Emerging Asia Pacific: Economic Review May 2011
Thomas White International
June 13, 2011
Aggressive interest rate hikes by emerging markets in the past twelve to eighteen months have started showing some initial results. Although food inflation in many emerging markets remains at elevated levels, the pace of inflation seemed to slow in some countries. Further, inflation expectations are expected to cool, primarily due to anticipation of record harvest of food grains in many countries. The threat from oil prices, which grew at a menacing pace during the first quarter of the year, also subsided a bit in May. Nonetheless, many central banks across Asia were cautious over monetary policy. Central banks, preempting inflation, hiked interest rates in many countries. Further, core inflation, which originates from structural factors like labor wages and capacity constraints, also sent mixed signals. Wages in many countries were hiked during the month. Consequently, some central banks were reportedly even willing to give up some amount of growth to contain inflation.
At a Glance
- China: China’s Central Bank hiked the reserve requirement ratio to a record 21 percent to rein in inflation.
- India: The government hiked fuel prices by nearly 8.5 percent in May. Budget deficit reduction goal is expected to be compromised due to rising oil prices and higher social sector spending.
- South Korea: Record exports in April propelled growth. South Korea and the European Union signed a historic trade pact.
- Indonesia: A strong rupiah, the country’s currency, helped alleviate fuel import bills. The government decided to continue with fuel subsidies to contain inflation.
- Taiwan: Exports surged in April as international orders were diverted to Taiwan away from earthquake-hit Japan. Property prices also cooled in April thanks to transaction taxes.
On the other hand, many central banks, which were bending over backwards to prevent the appreciation in the past year, intervened less frequently in the currency market. A strengthened currency hurts export competitiveness. Instead, many seemed to employ their stronger currency, a product of the past interest hikes, to combat food inflation by raising the purchasing power of the consumer.
China: Ready to sacrifice growth in fighting inflation
China’s central bank is at it again. With core inflation showing little signs of budging, the country’s monetary policy makers stepped in with more tightening measures of a yet another hike in the bank reserve requirement ratio. Raising reserve ratios will require China’s commercial banks to park more funds with the central bank, which in turn could slow down both lending and pull down inflation. The present increase in the reserve ratio is the fifth since the beginning of 2011. It also takes the reserve requirement ratio to a record 21 percent.
Nonetheless, many economists feel that China’s battle with inflation is far from over, as inflation is spreading beyond food and fuel. The price of bare essentials such as food, clothing and housing all went up during April. Non-food inflation grew at the fastest pace in nearly six years on further pressure from wages and rising commodity costs. Chinese officials are reportedly willing to sacrifice some amount of growth to bring down inflation. They are also trying other measures such as allowing their currency, the Chinese yuan, to appreciate to fight ‘imported inflation’. In mid-May, China’s central bank pegged the yuan at 6.495 to a U.S. dollar, the strongest level the Chinese currency has traded against the U.S. dollar since 1993. A stronger yuan could help reduce the country’s import bill for items such as fuel.
However, many western economies, in particular the U.S., still complain that China’s currency is not strong enough. China’s trade surplus figure which accelerated in April to $11.4 billion gave more ammunition to the west’s demand for a further strengthening of the Chinese currency. They still feel that China is manipulating the value of the domestic currency by selling the yuan in the currency markets. The excess selling of the yuan in the currency markets is also seen as one of the drivers of domestic inflation in China.
Meanwhile, many local governments in China are proving to be more open to liberalizing capital control measures. Currently, China restricts individuals from investing abroad. Investing abroad would entail converting yuan to buy assets abroad. Theoretically, as yuan get out of China, inflation could be brought down. Many cities like Shanghai are supporting such proposals and are pressing China’s central government to act. But to China’s central government such a measure is unthinkable. Traditionally, capital-starved developing countries do not allow their citizens to invest abroad to conserve capital. China had earlier rejected such a proposal from Wenzhou, a city in one of the country’s eastern provinces. Shanghai’s proposal too is widely expected to be turned down.
In other developments, China continued to be popular with foreign investors. In April, the country attracted more than $8 billion in investments as upscale coffee chain Starbucks and entertainment companies like Disney set up shop. These companies are expanding in China as the spending power of Chinese is widely expected to go up thanks to rising real wages. But even such investment-led growth is at best expected to help the Chinese economy only modestly in the short run. As Chinese officials are tightening the screws on excessive lending, the country’s manufacturing segment is facing the heat. The preliminary purchasing manager’s index compiled by HSBC fell to 51.1 in May, the lowest in nearly ten months, indicating a slowdown in the level of industrial activity.
India: Budget deficit could miss target on higher oil prices
Much like its northern neighbor China, India too is facing challenges from persistently high inflation. Rising prices of crude and food grains are consistently fueling inflation. The price of crude has almost shot up 40 percent over the past one year straining the country’s import bill. On the other hand, India’s farming sector, which is widely expected to post a record grain output, is also under pressure primarily due to the rising cost associated with farm inputs. Labor and fertilizer costs, in particular, have become excruciatingly expensive for India’s farmers. The Commission for Agricultural Costs and Prices estimates that India’s farmers are paying at least 20 percent more for agricultural activities.
India, which is facing a budgetary squeeze because of rising subsidies for fuel and social sector spending, is now faced with hard choices. In early May the country hiked prices of petrol by nearly 8.5 percent, the steepest hike in over nearly three years. The Commission for Agricultural Costs and Prices, which advises the government on what prices to pay farmers for agricultural produce, is largely expected to recommend a hike in the price that the government will pay farmers. This too is widely expected to exacerbate the inflationary pressures across the country.
In mid-May, the Governor of India’s central bank, The Reserve Bank of India (RBI), expressed concerns that a jump in food prices could intensify demand for higher wages. Further, the governor also worried about the country’s ability to bring down the fiscal deficit. India had announced that it will try to bring down the deficit to a four-year low of 4.6 percent for the fiscal year ending March 2012. But given the pressure on both the revenue and expenditures, the figure is now forecast to hover above the 5 percent for 2012. The RBI is now of the view that inflation in the country will be at elevated levels until at least September of this year.
Consequently, in early May the central bank, despite loud complaints from the country’s business over rising cost of capital, hiked interest rates for the ninth time since 2010. The central bank’s determination to control inflation, however, has spooked India’s equity markets in particular. As of late May, the country’s widely-tracked equity index, the Sensex, had fallen by 12 percent since the beginning of the year, on concerns that high interest rates will affect profits at large companies.
South Korea’s central bank loves to keep all those central-bank watching analysts and economists guessing. Contrary to widely-held expectations, South Korea’s central bank, the Bank of Korea refrained from hiking interest rates in mid May. This was the sixth time in the last 12 months that consensus predictions by a group of economists differed from the interest rate decisions taken by the central bank.
But one cannot blame the forecasters completely. A falling unemployment rate, soaring exports, and rising food prices were largely viewed as factors that would force the central bank to raise interest rates. The unemployment rate for April at 3.6 percent was the lowest this year and had fallen below the Korean finance ministry’s prediction of 3.7 percent during 2011. On the other hand, exports climbed 26.6 percent to $50 billion from the year-ago period as shipments to China surged. Demand for South Korea’s automobiles and electronic products such as mobile phones too were quite strong.
Nonetheless, the Bank of Korea said it wanted to measure how a strengthened domestic currency, the won, could help fight inflation. Further concerns about the sustainability of the economic recovery in Europe, the effects of Japan’s March earthquake, and prospects of slower growth in China all were reported to have prompted the Bank of Korea to take a wait-and-watch approach to interest rates.
In other developments, South Korea inked a free-trade agreement with the European Union, one of the world’s largest trade deals. Currently, the EU and South Korea exchange goods worth nearly $105 billion every year. The current deal will expand the prospects of trade by making nearly 99 percent of the trade between the countries duty-free. The trade deal will likely help some of South Korea’s Chaebols, or industrial conglomerates, which already count Europe as one of their largest export destinations. South Korean automakers, electronic goods makers and textile manufacturers may get a boost from the deal. Similarly, Europe, which has a comparative advantage in the manufacturing of pharmaceutical products, chemicals and capital goods, will gain access to Korea.
South Korea’s state-run Korea Institute for International Economic Policy has blessed the deal, touting its potential to boost the country’s GDP substantially. The move is estimated to eliminate Korean import duties worth €1.6 billion on European products and remove European levies of nearly €1.1 billion on Korean goods.
Indonesia: Strong currency aids fight against price rise
Indonesia’s economy grew nearly 6.5 percent during the first quarter of this year, much slower than the 6.9 percent registered during the fourth quarter of last year. Although private consumption has helped the economy, a mild slowdown in investments prevented a much larger growth. Indonesia’s central bank now estimates 2011 second quarter GDP growth to come around at 6.4 percent. Rising inflation, pressure on exports, and infrastructure bottle-necks are widely expected to put pressure on Indonesia’s growth through the year.
Currently, Indonesia is using its currency to fend off inflation. In recent times, the substantial inflow of capital from developed economies has pushed up the value of the country’s currency, the rupiah. As of May 2011, Indonesia’s currency had strengthened to its strongest level since 2004. The rupiah has also climbed nearly over 5 percent against the U.S. dollar since the beginning of 2011. Indonesia is now employing the strong currency to boost purchasing power.
Indonesia’s policy makers also decided to continue with fuel subsidies in May. The country, which has become a net importer of oil in recent years, offset imported oil bills primarily using the stronger rupiah. The fuel subsidies in turn have helped ease inflation for a third straight month in April. The central bank is considering allowing the rupiah to strengthen further to fight inflation. The strengthened currency has also given the country’s central bank more flexibility in determining interest rates. After three straight months of falling inflation, the country’s central bank refrained from hiking interest rates in May. Nonetheless, Indonesia is widely expected to increase interest rates at least once more in 2011, as core inflation has inched up.
Furthermore, Indonesia’s strong fiscal shape is likely to help attract more investments into the country in the long term. The country’s public debt as a percentage of GDP in 2010 had fallen to around 26.1 percent, the lowest among Southeast Asian countries. Raw material-hungry neighbors like China, India and even Japan are increasingly investing in the country’s natural resources such as coal. The country is estimated to spend nearly $250 billion on infrastructure projects such as roads, utilities and ports over the next five years.
Thailand: Weak currency helps exports but makes fuel expensive
Thailand’s GDP grew 2 percent for the quarter ended March 31, 2011. This was the fastest quarterly growth in a year and much higher than the 1.3 percent growth achieved in the fourth quarter of 2010. The country’s growth was supported by both strong consumption and exports. Despite concerns over Japan, Thailand’s largest export destination, the country expects exports to jump by over 15 percent for the full year. Exports from Thailand are also being helped by a weak domestic currency. The country’s currency, the baht, has fallen nearly 1.3 percent in 2011. The baht has been one of the few currencies in the ASEAN region to fall against the U.S. dollar this year.
However, the strong pace of growth in the economy and a weakening currency are giving way to inflation concerns in Thailand. Although the country’s central bank expects inflation to be within the 4 percent range by the end of the year, inflation in recent months has shot above the 4 percent mark. In April inflation touched 4.04 percent, the fastest pace of jump in nearly 15 months. Some of the large meat-producing companies in the country have already marked prices up. Private economists now expect the central bank to raise interest rates at least twice in 2011. The fourth hike in the interest rate is expected to come as early as June this year.
Meanwhile, Thailand is all set to go to the nationwide polls during the first week of July. In the past three years, Thailand has witnessed numerous mass protests over claims of election fraud, which disrupted the normal functioning of the government. More than 100 people have been reported dead in this period due to clashes between the government forces and opposition protesters. The current Prime Minister Abhisit Vejjajiva, who is aiming to maintain power, has promised to hike wages by 25 percent and increase subsidies on fuel and food items.
Philippines: Rising wages cause concern over inflation
The Philippines, like some of its Asian neighbors, is facing inflationary pressures. The cost of living has risen consistently over the first quarter of this year as prices of oil, food, and global commodities jumped in the period. Consumer prices in April spiked 4.5 percent in April, the fastest pace in the last twelve months. Some of the nation’s largest restaurant chains have reported that the cost of raw materials could hurt profitability. A part of this price rise is also expected to be passed on to consumers sooner rather than later. As of late May, the country’s currency, the Philippines peso, touched an eight week low. A weakened peso as well is anticipated to make the fight against inflation tough in Philippines.
What’s more, a persistent rise in the price of the essentials has led to demands for higher wages across the country. Some of the prominent trade unions in the Philippines, such as the Trade Union Congress of Philippines have demanded that the country’s minimum daily wage of 404 pesos be increased by another 75 pesos.
However, the country wage board is likely to raise the daily minimum wage by just another 22 pesos. Still, any increase in wages is largely expected to push inflation up in the near term. The central bank, which raised overnight borrowing costs by 25 basis points during the first week of May, has not ruled out further interest rates hikes during its policy meeting next month. The country’s government for its part is spending less to help ease inflationary pressures.
Malaysia: Central bank hikes interest rate for the first time in 2011
Malaysia‘s domestic consumption fueled the country’s economy and helped it register a 4.6 percent growth during the first quarter of 2011. Strong commodity exports and stronger-than-expected credit growth played a significant part in the lifting the country’s economy during the first quarter.
In recent months, Malaysia’s banks have lent more money despite monetary tightening measures from the country’s central bank. Loans disbursed by Malaysia’s retail banks jumped nearly 17.3 percent in March primarily due to strong growth in consumer credit business. However, the rise in lending has also stoked inflation in Southeast Asia’s third-largest economy. Malaysia’s inflation hit the roof in April as consumer prices in April advanced to 3.1 percent. This was the fastest pace of appreciation in nearly 23 months. To combat inflation, the country’s central bank hiked interest rates for the first time this year in early May and ordered retail banks to increase the amount of cash to be parked with the central bank. Malaysia has increased borrowing costs four times since March 2010.
Malaysia’s exports industry, which derives its strength from commodity exports such as palm oil, is widely expected to face headwinds in the near future due to a strengthening domestic currency. Malaysia’s electronic industry is also expected to face pressures due to supply chain disruptions in Japan. Already, electronics shipments from Malaysia to neighboring countries such as the Philippines and Thailand have fallen in the last two months primarily due to supply chain upheaval.
Taiwan: Exports soar as competition from Japan dwindles
Taiwan’s exports are climbing consistently. The demand for the island’s products such as semiconductors and other electronics parts have jumped recently as large buyers of electronic components have relied on Taiwan to make up for the lost supply from Japan. Productive capacity in a number of Japan’s export-based industries suffered in the aftermath of the March earthquake.
In April, Taiwan’s export orders climbed nearly 24.6 percent, much higher than the 13.4 percent growth witnessed in March. Exports in general have helped Taiwan raise its overall output throughout the last year. During the first quarter of March, Taiwan’s economy expanded 6.2 percent.
However, strong growth in exports and the broader economy have prompted concerns over inflation in the country. Although Taiwan’s inflation in April rose 1.4 percent, a bit lesser than that in March, the country expects inflation for the year to jump over 2.18 percent. Taiwan, which had hiked interest rates in March to weaken inflation, is largely expected to raise borrowing costs for the rest of 2011 as well.
But hiking rates is also expected to affect Taiwan’s export competitiveness. The country’s currency, the Taiwan dollar, climbed to a 13-year high in mid-May as capital from developed countries chased high interest rates in Taiwan.
In other developments, Taiwan’s property markets are finally responding to some of the tough measures taken by the government. The country’s property markets, which have risen for three continuous years, have fueled the government’s concerns over a property bubble. Consequently, Taiwan attacked speculation-driven property price appreciation during the initial months of the year by implementing a 15 percent transaction tax on residential properties sold within a year of purchase. This has helped cool a portion of the property market. Residential property, which started adjusting to the new taxes in March, continued to fall in April. Now rents and prices of commercial properties such as stores in Taiwan’s metropolitan areas too are falling. In April 2011, the average price of a store in the Taiwan metropolitan area fell 1.6 percent compared to the same month a year ago.
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