Inflation: more complicated this time

The Business Times Singapore

November 3, 2010 Wednesday

THE recent resurgence of inflation - not just in Singapore since April, but across Asia - would seem like deja vu. It was just over two years ago when global focus and concern were squarely on runaway food and commodity prices that had sent the inflation rate spiralling across the region, before a mounting global economic and financial crisis soon had consumer prices crashing back down. But this time, with a 'new' phenomenon of massive capital inflows at play, it looks like the uptrend in inflation across the region may not be over anytime soon.

For Singapore, after staying subdued and muted for well over a year during the recession, the inflation rate surged to a 20-month high of 3.7 per cent in September. To be sure, globally, sub-4 per cent inflation would, in many economies elsewhere, still be considered fairly benign. But considering that Singapore's annual CPI (consumer price index) increase had mostly hovered - save for the outlier year of 2008, when it averaged 6.6 per cent - well below 2 per cent since 1995, the uptrend in the last two quarters (crossing 3 per cent) is quite a spike. Similarly, as economists have noted, the inflation rates in countries such as China and India too have reached levels that are markedly higher than what they had been since the Asian financial crisis in 1997. And while food prices are a key source of inflation, it's by no means the only or even main driver, particularly for Singapore, where (if anything) higher transport costs - mostly car prices - have fuelled the CPI basket. As well, the spectacular rapid rebound out of recession across the Asian economies in recent quarters has also added to price pressures, as erstwhile excess capacity is soaked up.

But by far, perhaps, the biggest factor that could exacerbate the inflation scenario stems from the amounts of capital sloshing around in Asia as investment and speculative funds seek high-growth, high-yield markets - and which have pushed up asset prices in the region, if not in fact added overvaluation risks to the big picture.

The Asian economies, not least Singapore, have mostly responded to their inflation upsurge by allowing their currencies to appreciate. While a stronger local currency does render, in one fell swoop, imported goods cheaper, a faster appreciation pace also risks attracting even more capital inflows. In other words, we would be back to the circle of downward pressure on interest rates (not necessarily bad) and possibly asset bubbles (certainly undesirable). For Singapore, with monetary policy centred on managing inflation at a pace supportive of economic growth, economists reckon that the central bank would continue to strengthen the Sing dollar next April amid rising price pressures. But a stronger dollar also spells weaker exports - and Singapore, like the other Asian economies, is still mainly export-driven. Across the region, macroeconomic policy in the quarters ahead surely calls for not just a careful balancing act of managing inflation and capital inflows, but also keeping a close eye on the competitive edge, against exporters from the emerging world outside Asia.


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