Asia faces inflation challenge!

Asia faces inflation challenge!
Jun 12, 2008 04:43
FRANKENSTEIN Points: Join Date: Nov 29, 2004 Status: offline	Source: FT. Inflation shocks are challenges for Asia's economies By Mark Konyn Thursday, June 12, 2008 Thelatest sell off at the end of May in Asian markets follows the spectacular recovery in April when investors returned to the region that had previously been battered amidst global concerns of an economic slowdown and mounting inflationary pressure. It is now the latter that is troubling investors most as a combination of rising oil, food and commodity prices is causing concern that higher inflation will limit economic growth prospects. In the past 15 years Asia outside of Japan has been susceptible to inflation shocks that have hurt the region's competitiveness and undermined central bank credibility. For some time, analysts have been tracking food prices in China as a lead indicator of future wage inflation. In the past 10 years of accelerated growth in mainland China, droves of workers have left rural areas to work in cities and factories. As a result of both this labour migration and the under-investment in the agricultural sector, farming productivity has not improved. Higher living standards are now placing a heavier demand on food supply and as a result there has been a steady increase in food prices that has fed through directly to wages and prices more generally. The authorities have been early to recognise this potential threat to sustainable economic growth and have sought to cool the economy through a combination of monetary and administrative measures targeting specific parts of the economy, most noticeably credit growth in the housing market. In other parts of the region, rising commodity and oil prices are testing central banks' ability to take the initiative. For example, in Indonesia the central bank has acted early to raise interest rates, recognising that the removal of oil subsidies will be inflationary. In the previous cycle the inability of the central bank to demonstrate a measured and considered approach in managing the impact of subsidy changes cost the authority significant credibility with international investors. It seems this time around previous lessons have been learnt and investors are now pricing in an expectation of further interest rate hikes. The so-called frontier economy of Vietnam is also feeling the strain and the central bank has recently raised interest rates substantially to 12 per cent. It seems that once again last year's frontier market is this year's biggest challenge as international investors have been hurt in the downturn - Japanese investors were big buyers of Vietnam in 2007. Inflation is not being viewed negatively by economists and analysts in all parts of the region.

Jun 12, 2008 04:43

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Source: FT.

Inflation shocks are challenges for Asia's economies

By Mark Konyn
Thursday, June 12, 2008

Thelatest sell off at the end of May in Asian markets follows the spectacular recovery in April when investors returned to the region that had previously been battered amidst global concerns of an economic slowdown and mounting inflationary pressure.
It is now the latter that is troubling investors most as a combination of rising oil, food and commodity prices is causing concern that higher inflation will limit economic growth prospects. In the past 15 years Asia outside of Japan has been susceptible to inflation shocks that have hurt the region's competitiveness and undermined central bank credibility.

For some time, analysts have been tracking food prices in China as a lead indicator of future wage inflation. In the past 10 years of accelerated growth in mainland China, droves of workers have left rural areas to work in cities and factories. As a result of both this labour migration and the under-investment in the agricultural sector, farming productivity has not improved. Higher living standards are now placing a heavier demand on food supply and as a result there has been a steady increase in food prices that has fed through directly to wages and prices more generally.

The authorities have been early to recognise this potential threat to sustainable economic growth and have sought to cool the economy through a combination of monetary and administrative measures targeting specific parts of the economy, most noticeably credit growth in the housing market. In other parts of the region, rising commodity and oil prices are testing central banks' ability to take the initiative.

For example, in Indonesia the central bank has acted early to raise interest rates, recognising that the removal of oil subsidies will be inflationary. In the previous cycle the inability of the central bank to demonstrate a measured and considered approach in managing the impact of subsidy changes cost the authority significant credibility with international investors. It seems this time around previous lessons have been learnt and investors are now pricing in an expectation of further interest rate hikes. The so-called frontier economy of Vietnam is also feeling the strain and the central bank has recently raised interest rates substantially to 12 per cent. It seems that once again last year's frontier market is this year's biggest challenge as international investors have been hurt in the downturn - Japanese investors were big buyers of Vietnam in 2007. Inflation is not being viewed negatively by economists and analysts in all parts of the region.

Jun 12, 2008 04:43

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In Japan, anaemic growth combined with the constant threat of deflation is perhaps the region's exception where some inflation could help overcome some of the structural impediments. In the latest stock market downturn coincident with a weakening dollar, it has again been the exporters that have felt the most pain. It is hoped that modestly rising prices may help those companies exposed to domestic consumption factors and allow for some margin expansion.

Historically, in Asia higher inflation has initially been positive for equity markets, being supportive of higher valuations and earnings. However, later in the cycle markets have typically suffered as economies have lost competitiveness and margins have been eroded. At the same time central banks have stuck to their policy of shadowing the US dollar and therefore have not been pro-active in attempting to avoid
the later damage caused by rising prices. Hence, investors are examining central bank policy closely in the current cycle and policy makers have an opportunity to establish credibility internationally. Many have already acted to raise rates and tighten credit.

The Reserve Bank of India has perhaps surprised investors in its resolve and has consequently enhanced its reputation. Repeated measures to tighten money supply may cost the economy growth over the next couple of quarters, but most likely has prevented the building of a bubble that would have been more costly in the longer term.

For the region's investors, higher inflation and higher interest rates present different challenges. International diversification has been the watchword in the past year or so, whereby more institutional and private investors have begun to consider investment into international asset classes.

Despite the theoretical argument of greater diversification and consequently lower aggregate volatility, it is the allure of higher returns that dominates consideration. From a Japanese perspective, investing internationally has proven highly attractive given the moribund state of the domestic stock market that struggles to attract domestic institutions and retail investors alike.

For other economies in the region higher interest rates will challenge the attractiveness of equities generally and international equities specifically - it is difficult to convince investors to move money overseas when local interest rates are at an elevated level - even if real rates are negative.

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