer oil.

The good news on Asias inflation is, for the first time in years, producers are able to pass on higher input costs, such as oil, to consumers. As well, global growth is above a 20-year average and interest rates in the region are near historic lows.

The worrying part is that central banks will be raising rates just when exports and domestic consumption are reviving, raising the risk of stymied recoveries and government displeasure.

The policy dilemma is acute in Thailand, and to an extent in Indonesia, where authorities are unable to tackle oil-induced inflation with the conventional policy of letting currencies rise.

Increasing imports and slowing capital inflows have led to a sharp deterioration in Thailands and Indonesias trade balances, and to weakness in the baht and rupiah currencies.

Thailand has raised policy rates six times since last August, lifting them even after a first-quarter economic contraction.

Christa Janjic, regional economist with UBS, says if oil prices do not ease, Thai growth will slow, the baht will weaken, and inflation and interest rates will rise.

At the extreme it could lead to stagflation, a period of low growth and high inflation, Janjic said in a note.

GOOD INFLATION

Some parts of Asia have always had high inflation. Indonesias consumer prices have risen at an annual pace of over 4 percent for the past five years, even hitting 85 percent just after the 1997/98 financial crisis when the rupiah plunged.

Most of Asias inflation since the crisis was owing to higher oil and commodity prices, droughts and floods affecting food prices or weak currencies pushing up import costs. Right now, we are looking at a different sort of inflation, one which is demand-pull driven, which is caused by the recovery in the business cycle. It is less balance-of-payments induced, said Adam Le Mesurier, regional economist with Goldman Sachs.

Costlier oil was pushing up producer prices, but rising consumer prices showed there was demand in these economies.

Reuters