Asia

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EXPERT OBSERVER
More and more evidence. Inflation across Asia keeps sliding. India's dipped further in January to a touch above 2% y-o-y. In China, the PPI barely held in positive territory last month, and consumer inflation cooled again. It's easy to shrug it all off as a temporary drag from lower oil prices and well-behaved food cost. But that's not the full story: underlying price pressures are remarkably soft as well and broadly falling. As a result, real interest rates continue to climb and the region's already substantial debt load becomes harder to service. The case for further monetary easing may thus become more pressing, even if in itself this may not be enough to push up growth materially.
You will have seen the headlines. Over the past week alone, both India and China reported remarkably subdued inflation. In India, the headline CPI is running at close to half the central bank's mid-point target. True, core prices are well above this (around 5.4%), but that was down from a 6% handle. In China, PPI inflation, a good proxy for industrial profits, has essentially stalled and the headline CPI hit 1.7% (though core nudged up to 1.9%).
Elsewhere, the trend is much the same: from Indonesia to Thailand to Korea, including Japan and Australia, and everywhere in between, inflation is running short. Even in the Philippines, which saw a sharp spike last year, it's rapidly coming off the boil.
It's tempting to attribute much of this to falling oil prices. And as these are now ticking up, that drag is bound to reverse. Plus, food inflation has been remarkably subdued across the region of late (keep an eye though on the return of El Nino this year).
However, core inflation is running at a fairly tepid pace in most places, or at least showing signs of slowing substantially. From a broader perspective, in fact, it is remarkable that the synchronized global upswing in 2016-2017, followed by last year's exchange rate stumbles and, temporarily at least, soaring oil prices, didn't deliver a bigger inflation kick (see also We got an inflation problem, 10 December, 2018).
That means that the "jumping off point" for inflation as growth continues to slow is dangerously low, risking, if not outright deflation, a prolonged period of extremely subdued price pressures.
That poses two big challenges for Asia.
First, it pushes up real interest rates as low (or even lower) inflation increasingly pushes down inflation expectations. And with nominal rates already near record lows in many places, there's little that a loosening in monetary policy alone can do to correct this.
Second, and related, the debt service burden increases as inflation falls short. Even if inflation expectations, which determine the real interest rate, don't fall further, lower realized inflation makes it harder to service debt already taken out. And since the region has splurged on the stuff in recent years, falling price pressures can thus act as a powerful drag on growth.
What, then, are the policy options?
Monetary easing is the obvious one. But, as mentioned, this has started to run into "diminishing returns": with interest rates already low, further cuts will provide only a limited boost. Ideally, this should be complemented by fiscal easing. And in a few places, notably China, that's exactly what's occurring. But, more broadly across Asia, the policy room for a significant fiscal kick is limited (see How much policy room?, 28 January, 2019).
Further out, Asian central bankers will also need to think about more unorthodox policies. If rate cuts alone don't do the trick, and fiscal support isn't readily available, at least in sufficient size, the entire tool box of policies tried out in advanced economies over the past decade should be on the table: from targeted lending schemes to aggressive base money expansion.
Granted, these didn't work necessarily all too well in all instances. And emerging Asia isn't quite yet so demand deprived that it's about to fall into a deflationary trap.
Yet, given the growing risks of such a stumble, it's probably best to act pre-emptively.
Cuts anyone?
Frederic Neumann is Co-head of Asian Economics Research at HSBC.
 
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j.ballantyne1990-6AQqhLzZaK

The dangerous inflation fizzle: Frederic Neumann

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GUEST OBSERVER
Asian currencies hit a seven year low in November, on Donald Trump’s election and the potential for his policies to spur US inflation and bond yields.
Investors who fanned out across emerging markets in recent years are now bringing their money back to America.
The steep drops, and the seeming inability of some central banks to do much about it, has led to worries of a financial crisis. Some columnistsare even drawing comparisons to the currency meltdown that preceded the 1997-1998 Asian Financial Crisis (AFC). 
The AFC’s impacts were dramatic. It led to the sudden collapse of President Suharto’s regime in Indonesia and triggered the 1998 Russian bond default. Everyday economic life was upended as the five worst hit economies saw unemployment surge, inflation balloon, and investment as a share of GDP plunge more than 10%. 
It took five years for GDP per capita to reach parity with pre-AFC levels. Austerity was imposed to pay for large financial sector bailouts, in Indonesia the net cost of rescuing the financial sector exceeded 40% of GDP.
But much has changed since 1997. China’s rise means an increasingly multipolar economic order, new regional partnerships are in place, and central bankers and policymakers are less likely to repeat some prior mistakes. Even if a crisis were to materialise, it would look quite different from that of two decades ago. 
<h2>What triggered the AFC?</h2>
The AFC began in July 1997, when Thailand gave in to speculators and devalued the Baht. Many Asian nations had long either pegged or closely tethered their currencies to the US dollar. After the baht, speculators quickly turned on the currencies of Indonesia, Malaysia, and South Korea. To fight the attacks on their exchange rates, central banks had to sell dollars (Thailand) or abruptly raise interest rates (Indonesia), but eventually caved - sometimes after depleting foreign exchange reserves - and allowed their currencies to fall. 
The exchange rate declines wreaked havoc by driving up the cost of the money private companies had borrowed from abroad. Many were already struggling, amid an economic slowdown, with large foreign exchange borrowings and poor investments in overheated sectors like property. Once currencies floated, the companies’ flight to the US Dollar put pressure on domestic banks. Financial sectors became rapidly insolvent, triggering state interventions and bailouts. 
The use of fixed or managed exchange rate regimes meant central banks assumed the risks of sudden foreign exchange movements. This perceived security further prompted capital inflows and resulted in real exchange rate appreciation and asset bubbles. Hedging, an investment tool limiting the risk of exchange rate changes damaging the price of an asset, was not widespread. 
Governance problems and “crony capitalism” exacerbated these issues. The Indonesian central bank governor, for example, was part of cabinet and had little power to resist instructions to pump liquidity into ailing banks. In the end, US$14 billion was pumped into an insolvent banking sector and state auditors later found more than 60% of the funds were misused. 
<h2>A lot has changed since the AFC</h2>
It was in the reaction to the AFC that a lot of changes were made. In return for cash infusions, these countries committed to IMF supervision and extensive programmes of economic reform and liberalisation. In addition to financial sector restructuring, the programs also included “structural reforms,” such as dismantled barriers to foreign investment and liberalised trade regimes. 
From Indonesia, the IMF demanded dismantling of the monopolies and rent-creation schemes at the heart of the regime; from South Korea, it demanded large layoffs and union-busting measures. In both cases a back and forth between leaders and the IMF played out in real time as the currencies continued to fall and financial sector insolvency accelerated.
Many of these countries have also built up huge foreign exchange reserves over the past decade. Banking supervision has also greatly improved, and countries like Indonesia have created genuinely independent banking supervisory agencies and monetary authorities. 
Regional financial integration has also deepened, with initiatives like the Chiang Mai Agreement, a framework adopted by members of ASEAN as well as China, Japan, and South Korea, for bilateral currency swaps and repurchase agreements. 
China also has expanded its role, including a web of bilateral currency swap agreements with Indonesia, Malaysia, and Thailand. These Chinese renminbi (RMB) swaps are designed to facilitate trade – the RMB is the world’s second-largest trade finance currency – but swapped RMB can be converted to USD through offshore RMB trading centres and have been used to provide emergency liquidity to countries facing currency challenges (Pakistan in 2013, Argentina in 2014).
Central banks have reacted to the dollar’s sudden strength by announcing currency interventions, discussing rate hikes, and pressuring banks to curb “speculative” trading. China has announced closer scrutiny of some outbound transactions and Malaysian authorities have asked banks to limit some investments used for offshore ringgit hedging. This has prompted fretting among financial analysts who recall that Malaysia imposed some capital controls - effectively preventing ringgit from being exchanged and transferred out of the country - during the AFC. 
<h2>Going forward</h2>
This is not to rule out a crisis (although markets may well reevaluate assumptions about Trumpnomics), as the end to years of plentiful dollars will have an impact. Debt levels are higher than pre-AFC levels, and foreign currency-denominated emerging market debts have more than doubled in the last ten years. Instead, global economic polarities are much changed because of China’s emergence, weakness in Europe, and isolationism in the US. Any crisis would play out differently than in 1997/98. 
Economic managers are far less in thrall to economic orthodoxies as they were in the 1990s to the “Washington Consensus” and are therefore likely to blaze their own trails. The IMF, which remains the global lender of last resort, has also fine tuned its approach and is far less prescriptive than after the years of heady growth during the 1990s.
Whereas Malaysia during the AFC imposed capital controls and snubbed the IMF, just across the Malacca Strait Indonesia provided free movement of capital, which allowed the mass exit of both foreign and domestic capital. Combined with efforts to provide liquidity to the banks, the absence of capital controls undermined the government’s ability to carry out monetary policy. Many countries prudently used some capital controls during the global financial crisis, and as a result, some mild to moderate capital controls are likely.
A final variable is China, which despite its own currency challenges is keen to further the end of the US’s sole leadership of the international financial order. The aforementioned currency swaps, though likely insufficient for seeing off a systemic, regional crisis, show its ambitions to position itself as emerging markets’ preferred economic partner. 
Efforts like the recent purchase of US$4 billion in assets from Malaysia’s disgraced 1MDB further shows an opportunistic approach to emerging geostrategic events. As a result, the likes of the IMF and friends, which dictated large, condition-laden bailouts in return for AFC assistance, are no longer the sole port of call for a beleaguered economy, and any post-crisis order, much shaped by these institutions after the AFC, might end up quite different.
Matthew Busch is PhD candidate at Melbourne Law School, University of Melbourne and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/matthew-busch-284580" target="_blank">here</a>.
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