Growth vs inflation trade-off gets tougher in Asia

Asian policymakers presiding over a sturdy economic recovery can be forgiven if they felt smug watching Europe's debt crisis and America's budget woes mount.

But fast-rising food and oil prices have shattered any complacency, complicating the eternal trade-off between sustaining growth and keeping a lid on prices. The central banks of South Korea and Thailand both cited the threat from record food price inflation as a reason for raising interest rates last week. "Unlike previous episodes of spiking raw material costs, there is now a greater realisation across Asia, and apparently also in Korea, that such bursts of inflation cannot be shrugged off as temporary and need to be addressed with a more pro-active monetary policy stance," said Song-yi Kim, an economist at HSBC. China, which on Friday ordered banks to hold more of their deposits in reserve, is also waging a vigorous campaign to keep inflation expectations anchored in the face of spiralling food costs. Hans Timmer, director of development prospects at the World Bank, said it was in the interest of countries that are doing well to act promptly to prevent their economies from bubbling over. "For that reason it is very logical that many governments in developing East Asia are very concerned now about the first signs of inflation and are asking themselves what they should do about it," Timmer said. Yet what is striking is that monetary policy across the region is far from tight. The cost of money, which was slashed to emergency levels as the global economy tottered in 2008, is still well below the rate of inflation in most countries -- and below historical averages. This is partly because Asia is worried that raising interest rates will attract unwanted inflows of cash minted by Western central banks. It is also due to the ingrained instinct of politicians to put growth before price stability. "In general, countries are a bit behind the curve. They have not tightened enough and they should be pre-emptive in order to try to sustain the longevity of the cycle and not let inflation get in the way," said Bill Belchere, global economist for Mirae Asset Securities in Hong Kong. "I would say policymakers in the region are much more concerned about inflation right now. I think they do 'get it', but there are some political rigidities about how quickly and aggressively you tackle these things," he said. Indonesia, India in spotlight One country where investors sense political constraints is Indonesia. Foreigners have been big sellers of bonds and shares since the central bank declined to raise interest rates earlier this month despite a jump in inflation. "They are in a little bit of trouble and, after three strong years, could encounter both volatility in the exchange rate and in their equity market," Belchere said of Indonesia. India is also vulnerable to investor skittishness. The Reserve Bank of India is widely expected to raise interest rates in its Jan. 25 policy review meeting after wholesale inflation in the year to December leapt to 8.4%, well out of its comfort zone. But the central bank needs the government to pull other policy levers to help stop aggregate demand running far ahead of supply, according to Sonal Varma with Nomura in Mumbai. "However, we see a rising risk of Indian policymakers focusing more on economic growth than the increasing symptoms of overheating, and hence not tightening macro policies, particularly fiscal policy, sufficiently," she said in a report. Apart from frothy prices and a big budget deficit, 94% of India's record current account deficit of 4.1% of GDP in the July-September quarter was financed by short-term portfolio inflows. "The danger here is that at some point investors shift their focus from the rewards of high growth to the risks of deteriorating economic fundamentals, triggering a sudden stop in capital inflows," Varma said. Yet Richard Jerram, chief Asian economist at Macquarie in Singapore, said the measured response of policymakers across Asia was understandable to a certain extent. Inflation readings remain mostly subdued, and, while agreement to cut US taxes had reduced global cyclical risks, the world economy still faced still headwinds. "You have terrible problems with European sovereign debt and you have a lot of uncertainty about the quality of global financial system regulation. The risks aren't just what's first-quarter growth going to be in the US: the risks are macro-systemic," he said. Mr Hu goes to Washington China, for one, is unlikely to tighten policy aggressively, many economists say. President Hu Jintao said before leaving for a state visit to the United States that inflation was "on the whole moderate and controllable". Because the ruling Communist Party was not too worried about inflation, monetary policy would be "mildly accommodative" this year, said Andy Rothman, an economist with brokerage CLSA in Shanghai. "My guiding principle is that the Party chooses a level of lending and money supply growth that it thinks will support its desired pace of GDP growth, and I think that is about 9%," Rothman said. And it is the Party, not outsiders or the markets, that determines how fast the yuan will rise. As such, US President Barack Obama is unlikely to persuade Hu to show Asia how to rebalance its economy away from exports and dampen inflation by letting the Chinese currency climb more quickly. The yuan rose 7% a year between 2005 and 2008 and climbed at a 6% annualised rate in the second half of 2010. "I don't think there is going to be a significant change from what we have seen in the last few years," Rothman said.