Asian central banks are being urged to stay vigilant on the
medium-term threat of inflation as they are locked in a
prolonged period of loose monetary policy.
This week, Indonesia reported 7.3% inflation in April, its
lowest level since December 2007, and South Korea announced a
3.6% inflation rate for last month a 14-month low.
Asian central banks have this year aggressively slashed
interest rates and bank reserve requirements to expand credit
and boost sluggish growth. Analysts expect Indonesias
central bank, led by governor Boediono, to ease policy further
Tim Condon, chief economist for Asia at ING, said that although
the pace and extent of monetary easing has now begun to slow,
the regions counter-cyclical policy firepower will rely
on prolonged monetary stimulus as fiscal stimulus
The proactive Asian monetary response to the crisis has been
widely praised, and contrasts with policy impotence during the
1997 regional crisis. But the speed at which Asian central
banks have reacted to lower interest rates although
supported by economists - has heightened the perception that
monetary policy is still biased towards growth and soft on
The fear is that this will feed into future wage and price
setting behaviour as central banks may lack credibility to
anchor inflation expectations.
William White, former chief economist at the Bank for
International Settlements, told Emerging Markets: Asian
central banks like their counterparts globally
need now to look beyond positive short-term boost to economic
growth, and look at the longer-term effect of their
Before the world hurtled to disaster in August last year, the
region was besieged by high energy and food prices, and their
overheating economies caused high systemic inflation. This
triggered a regional monetary tightening cycle from May last
year as well as currency appreciation until September.
However, monetary conditions remained effectively loose as real
interest rates largely stayed negative. With rates expected to
remain low into 2010, Condon fears that Asian central banks
will remain behind the curve on inflation again
once economic activity picks up.
Central banks try to target interest rates by balancing the
need for price stability with potential output. However, the
unprecedented financial and economic turbulence has
undermined confidence in predicting short- and
medium-term growth, White said.
As a result, central banks may overshoot with loose monetary
policy, in response to high expectations of Asian growth
Once the region regains its growth momentum, there are
predictions that inflation may take central banks by
surprise as producers reinvest, domestic consumption
increases, and supply-side pressures such as higher energy
costs kick in, Condon said.
In addition, with inflation falling on the collapse in
commodity prices last year, central banks may have concluded
that monetary policy is essentially impotent in addressing
exogenous shocks. This is the view that so-called supply-side
pressures from high commodity prices are temporary in nature
and so higher interest rates will not significantly affect core
This contrasts with the more hawkish view that strong domestic
demand significantly fuelled inflation in Asia in 2007-08 and
the distinction between demand and supply-side shocks is too
simplistic given the overlapping nature of structural,
cyclical, domestic and external price pressures.