Inflation a threat to sustained Asian recovery - ADB

MANILA/HONG KONG Wed Apr 6, 2011 12:20pm IST

A labourer pulls a plastic sheet to cover sacks of paddy from rain at a grain market in Chandigarh January 13, 2010. REUTERS/Ajay Verma/Files

A labourer pulls a plastic sheet to cover sacks of paddy from rain at a grain market in Chandigarh January 13, 2010.

Credit: Reuters/Ajay Verma/Files

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MANILA/HONG KONG (Reuters) - Some of Asia's emerging economies are showing signs of overheating, underscoring the need for further policy tightening and more flexible foreign exchange rates to tackle growing inflationary pressures, the Asian Development Bank said on Wednesday.

Developing Asia, a diverse group of economies including China, India, Azerbaijan, Thailand and Fiji, is expected to grow 7.8 percent in 2011 and 7.7 percent in 2012, robust rates albeit slower than the 9 percent seen in 2010, the ADB said in its latest Asian Development Outlook report.

At the same time, inflation is expected to quicken to an average 5.3 percent this year from 4.4 percent in 2010, before easing to 4.6 percent in 2012, the ADB said. Some countries such as Vietnam and Pakistan could see inflation rates climb well into the double digits.

"There is some sign of overheating, some need for more policy tightening in future," ADB chief economist Changyong Rhee said at a media briefing in Hong Kong, speaking generally of Asian inflation.

"Developing Asia is home to two-thirds of the world's poor and it is they who are most vulnerable to the effects of price increases," he said. "Policymakers must therefore consider preemptive action to control inflation before it accelerates."

Higher interest rates alone may not be enough to tamp down price pressures, Rhee added, urging policymakers to use a variety of measures to curb inflation, including allowing greater flexibility in their currencies and capital controls.

"The region's outlook is for continued strong growth in 2011- 2012, but with the threat of inflation looming closer," the ADB said in its report.

"When weighing their macroeconomic policy choices, many of developing Asia's policy makers see that the balance has tipped toward avoiding overheating."

Besides rising food and fuel prices, other risks to regional growth included soft job and housing markets in the United States, Europe's debt problems, and the economic impact of last month's massive earthquake in Japan and nuclear crisis, the ADB said.

The ADB, which said its report was generally based on data available up to March 16, said the impact of Japan's disaster was hard to quantify, but was likely to impact negatively on the country's economic growth for the next two quarters, with minimal spillover disruptions to other Asian economies.

"The impact on Japan in the short run will be large in the next two quarters for example, but I think the long run economic prospects will be less dire and the impact on other regions will be contained. I don't think there will be a very significant threat to other regions at this moment," said Rhee.

INFLATION THREAT

China, in particular, could do more to tighten monetary policy, the ADB said, even after Beijing raised interest rates on Tuesday for the fourth time since October. Inflation in China is running at around 5 percent and could accelerate further in coming months.

"Unless the Chinese government sees the stabilization of inflation in a short period of time, I think they may have to consider more tightening," Rhee said.

A surge in inflation, particularly food price inflation, could pull down those who are currently just above the poverty line, making it a social as well as economic concern, the ADB said.

The report said recent estimates showed a 10 percent rise in domestic food prices would raise the number of poor in developing Asia by about 64 million, or more than 7 percent.

"High inflation is a direct threat to stable and inclusive growth since rising domestic prices can lead to social tensions," the ADB said, singling out Vietnam as among the most at risk from rising prices.

Inflation in Vietnam could reach 13.3 percent this year, the second highest in the region after Pakistan, which could see inflation of 16 percent, the ADB said.

But tackling inflation driven by global and supply-side factors can put policymakers in a difficult position.

Steps such as tariff cuts and export bans have varying success, and there could also be problems with local infrastructure or domestic supply chains that exacerbate price pressures.

Raising interest rates can also attract more foreign inflows, which adds to pressure from currencies to appreciate and creates greater liquidity in domestic money supply, compounding problems for policymakers.

Allowing currencies to appreciate was effective when dealing with a sustained surge of inflows, but could cause problems if the inflows are temporary, the ADB said.

"Unfortunately, distinguishing between permanent and temporary capital inflows is difficult, so countries will have to decide on the nature of problem while taking the necessary actions."

(Additional reporting by James Pomfret in Hong Kong; Editing by Kim Coghill)

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