Inflation and Growth in Asia Pacific – The Myth of Economic Decoupling

Currently central banks around Asia Pacific region have to worry of two pronged worries; inflation which is fueled by fuel price and economic growth which is adversely affected by global slowdown. The usual weapon employed, and recently advocated by policy makers, is tight monetary policies, which means squeezing liquidity out of the market through higher interest rate. However, this time the freedom to use is limited by possible drop in demand both domestically and internationally.

Internally, export growth around the region has been supported by foreign markets, mainly developed nations. Although US may not be the largest trade partner in terms of export for some of the countries, its thirst for goods from other nations which has been purchasing in large number from the region indirectly affects the export growth. And high dependence on export to fuel the domestic growth adversely affects the growth prospect.

Propelled by low interest rate before the mortgage crisis, claims in US were factored by loans and debts from around the world; China, Japan, Middle East, which hold large US government debts. The liquidity created has been channeled to pop up demands for toys from China, Oil from Middle East and manufacturing products from India and Japan. Some of these countries, such as China and India, and also some of the emerging countries such as Indonesia, Vietnam and Malaysia, are main players in regional trade. For example, China has been main buyer of intermediate manufacturing goods, including producing large quantities of finished goods to be sold in the region and US. Vietnam and Indonesia, are fast becoming investment destinations due to their low labor cost. The network of regional trade has one common destination and hope; the large market in Europe and US. Thus, any hiccup occurs to US economy, the whole network is affected.

When the oil price escalated, many countries in the region have started to cut subsidies, as the burden of USD140 per barrel is unbearable. Malaysia, Indonesia, Vietnam, India and China, the saved subsidies, are said to be re-channeled for other development policies. However, this unpopular move has negatively affected the low and middle income groups in the countries. Higher portion of income is now allocated and spent on fuel and food. The spillover can be felt in price increase in bread, rice, vegetables, milk and frequency in eating outside is cut and purchase of fuel efficient automobiles has increased. The signs around is bleak; the domestic demand and consumer sentiment has dropped.

Against these backdrops, the stage is now set to promote higher interest rate, tighter loan expansion to lower consumption. But at the same time, the worry that tighter loan growth and consequentially lower consumption hampers economic growth which is already under stress looms. More importantly, the tighter monetary policy could appreciate countries' currencies and cause products to be less competitive. Since US currency is weak now due to low interest rate and other worries of economic recession, any appreciation of regional currencies will not help the export growth which the region depends so much. But inflation worry starts to pop up in the central banks' radar screen, workers are now asking for higher wages to compensate the higher cost of living. If the price wage effect spirals out of control, it may warrant interference, provided it does not negatively affect the production sector.

It is really a stressful period, as both inflation and economic slow down could trigger regional stagflation, or if the inflation is tackled, economic slow down. There is never decoupling of Asian economy from US economy in this globalized world.


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