A heady cocktail of stronger global recovery prospects, surging prices for crude oil and other commodities, supply-side disruptions and rising container shipping costs has fuelled concerns of rising inflation. This has sparked a sell-off in global bonds in recent weeks, from which Asia has not emerged unscathed.
Within Asia, however, inflation concerns do not seem very pronounced at the moment. Price rises have climbed above Q4 2020 levels in Hong Kong, Taiwan, South Korea, Singapore, Malaysia and the Philippines since the start of the year. But they remain contained elsewhere.
And despite those spikes, headline inflation is still either below central bank targets or within their range in all Asian economies other than the Philippines.
We forecast a sharp rise in Asian inflation to 2.4% year-on-year in the second quarter of 2021 from 1.7% in the last quarter of 2020. But we don’t think this pace can continue given that sizeable output gaps should contain demand-pull pressures, and we expect cost-push pressures to abate in the second half of 2021.
Exhibit 1: Inflation risks are concentrated in the short term
Putting inflation fears into perspective
Prices of core items in the CPI baskets, excluding food and fuel, are likely to pick up as economies recover from the devastating blow to demand that the strict lockdowns have dealt. We also see scope for a temporary surge in prices in some categories, especially in services that have lagged the headline GDP recovery and could still benefit from pent-up demand. However, we think concerns of a sustained and substantial rise in inflation are overdone.
Four factors underpin our relatively sanguine outlook for Asian inflation:
Notwithstanding the notable improvement in growth outlook for several Asian economies since the start of the year, we project demand will remain substantially below potential even in 2021 (Exhibit 2). In particular, Southeast Asian economies such as Indonesia, Malaysia and Thailand, which instituted renewed social distancing measures in Q1 to contain another coronavirus wave, are likely to witness a drawn-out recovery. This should keep a lid on core inflation.
Exhibit 2: A significant output gap underpins our view of soft demand-pull pressures
The composition of Asian CPI baskets has gradually shifted towards services and non-tradables over the years. At an aggregate level, fuel has a less than 9% weight in the basket, with the share being highest for Singapore at 15.23% and lowest for Hong Kong at 2.67%. Therefore, the direct impact of rising prices of oil and other raw materials is likely to be felt more on the producer price index, which has picked up sharply in recent months (Exhibit 3). Generalised prices pressures would feed into core consumer inflation, but not overwhelmingly.
Exhibit 3: Input prices feel the brunt of rising global commodity costs
Administrative price controls and other measures have played an important role historically in containing inflation pressures in Asia. This is true for both food and fuel inflation. Even with declining subsidies in recent years, we see scope for governments to impose price ceilings, manage exports, boost imports and adjust administered prices to contain risks of runaway food and fuel inflation.
Finally, the appreciation in Asian exchange rates that we expect this year should provide some buffer against imported inflation. On an average, we forecast Asian currencies will end the year 2% stronger against the US dollar compared to current levels.
Lower than it seems
Excluding India, where we expect inflation to benefit from stable food prices and a favourable base this year, we forecast Asian inflation will pick up to 1.5% year-on-year in the second quarter of 2021 from 0.1% in the fourth quarter of 2020. Following that, we expect upward pressures to ease, with inflation ending the year at 2.2%. This is consistent with our projected narrowing in the output gap and our forecast of a more measured pace of commodity price increases in the second half of this year.
While the magnitude of the inflation increase in 2021 seems large, we note that:
- This only brings back inflation to pre-pandemic levels. Over 2018-2019, Asia ex-India inflation averaged 2.1%.
- While we project inflation will end 2021 higher than 2020 in all Asian economies barring India, the aggregate headline number is boosted by a very low base in China, Hong Kong and Malaysia (Exhibit 4). This gives a false impression of accelerating price trends, while the sequential narrative is that of a controlled rise in fuel and other non-food prices.
- The underlying forecasts still result in below-target inflation for all Asian economies by the end of 2021, which is unlikely to lead to broad-based monetary tightening in our view.
Exhibit 4: Unfavourable base effects distort headline data
Stronger upside risks for some
We noted at the start of the year that fluctuations in key economic relationships could trump our benign global inflation expectations. This is true for Asia as well. Further upward revisions to our global oil and commodity forecasts, as well as our GDP growth outlooks, would lead us to review our inflation projections.
Such developments will not only have a direct bearing on the inflation trajectory, but also may result in substantial second-round effects for some through the FX channel. This is particularly true for emerging Asian economies with current account deficits, as corroborated by our modelled inflation risks for emerging markets globally. We find that a 20ppts fall in the effective exchange rate considerably raises the upside inflation risks for emerging markets.
For now, however, amidst all the economic challenges the region’s economies face—and there are many—runaway inflation is not one of them.
Priyanka Kishore has more than a decade’s experience in macroeconomic research and forecasting across emerging markets, with a special focus on India and ASEAN. She currently leads Oxford Economics’ Singapore Global Macro Services team and is responsible for overseeing the firm’s South and South East Asia research.