Central banks in Indonesia and India, with the worst-performing currencies among Asian emerging markets this year, will face more challenges in 2013 as they balance inflation risks with the need to boost growth.
The Reserve Bank of India must deal with “conflicting cues” from elevated prices and an economic slowdown, complicating policy decisions even after it recently signaled there is room to lower interest rates, Mizuho Corporate Bank Ltd. economist Vishnu Varathan said. Indonesia’s inflation may be at the upper end of the central bank’s targeted range, forcing it to raise borrowing costs “aggressively,” according to HSBC Holdings Plc.
Demand for higher wages, reduced government subsidies and greater capital inflows may drive up price pressures in the world’s fastest-growing region. Bank Indonesia refrained from raising rates this year even as the currency slumped and costs accelerated, while delayed reforms and infrastructure bottlenecks in India have spurred the most rapid inflation among the largest emerging nations.
The Reserve Bank of India headquarters in Mumbai. (Bloomberg)
“Central banks will have to strike a delicate balance between tightening policy, allowing stronger exchange rates and looking past inflation humps,” Varathan said in a Bloomberg News survey of 15 economists on challenges facing policy makers. “Inflationary pressures may be emerging in a few quarters, whereas growth may not be recovering quickly and broadly enough to justify shifting to decisive policy tightening.”
Indian inflation has remained above the central bank’s comfort level of 5 percent every month for the past three years, while growth is forecast to be the slowest in a decade in the current fiscal year. The paradox is pitting Governor Duvvuri Subbarao against Finance Minister Palaniappan Chidambaram, as the central bank chief resisted calls for lower borrowing costs to aid a government policy overhaul.
“Policy makers there will continue to grapple with uncomfortably-high inflation and a substantial slowdown in investment and gross domestic product growth,” said Sukhy Ubhi, who covers Asian economies at Capital Economics Ltd. in London. “The former suggests that monetary policy should be tightened, while the latter suggests it should be loosened. We expect inflation to fall only gradually.”
The rupee has declined more than 3 percent this year, after plunging 16 percent in 2011. Wholesale prices rose 7.2 percent last month, and gains may moderate to as little as 6.8 percent by the end of March, the government predicts. The economy will expand about 5.7 percent to 5.9 percent in the year through March, less than an earlier estimate of as much as 7.85 percent, the Finance Ministry said Dec. 17.
“The RBI’s dilemma is especially acute, given that sticky inflation is entrenched as it is due to structural or supply- side factors that are not reflective of underlying demand conditions,” Varathan said. “The risks of policy error remain pronounced, and the RBI will remain acutely aware of this.”
Bank Indonesia will start raising rates as early as next quarter, according to a Bloomberg survey of economists last month. The central bank has kept borrowing costs unchanged for 10 straight meetings, seeking to bolster a currency that has dropped more than 7 percent against the dollar this year as rising imports and declining exports led to a widening current- account deficit and a $1.5 billion trade gap in October.
While Bank Indonesia expects inflation of about 3.5 percent to 5.5 percent next year, price gains may exceed that target amid a planned increase in electricity tariffs and a possible reduction in fuel subsidies, said Chua Hak Bin, an economist at Bank of America Corp. in Singapore.
Economic Stability
“Bank Indonesia needs to be more pro-active in containing latent inflationary risks now,” said Lim Su Sian, a Singapore- based economist at HSBC. “Otherwise the central bank may have to tighten policy faster and more aggressively than expected, particularly in the second half, when we expect inflation to climb towards the upper end of its target.”
The Philippine central bank will also struggle to manage inflation without sacrificing competitiveness or economic stability, said Aninda Mitra, an economist at Australia & New Zealand Banking Group Ltd. in Singapore. Its growth is attracting funds that pushed the peso to a four-year high in November, even as Bangko Sentral ng Pilipinas lowered rates four times this year and introduced measures to curb inflows.
“In the absence of measures to sterilize liquidity more effectively, or much faster capital formation which will heighten the economy’s absorption capacity, BSP’s monetary dilemmas will get worse in 2013,” Mitra said. “With growth above potential, market rates and credit costs at historic lows, we could see rapid asset price growth or more inflation.”
Fewest Challenges
The majority of economists surveyed by Bloomberg said Malaysia’s central bank will face the fewest challenges next year. The nation boasts the slowest inflation in Asia and growth that exceeded 5 percent for the past five quarters, giving Governor Zeti Akhtar Aziz room to extend a 1 1/2-year rate-pause.
The country must hold general elections in early 2013, and Prime Minister Najib Razak may resume a plan shelved in December 2010 to cut fuel subsidies, said Enrico Tanuwidjaja, a Singapore-based economist at Royal Bank of Scotland Group Plc. Najib has raised sugar prices as he tries to narrow the budget deficit to 4 percent of GDP in 2013 from 4.5 percent this year.
Malaysia can reduce subsidies in a gradual manner, allowing businesses to adjust without having to pass on rising costs to consumers, Zeti said Dec. 6. Consumer prices have gained 1.3 percent in each of the past three months.
While the central bank will probably keep rates unchanged at 3 percent at its six meetings next year, it has “ample flexibility” to lower borrowing costs if the global economy deteriorates sharply, Bank of America’s Chua said.
“Bank Negara has kept its ‘policy ammunition’ dry,” Mitra of ANZ said. “The central bank also has a toolkit which is well suited to managing capital flows and inflation, and is relatively free from political interference.”
Interest rates alone increasingly won’t be enough to manage the various threats facing Asian central bankers, Varathan said.
“Central banks will have to flexibly employ the entire tool box ― main policy rate, reserve requirements, macro prudential measures, currency market signals ― to manage sometimes conflicting risks,” he said. (Bloomberg)
