Inflation in Asia? – Remarks on China, India and Japan

It was forecasted for the Year of the Rabbit that the excessive prices would level out and that stock markets, in China for example, would consolidate. 2011 is also supposed to see robust growth in South East Asia. The reality, however, is that Asian markets have had an unexpectedly rocky start to the year, with inflation being among the main headaches. Inflation is frequently seen as a uniform phenomenon that exhibits the same effects all over the globe. However, this is not the case; the effects that it may have on countries can vary, and these effects may under certain circumstances even be positive. Let us consider the four major economies dominating the Asian investment landscape at the moment, namely China, India, Japan and the United States. Many blame the current level of inflation on the US’ excessive use of “quantitative easing”, but the USA is facing a skyrocketing account deficit and problems with unemployment.

When we consider this, it is not surprising that the Fed seems to actively seek inflation as a way to lower real interest rates, encourage investment and spur on job creation. A weaker dollar helps by making US labour cheaper on world markets. China’s problem is the opposite, with low unemployment and an ever-increasing account surplus. The obvious answer would be to pursue a tighter monetary policy and to let the exchange rate appreciate. This is exactly what the Chinese have been doing over the past few years, albeit reluctantly and at a gradual pace. China seems to be content to raise interest rates, increase the amount of cash that banks were required to keep in reserve and not make available for lending, cool property speculation by means of government decrees, all the while allowing wages to rise, making Chinese goods more expensive and its asset markets less attractive. These measures, however, are little more than blunt tools. The Yuan may still rise yet, but the Chinese seem to be determined to do it in their way and at their pace. The Chinese currency is bound to replace the US Dollar as a global currency eventually, and it may even do so just in time for the 100th anniversary of the People’s Republic of China.

Inflation in Asia – Unfinished business

The two other Asian giants – India and Japan – also represent opposites. India has both a budget deficit and a current account deficit. The country is also exhibiting high inflation and prices are continuing to rise. The appropriate ‘cure’ for India may well be to accelerate the reforms of its public sector. Capital is scarce in India because of the government debt. These two factors may have an effect on India’s handling of its infrastructure bottleneck, which represents the main risk for this booming economy.

Japan, in stark contrast to India, is suffering from weak domestic demand and a chronic external surplus. Much like Germany, it is an economy that craves inflation. A weaker exchange rate may simply serve to increase its current account surplus, which would provoke the consternation of many of its trading partners. With public debt approaching 220% of GDP, Japan’s government budget seems stretched. Inflation, in contrast to India, may be helpful to Japan, as it may push real rates into negative territory, which may be necessary to achieve the rates of investment needed to revive demand. As shown above, inflation can elicit different policy responses from different countries, depending on the state of their economies. There is, however, one element that all have in common, and that is the rise in food prices. While this concerns everyone, it dampens demand disproportionately in less wealthy countries, where food represents a larger percentage of per capita consumption. Alas, there is little that can be done in the short term, given that 2010 was a hot year and that harvests have been poor. People in Asia can only hope for more to be planted and for a better harvest next year. While Asian governments have taken bigger risks and have adopted a more active stance in handling inflationary pressures, investors should consider that these policies are not uniform throughout the region. Inflation is also worth considering as a possible sign of strength.

It would seem that the excessive and long-term growth in Asia has taken its toll in the form of inflation. Provided that some level of control can be achieved over it, it may well be worth it in the end though.

This article was originally published in Berenberg Bank Newsletter – Asian Monitor – Issue 2

(March 1st, 2011, N° 08 / 2011)

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