Global economy: A high price to pay
By Stefan Wagstyl and Jonathan Wheatley
Published: May 30 2011 20:10
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| Counter action: bank staff in Hanoi receive bricks of dong, a currency devalued four times in the past 18 months |
In his 20 years as a Hanoi taxi driver, Pham Van Vinh has learnt to negotiate the chaotic streets of Vietnam’s capital and the demands of its avaricious traffic police.
But the 44-year-old father of two is working harder than ever because of a triple hit from inflation, which accelerated to 19.8 per cent year-on-year in May, one of the highest rates in the world.
Petrol prices are up 30 per cent since February; increases in government-regulated taxi fares have driven away customers; and family living costs have jumped in the past year, with some food prices doubling. “Life is tough and I have to work 12 hours a day, seven days a week, to keep putting rice and noodles on the table,” says Mr Pham.
His is a familiar story across the emerging world. Year-to-year figures for the latest months available show inflation in fast-growing Bric nations of 6.5 per cent in Brazil, 8.7 per cent in India, 9.6 per cent in Russia and 5.3 per cent in China. The International Monetary Fund predicts this year’s emerging market average rate will be 6.9 per cent, compared with just 2.2 per cent for the developed world.
The question is how much this poses a threat to global economic growth. After all, emerging economies have come out of the 2008-09 crisis growing much faster than the developed world. The IMF forecasts 6 per cent gross domestic product growth rate for 2011 for emerging economies – three times higher than in the developed world. Surely, inflation of 6-7 per cent is a price worth paying for the big boost to the global economy from emerging markets?
Perhaps – if it remains at moderate levels. But emerging market policymakers are battling a range of inflationary challenges including higher food and energy prices, skilled labour shortages, infrastructure bottlenecks, property booms and huge waves of liquidity generated by central banks in the US, Europe, China and elsewhere to pull the world economy out of the crisis. As Wen Jiabao, Chinese prime minister, says: “Inflation is like a tiger: once set free it is very difficult to get back into its cage.”
While countries face common dangers, much will depend on how they respond individually. Some states have learnt from history and tamed inflation through consistent anti-inflationary policies, including tight fiscal management and bank supervision. The Czech Republic is an example, with inflation of just 1.6 per cent.
But nations where fiscal, monetary and banking policies are chronically lax are close to inflationary crisis. In Argentina, for instance, economists reckon inflation is running at 25 per cent – making a mockery of the official figure of 10 per cent.
For policymakers, it is more than a question of economics. The doubling of food prices in many emerging economies in the past year hits the poor hardest, fuelling poverty, inequality and resentment. In recent weeks, there have been anti-inflation protests in India, Ukraine and China, where Shanghai truck drivers staged strikes.
The main driver of inflation in the past 18 months has been the soaring rise in oil, food, and raw materials prices, powered by growing demand from China, India and other emerging countries. Food accounts for just 8 per cent of consumer spending in the US. In China, the figure is 30 per cent; in India, 45 per cent.
The May sell-off in commodities has eased concerns, with oil falling back from about $125 a barrel for Brent crude to about $110; and raw materials prices dropping 10 per cent from their April peaks. The IMF forecasts emerging markets inflation will fall next year to 5.3 per cent.
Some economists see this as panic over. As developed states struggle with sluggish growth and huge debt, the real threat in emerging markets, they argue, is an output slowdown, not an inflation take-off. “I don’t see the levels of inflation that have been destructive in the past,” says Bill O’Neill of Merrill Lynch BofA.
But others remain worried. John-Paul Smith of Deutsche Bank says: “Investors are underestimating the extent to which inflation across many emerging markets is a structural as opposed to a cyclical phenomenon.”
Even after the recent sell-off, the CRB commodity futures index remains about 72 per cent above its 2009 lows and 14 per cent higher than its average since 2006. Forecasting commodity prices is difficult, given the speculative flows – boosted by loose monetary policies – pouring through the markets. But little can be taken for granted given the potential impact on oil markets of further Middle East turmoil and the weather on food supplies. As Renaissance Capital notes, the next few months are crucial. “The food price threat for 2011-12 is very significant, but may disappear in August [when northern hemisphere harvests come in].”
Higher commodity prices are having knock-on effects in domestic economies, especially those where supply and demand are tight, and labour costs are rising – including Brazil, India and China.
With the rapid recovery of the past two years, many companies are running at full stretch. HSBC says the output gap – the difference between actual output and maximum capacity – has disappeared in most east Asian economies, including China, and in Brazil. Workers are winning pay increases and employers are passing on the costs. The UK bank says: “This creates the risk that in emerging economies inflation shocks turn into self-perpetuating inflation processes.”
The examples are multiplying. In China, where officials have supported wage increases to help rebalance the economy, pay has risen by 20-40 per cent in some companies. In India, hotel managers’ salaries are forecast to rise 50 per cent this year. In Brazil, construction workers this month secured rises of almost 10 per cent. This year, the country’s indexing formula has set the minimum wage increase at 6 per cent. Next year it could be 14 per cent.
“The biggest danger facing Brazil is a return of indexation,” says Abram Szajman, head of Fecomércio, a retailers’ and wholesalers’ association. “That’s one evil we don’t want again, or we will have salaries going up every year, then every six months, then every three, then every month – and we’ve seen that all before.”
Higher costs are squeezing industry’s margins. Hon Hai, a Taiwanese electronics assembler that last year increased pay by 30 per cent after strikes at its Chinese plants, last week revealed operating expenses rose 80 per cent in 2011’s first quarter. Operating margins halved to 1.1 per cent.
Infrastructure, too, is under pressure, notably in India, where construction lags behind that of the other Brics. Roads, airports and power supplies cannot keep pace with demand. “We have to address the bottlenecks on the supply side,” says Rajiv Kumar, director-general of Ficci, the Indian employers’ body.
The IMF says core inflation – excluding commodities – has risen from 2 per cent to 3.75 per cent “suggesting that inflation is broadening” beyond commodities-linked increases. Central banks in most emerging economies have responded by raising interest rates and imposing quantitative controls on bank lending.
In Vietnam, official rates have doubled in six months to 14 per cent. In India, among the first to take action last year, rates have risen nine times to 6.75 per cent. In China, following four increases, they are at 6.31 per cent.
But it is not enough to hold back a wave of credit creation – and red-hot property investment. In its World Economic Outlook last month the IMF said: “The issue is whether [leading emerging markets including China, India and Brazil] are experiencing the kind of credit boom that inevitably ends with a bust. Evidence is not reassuring in this regard.”
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In the four largest emerging markets, the Brics, credit is still growing at 17-20 per cent annually, with only China experiencing a serious slowing in the past six months. Officials, notably in Beijing, who boosted credit to counter recession remain cautious in applying the brakes for fear of hitting growth. After allowing for inflation, interest rates are negative in Russia and India, and barely positive in China. So borrowers pay little or nothing, in real terms, for money. Only in Brazil are rates strongly positive.
Admittedly, credit in emerging economies is growing from low levels. It is just 46 per cent of GDP in Brazil and 60 per cent in India. But in China, it is already at 140 per cent. All are well short of America’s 360 per cent for 2010 – but the gap is closing.
Evidence of credit-fuelled property booms is visible in luxury homes in Mumbai, Rio de Janeiro and Chinese cities. As the IMF report says: “Credit and asset price behaviour is disconcerting in China and Hong Kong, showing boom-like dimensions . . . and there are mounting concerns about the potential for steep corrections in property prices and their implications.” Emerging markets as a whole do not face a property bust. The world’s urban population will grow by 1.4bn in the next two decades, taking the total to 5bn. So most homes will find buyers – but not overpriced prime accommodation.
Complicating life for emerging market policymakers is the flow of cheap funds generated by the developed world’s easy money policies. The US Federal Reserve ends quantitative easing in summer but serious tightening is not expected until later this year or in 2012.
Emerging market governments were loath to let their currencies rise last year, sparking fears of currency wars. But this year they have allowed limited appreciation to counter the rising cost of imported commodities.
However, officials have capped the gains for fear of hurting exports. The renminbi has climbed nearly 5 per cent against the dollar since last summer’s liberalisation. But on a trade-weighted basis, it fell 1.8 per cent in January to April 2011, according to Bank for International Settlements. India’s rupee slipped 2.6 per cent and the Turkish lira 5.9 per cent. The real and the rouble were higher – by 3.7 per cent and 3.4 per cent.
Overall, emerging nations’ rapid recovery from the global crisis is a historic achievement that has helped prevent prolonged worldwide recession. Their economies are resilient and their companies compete with best anywhere. For most, the cost in terms of increased inflation is so far justified by the GDP growth generated.
What comes next matters, however.
Another surge in commodity prices would create dangers for nations facing inflationary challenges, including the Brics. And there are countries already in danger: not least Vietnam. Mr Pham will have to be as careful with the family budget as he is in the Hanoi traffic.
VIETNAM
Hanoi leadership is at risk of undermining an impressive growth record
As in Ukraine and Argentina, so in Vietnam. The emerging nation is the latest in which surging inflation threatens to undermine an impressive record of economic growth.
Hanoi’s Communist leadership has steadily opened the country to global trade in the past 25 years, a shift that intensified ahead of the country joining the World Trade Organisation in 2007.
However, while gross domestic product has been growing at an average of 7 per cent a year in the past decade, rapid credit growth and large investments in wasteful state-owned companies have brought the economy to the brink of crisis.
Battling wide trade and budget deficits, Vietnam’s foreign exchange reserves have shrunk to cover less than two months of imports, according to the Asian Development Bank; the central bank has been forced to devalue the currency, which is pegged to the dollar, four times in the past 18 months; and annual inflation accelerated to 19.8 per cent in May, a 29-month peak and the highest rate in Asia.
The government was reluctant to cool the overheating economy in the run-up to key Communist party elections in January. But in February it finally sprang into action, unveiling a package of fiscal and monetary tightening measures – known as Resolution 11 – aimed at shifting the focus of policy from growth at all costs to stability.
It also deployed administrative measures, introducing price controls and tightening restrictions on the buoyant black market trade in gold and dollars – a trusty store of value for many inflation-battered Vietnamese.
While economists have praised the government’s moves, some question whether it is willing and able to deliver. Although the central bank has increased interbank interest rates to as much as 14 per cent and vowed to restrict credit growth to less than 20 per cent this year, there are few signs yet of economic activity slowing.
In a note to clients, Santitarn Sathirathai of Credit Suisse wrote of the difficulty in determining whether “this is simply due to the fact that monetary policy works with a lag, or that the government has not been effective in enforcing these measures”.
Matt Hildebrandt, an economist at JPMorgan Chase in Singapore, believes the central bank’s ability to fight inflation is limited by the nation’s exposure to rising global commodity prices. Food, fuel and raw materials for construction account for about 60 per cent of the consumer price index basket. “Small, open economies like Vietnam tend to be dictated by global trends,” he says.
However other economists argue that the country’s problems are mostly self-inflicted. According to Jonathan Pincus of Harvard University’s economics teaching programme in Ho Chi Minh City: “Vietnam printed money for a couple of years so now there’s inflation. Ben Bland
.Hanoi leadership is at risk of undermining an impressive growth record
As in Ukraine and Argentina, so in Vietnam. The emerging nation is the latest in which surging inflation threatens to undermine an impressive record of economic growth.
Hanoi’s Communist leadership has steadily opened the country to global trade in the past 25 years, a shift that intensified ahead of the country joining the World Trade Organisation in 2007.
However, while gross domestic product has been growing at an average of 7 per cent a year in the past decade, rapid credit growth and large investments in wasteful state-owned companies have brought the economy to the brink of crisis.
Battling wide trade and budget deficits, Vietnam’s foreign exchange reserves have shrunk to cover less than two months of imports, according to the Asian Development Bank; the central bank has been forced to devalue the currency, which is pegged to the dollar, four times in the past 18 months; and annual inflation accelerated to 19.8 per cent in May, a 29-month peak and the highest rate in Asia.
The government was reluctant to cool the overheating economy in the run-up to key Communist party elections in January. But in February it finally sprang into action, unveiling a package of fiscal and monetary tightening measures – known as Resolution 11 – aimed at shifting the focus of policy from growth at all costs to stability.
It also deployed administrative measures, introducing price controls and tightening restrictions on the buoyant black market trade in gold and dollars – a trusty store of value for many inflation-battered Vietnamese.
While economists have praised the government’s moves, some question whether it is willing and able to deliver. Although the central bank has increased interbank interest rates to as much as 14 per cent and vowed to restrict credit growth to less than 20 per cent this year, there are few signs yet of economic activity slowing.
In a note to clients, Santitarn Sathirathai of Credit Suisse wrote of the difficulty in determining whether “this is simply due to the fact that monetary policy works with a lag, or that the government has not been effective in enforcing these measures”.
Matt Hildebrandt, an economist at JPMorgan Chase in Singapore, believes the central bank’s ability to fight inflation is limited by the nation’s exposure to rising global commodity prices. Food, fuel and raw materials for construction account for about 60 per cent of the consumer price index basket. “Small, open economies like Vietnam tend to be dictated by global trends,” he says.
However other economists argue that the country’s problems are mostly self-inflicted. According to Jonathan Pincus of Harvard University’s economics teaching programme in Ho Chi Minh City: “Vietnam printed money for a couple of years so now there’s inflation. Ben Bland
Additional reporting by Ben Bland
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Copyright The Financial Times Limited 2011.
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