The latest Asian export: inflation

By Associate Editor David Stevenson May 23, 2008

David Stevenson

For years now Western economies have been importing cheap textiles and electronic goods from  Asia. But its most recent export – sharp price rises – is not so welcome, says David Stevenson

What’s the big worry?

Fast-rising inflation in Asia. In Britain, consumer price inflation (CPI) has now hit 3%. That’s well over the Bank of England’s target, but it’s nothing compared with what’s happening in the East. In India, consumer prices have hit a 42-month high of 7.6% while, at 8.5%, China’s inflation is at its fastest pace in 11 years.

Elsewhere, things are generally worse. In Vietnam, prices are rising at 21% annually – their highest rise since 1992. In Indonesia the rate is 9%, in the Philippines it’s 8.3%and in Singapore it’s 6.7%, its highest since 1982. 

Why is this happening?

Asian economies are expanding fast. Industrial production is advancing at over 8% year-on-year in India, and at almost twice that rate in Thailand. For emerging economies overall, internal demand now generates some 90% of annual output growth. For example, in 1998, Chinese new vehicle sales were just 10% of America’s. Now they’re more than two-thirds of the level achieved in the US. Yet the amount of money entering these fast-growing economies is rising even faster than output. Emerging economies’ domestic credit growth has expanded at 27% annually, according to Legal & General Investment Management, up from 6% six years ago.

For example, Vietnam’s bank lending rose 14.7% in the first four months of 2008, reaching almost half the central bank’s 30% annual limit. In other words, domestic demand has been stoked up rather too much. If the supply of money is rising faster than the supply of goods, that means rising prices.  

Isn’t money supply just a local problem?

No. US Federal Reserve rate cuts, aimed at avoiding recession, have made the money supply problem worse by adding more liquidity. As US monetary policy has loosened and the buck bombed, cash has poured into Asia as investors look to tap into its economic advance. This has forced up exchange rates against the dollar and the pound.

To slow down this exchange-rate appreciation and help their exporters keep prices down, Asian countries have been expanding the supply of their own currencies too. The net result: an even greater money-supply surge. Throw in soaring commodity prices and you have the perfect recipe for an inflation take-off. 

What does this mean in practice? 

The Asian Development Bank predicts inflation will reach a decade high this year. Food prices have been rocketing: some countries are now suffering food riots and workers “will soon be fighting for much higher wages”, says the FT’s John Plender. An annual wage guideline by the Shanghai labour and social security bureau recently recommended maximum increases of 16%, an average of 11% and a minimum of 5%. That’s about 2% higher than last year and follows news that average wages in Chinese urban areas climbed over 18% in the first quarter from a year earlier. Barron’s reckons that wages paid to both Indian engineers and call centre workers are rising in excess of 20% a year. 

How are central banks responding?

They’re finally starting to get tough. Surging inflation is hurting business confidence and means the brakes must now be applied. So Asian interest rates are headed upwards and reserve requirements are being upped. For example, this week in Vietnam the State Bank raised its base rate to 12% from 8.75%. Other draconian measures include the recent suspension by India’s government of futures trading in a number of key commodities.

Currencies are now being allowed to appreciate faster as well. Thailand’s baht has gained 16% against the American dollar (and a similar amount against sterling) over the past 18 months, part of an Asia-wide trend. Still, once inflation gets going it can be hard to rein in: there is little expectation that a low inflationary environment will return anytime soon. 

What does this mean for us?

Nothing good. The days of £4 dresses and £2 shoes might be over. For years, we in the West have assumed we could relyon a steady stream of manufactured goods from the Orient, made at prices with which our own manufacturers could not possibly compete, but which we could snap up with the proceeds of cash released from our houses. Sadly for us, the game is well and truly up. The equity release cashpoint has been firmly shut, as house prices have started to tumble and banks tightened up their lending criteria. And the latest Asian export – rising prices – isn’t nearly as welcome as the cheap goods once were.    

Is it back to 1970s stagflation for Britain?

Britain has a new inflation problem. The Consumer Price Index (CPI) is now climbing at 3% year-on-year and the FT has just reported a higher level of national scepticism about the Bank of England’s (BOE) ability to control price pressures than there has been at any time since it gained independence. But it may not be all the BOEs fault. As sterling tumbles, rising food and energy costs have been pushing up the CPI, and more expensive manufactured goods from Asia make matters worse.

Still, the Bank has to deal with the fall out. To meet its inflation target, the Bank of England needs to offset higher import prices by dampening demand elsewhere. That means that the British economy is going to suffer a serious squeeze – lower profits, suppressed wages and fewer jobs. Tim Bond of Barclays Capital says the next few years could rival the 1970s: ”It might be accurate to state that the ‘nasty decade’ is on the way”.

Published in Economics | More articles by David Stevenson

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