SINGAPORE, June 8 (UPI) -- Inflation risks still appear as risks not realities for most Asian countries. Yet with strengthening domestic demand and rising inflation rates, the prospect of a breakout in inflationary pressure in the region is real.
"As economies have recovered, domestic demand is taking over as the driver of top-line growth," said Tim Condon, head of financial markets research fo Asia at ING Financial Markets. Condon pinpointed China and Indonesia as prime candidates for an acceleration in inflation and where both central banks are expected to raise interest rates to try and slow it.
"The natural tendency in export-led economies coming out of a recession or slowdown is to move in a southeasterly direction, that is, domestic demand displaces net exports as the driver of growth. Korea is the only laggard where domestic demand is still contributing negatively to growth," Condon noted.
China's inflation momentum is the strongest in the region based on rapidly accelerating food and services price inflation. The country's consumer prices rose to their highest levels in seven years in April pushed by a soaring cost of food. April CPI's rate of 3.8 percent, after a 2.8 percent rise in the first quarter, is expected to have been topped in May.
"Headline inflation could exceed 4 percent any month now, or even 5 percent," Condon warned.
Based on remarks by officials at the People's Bank of China this would raise the likelihood of an interest rate hike, which many economists are now expecting to take place over the summer.
"We believe the rate hike is likely to happen before the end of summer, mostly likely in mid-July," said Goldman Sachs' China economist Hong Liang.
"We don't believe the timing of a Fed move is an important factor for China's decision on rates. The key factor will be CPI movement (not the GDP year-on-year growth rate in the second quarter, which the market expects to be in the range of 11-12 percent due to the low base effect of SARS last year), and 5 percent CPI inflation has been publicly cited by the governor of the PBOC as the threshold for changing the interest rate policy," she said.
Liang expects CPI inflation in May to be 4.5 percent with the 5 percent level likely to be breached in June.
But not all economists agree the Chinese rate hike will come sooner rather then later. Some economists point underlying inflationary pressure is actually not as strong as the headline CPI figure would have otherwise suggests.
"The current inflation dynamic in China is a lot different from the era of 1993/94. Other than the food component which weights almost 50 percent of the CPI, there is no hint of rampant inflationary pressure as most other items are either registering minor growth or even falling," noted DBS economist Chris Leung in a report.
In 1993-1994, inflationary pressure was much more broadly based with consumer also jumping on the bandwagon, he pointed. Retail sales growth at that time was above 20 percent during that period compared with steady growth between 9-10 percent now.
Moreover, both loan and money supply have begun showing early signs of deceleration and are likely to slow down notably more in the third quarter. "As a result, the government may choose to wait a bit longer before deciding on the magnitude and the velocity of the rate hike, especially when a vector of economic figures in the second quarter are going to be distorted by the SARS-ruined comparison base which makes interpretation more difficult," Leung said.
Inflation in Indonesia could also accelerate. Though the country is one of the few in the region where food price inflation is subsiding, its problem resides in the service sector.
In May, inflation in the housing component was 20 percent, education was up 15 percent, transport health care up 13 percent and medical services up 11 percent.
"As in China we believe the problem is that monetary conditions are too accommodative for price stability. In view of the broad-based nature of services price inflation in Indonesia relief on the food price front will be needed to keep inflation at May's 6.5 percent, which is needed to hold annual average inflation to 6 percent this year," Condon said.
In response to this rising inflationary pressure (and also its weakening currency), the Indonesian central bank has recently announced several measures that it hopes will drain excess liquidity from the system. The measures amount to a de facto tightening.
But economists believe headline inflation will continue to rise in this presidential election year with election spending likely to remain in place until September and imported inflation from higher food and fuel products prices fully entrenched until early 2005.
CSFB in a recent research note forecast inflation to rise to around 6 percent by the end of the year, up from its previous forecast of 5.3 percent.
