Global inflation is making a comeback, but while this is to be welcomed, it could also bring financial stresses in Asia, says Manu Bhaskaran
This article was first published in the April 2017 China edition of Accounting and Business magazine.
For several years after the outbreak of the global financial crisis, financial markets were dogged by concerns that the world economy could tip over into the type of persistent deflation that Japan has endured since 1990. Now there are signs that prices are rising again at the global level.
Moody’s Analytics’ measure of global consumer inflation accelerated to 3.3% year-on-year in December 2016 from 3.1% in November. Underpinning this was the rise in price pressures in developed economies.
Global inflation seems likely to be in a sweet spot for some time to come – not so low as to create fears of deflation that would hold consumers and businesses back, but not high enough to spark a sharp tightening of monetary policies.
There are many reasons for an improvement in the global inflation outlook. First, rising commodity prices will support an uptick in global inflation. Oil prices are likely to average higher over the course of this year following the agreement by the OPEC cartel of oil-exporting nations to curtail production just as demand is recovering. Other commodity prices are also rising.
Secondly, steady economic growth in the eurozone and US will reduce the slack in those economies that have restrained inflation. But since the slack will only diminish slowly, there is little risk that inflation will accelerate abruptly.
Thirdly, there are signs that, as these economies recover from the multiple challenges they have endured since 2008, the credit systems in the US and eurozone seem to be functioning better. This will help improve the transmission of monetary policies into the economy, helping to push prices up gently.
Rising prices of commodities which Asian economies export and reduced fears of a global deflationary crunch are, of course, welcome in Asia. However, the other consequences are less benign.
The US Federal Reserve Bank raised rates in December and has signalled two to three more 25-basis-point rises in the course of 2017. But a much faster than expected recovery in the world’s biggest economies could cause central banks to fear that inflation will move into more dangerous territory. Monetary tightening could well be faster than expected, especially in the US.
As Asian currencies are likely to depreciate against the dollar, import prices in Asia will tend to rise, raising domestic inflation in the region. That puts a limit on any further cuts of domestic interest rates in Asia.
Higher rates will increase the interest burden on corporate debt in US dollars and that will be compounded by the need to repay principal and interest in more expensive US dollars, resulting in a higher risk of some companies defaulting on their loans.
And as higher bond yields in the US and other developed economies and a stronger US dollar make US assets more attractive, portfolio investors are likely to pull out more money from bond and equity markets in Asia and other emerging markets. Where there is an unusually high foreign ownership of these assets, such as in Malaysia and Indonesia, the fall in bond and equity prices could be abrupt and hurt domestic confidence. Moreover, the outflow of capital would put further downward pressure on Asian currencies.
Global inflation is making a comeback and that is to be welcomed. But the consequences for monetary policy in the US and possibly in the eurozone could raise the risk of financial stresses in Asia.
Manu Bhaskaran is CEO of Centennial Asia Advisors in Singapore