Keeping Asia from Overheating

By Anoop Singh

Asia’s vigorous pace of growth has seen the region play a leading role in the global recovery. But, there are also now growing signs of price pressure across the region’s goods and asset markets.

Headline inflation in Asia has accelerated since October 2010, mainly owing to higher commodity prices. There are, of course, variations in how much this has affected inflation across Asia, partly reflecting differences in the shares of food and energy items in expenditures.

But there are signs that higher commodity prices are spilling over to a more generalized increase in inflation. Expectations of future inflation have picked up. And accommodative macroeconomic policy stances, coupled with limited slack in some economies, have added to inflation pressures.

So, is Asia overheating? While inflation is generally expected to decelerate moderately in 2012, after first increasing further in 2011, inflation risks remain on the upside. Low inventories and limited scope for supply to respond to higher demand mean that commodity prices are vulnerable to new supply shocks. In addition, persistent concerns about food shortages could trigger an upward spiral in global prices.

At the same time, overheating pressures are building within a few Asian asset markets. There are two telltale signs.

  • Equity and bond markets seem to be in line with past norms, as indicated by their valuations and yields relative to historical trends, but credit growth has accelerated in recent months.
  • Property prices appear relatively buoyant in some cases, particularly in certain segments of the market in China, Hong Kong SAR, and Singapore.

Against this backdrop, the need for policy tightening in Asia has become more pressing than it was six months ago, especially in economies that face generalized inflation pressures. How should policymakers address these challenges?

  • In addition to higher policy rates, exchange rate appreciation would help thwart overheating pressures by making overall monetary conditions tighter.
  • While capital inflows tend to complicate the task of policy tightening and this remains an issue in a few countries, such flows have moderated in recent months in many countries. 
  • The run-up of inflows in 2010 in many countries also raised concerns about how to handle a “sudden stop” or reversal of capital flows. In this context, macroprudential measures could help complement the policy mix, particularly in terms of addressing overheating in asset markets.
  • More fiscal consolidation would also help reduce the burden to be borne by monetary tightening. At the same time, consolidation should allow for targeted social programs to cushion the impact of inflation on the most vulnerable groups, and also to maintain sufficient fiscal space for meeting longer-term investment needs in infrastructure and social sectors. As I wrote about a couple of weeks ago, such spending is important for economic rebalancing and more inclusive growth.

To conclude, we expect Asia to continue to be a key engine of global growth over the next two years. But with overheating pressures now in clear sight, policies need to be geared toward keeping these pressures from boiling over in a way that could undermine Asia’s economic prospects and, therefore, the global economic outlook.

5 Responses

  1. “•While capital inflows tend to complicate the task of policy tightening and this remains an issue in a few countries, such flows have moderated in recent months in many countries.
    •The run-up of inflows in 2010 in many countries also raised concerns about how to handle a “sudden stop” or reversal of capital flows. In this context, macroprudential measures could help complement the policy mix, particularly in terms of addressing overheating in asset markets.”

    The conversation, below, on these two aspects of Mr. Singh’s post (the conversation between Per and me) points out the pressing need for capital controls to prevent the surges of commodities inflation that periodically force them to migrate back and forth between continents. Labour mobility is one thing but forced labour migration is quite another, so I think the case is now clear that capital controls are needed wherever the owners of speculative capital are “negligently guilty” of forcing labor migrations.

  2. “•While capital inflows tend to complicate the task of policy tightening and this remains an issue in a few countries, such flows have moderated in recent months in many countries.
    •The run-up of inflows in 2010 in many countries also raised concerns about how to handle a “sudden stop” or reversal of capital flows. In this context, macroprudential measures could help complement the policy mix, particularly in terms of addressing overheating in asset markets.”

    Many have commented that the pace of financial reform occurring in the G20 has slackened dangerously in the last year. And others have pointed to capital inflows in various markets being destabilizing to the prices making up the cost of basic living (food, energy, housing). So is there not a strong case for the IMF to encourage cooperation amongst all parties to the G20 conversations to address these related issues together?

  3. I do not know about Asia but with respect of China…is not overheating, with the resulting inflation just another way to take care of an undervalued currency?

    • In a sense, Per, it might be construed as another “way to take care” of an undervalued currency. But is it a good way?

      To determine that, one must put oneself in imagination in all the shoes of the people whose lives are affected by that “way”. Currencies are inanimate; people are beings with sufferings and joys. People must therefore be, must they not?, the focus of consideration and currency kept in mind only as a vehicle in this consideration.

      • “But is it a good way?”

        I am not qualifying whether it is good or bad, just that it happens, but of course, I agree on that we need to put people first… and so in this respect let us then also imagine perhaps all those many Central Americans who, were it not for China’s undervalued currency, might have been able to stay home and produce under Cafta for the US some of what is currently being imported from China… and instead they had to emigrate leaving family? Now with some overheating and resulting inflation in China and which betters their relative competitive position, perhaps they can think of going back home.

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