Asia faces tough test as inflation soars

SEOUL/JAKARTA - Inflation hit a seven-year high in South Korea in May, neared a decade peak in Thailand and crossed into double digits in Indonesia as Asia's policymakers grapple with their toughest test since the 1997 financial crisis.

By (Reuters)

Published: Mon 2 Jun 2008, 6:39 PM

Last updated: Sun 5 Apr 2015, 1:06 PM

Across the region central banks are under growing pressure to tighten monetary policy to prevent $130-a-barrel oil and soaring commodity prices from seeping into wages and other costs. Governments fear rate hikes could choke off slowing growth.

India's prime minister said he hoped Asia's third-largest economy would be able to do both -- check inflation and support growth in the face of a global slowdown triggered by the fallout from U.S. credit crisis.

Indian consumers, like those in other Asian countries, could soon be hit with a spike in subsidised fuel prices in another sign that governments are running out of options.

"Asian central banks have not faced a scenario like this since the Asian crisis," said Huw McKay, an economist at Westpac, noting that the declining gap between output and demand meant that economies would find it more difficult to grow quickly without pushing up prices.

"It's a huge challenge for them, because running monetary policy with economies running close to capacity is a job which requires a lot more finesse than running monetary policy when you have a lot of spare capacity," he said.

Nowhere has the inflation-versus-growth debate been as bitter as in South Korea, where the government has been pressing the central bank to cut rates, to help it meet an election pledge on the economy.

The central bank gained room for manouevre on Monday from data showing the consumer price index rose 4.9 percent in May, the fastest rate since June 2001 and above the central bank's comfort zone.

The Bank of Korea will definitely miss its inflation target if oil prices do not plunge," said Oh Suk-tae, economist at Citibank. "So markets will expect an interest rate hike despite the fact that the government wants the Bank of Korea to ease monetary policy to boost the economy."

The inflation spike also has the government worried. The finance minister said last week the won may have fallen too fast and authorities stepped into the foreign exchange market to support the currency.

More to come

Indonesia's CPI rose in May by 10.38 percent from a year earlier, up from 8.96 percent the month before and the fastest pace in 20 months.

Meanwhile, Thailand's annual consumer inflation hit a near 10-year high of 7.6 percent in May, jumping from 6.2 percent in April.

All the results were higher than forecast and prompted economists to anticipate rises in interest rates, a bitter pill at a time when weaker global demand already threatens to set some economies across the region off their paths of robust growth.

In Indonesia, the acceleration in inflation reinforced existing expectations that the central bank will raise rates later this week for the second time this year.

The pick-up in inflation partly reflected a sharp rise at the end of May in state-controlled fuel prices to relieve pressure on government subsidies that have been hit by record oil prices, which hit a high above $135 a barrel last month but have since retreated to below $127.

"This is not the peak; inflation may accelerate further in the coming months," said Juniman, an economist at PT Bank Internasional Indonesia Tbk.

Most analysts predict Bank Indonesia will raise its key interest rate by 25 basis points to 8.50 percent when the central bank reviews policy on Thursday, and to tighten further later this year if inflationary pressures remain high.

McKay said that relatively healthy export and consumption figures should mean that Indonesia will be able to weather a rate rise without it presenting much of a threat to growth.

Weathering the storm

Thailand's central bank will probably wait until its July meeting to raise rates, in part because of the political uncertainty surrounding worries over another potential coup, said Nuchjarin Panarode, an economist with Capital Nomura Securities.

"Any rate rise before the appropriate time could aggravate people's confidence and market sentiment," Nuchjarin said.

Some economies in the region are seen as more vulnerable to the current uncertainties than others.

Fitch Ratings last week lowered its outlook on Vietnam's BB-minus sovereign rating to negative from stable, saying authorities had not dealt swiftly or strongly enough with inflation, posing risks to the banking system. Vietnam's annual inflation is running at about 25 percent.

India should be able to sustain growth despite the challenges created by high crude prices and the need to contain inflationary expectations, Prime Minister Manmohan Singh said on Monday.

India too is grappling with whether to raise domestic fuel subsidies, which would lower the government's fiscal burden but would add further to inflation, which is running at a 3-” year high of about 8 percent.

"It has been our endeavour to tame inflationary expectations without hurting the rhythm of the growth process and also to protect the weaker sections against rising prices," Singh told a meeting in industrial leaders.

"I am confident that the mix of policies we have adopted will yield results once the full impact of a normal monsoon is felt."

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