Monetary measures, Statistical Yearbook for Asia and the Pacific 2011

Statistical Yearbook for Asia and the Pacific 2011

Economy

Monetary measures

Data source: International Monetary Fund (IMF), International Financial Statistics.

Economic slowdown in 2009 brought an easing of inflationary pressure in Asia and the Pacific, with the inflation rate falling to 2.6%, the lowest point in a generation. The slowdown and reduced inflationary pressure led central banks in many of the countries to reduce their discount rate.

Inflation

Inflation in Asia and the Pacific fell dramatically from 6.6% in 2008 to 2.6% in 2009. Worldwide, inflation dropped from 5.1% to 1.5% in 2009 as a result of the sharp decline in activity in the global economy, following the 2008 financial crisis in the developed countries.

The financial crisis weakened demand for exports to the United States and Europe and caused GDP growth to slow markedly in most Asian and Pacific countries. The year 2009 brought deflation to Cambodia, China, Japan and Thailand. In 2008 and 2009, the sharpest declines in price inflation rates occurred in Cambodia and Myanmar. India and Nepal were the only countries in the region that saw increases in inflation rate during 2009.

Throughout developing countries in the Asia-Pacific region, food prices tend to have direct and indirect impacts on inflation. Food purchases constitute 30% to 40% of the average consumption basket in many developing countries. Any significant food-price increases, due to drought, flooding or other factors, immediately push inflation upward. Less directly, rising food prices also cause unskilled wages to rise and thus further add to cost-push pressures. After the large increase in food prices in 2008, the economic slowdown in 2009 brought an easing of food-price pressures that translated into reductions in inflation across the region in 2009.

In East and North-East Asia, deflation of 0.7% replaced inflation of 3.2% over the 2008 and 2009 biennium, the outcome of price declines during 2009 in both China and Japan (0.7% and 1.4%, respectively) that followed increases during the previous year (5.9% and 1.4%, respectively).

Figure III.6 – Inflation rates, Asia and the Pacific, 2008 and 2009

In South-East Asia, inflationary pressures abated substantially from 9.7% to 3.4%. South-East Asia includes the customarily low-inflation countries of Malaysia, Singapore and Thailand as well as the relatively high-inflation countries of Cambodia, Myanmar, Indonesia and Viet Nam; hence, the subregion includes a highly mixed group of countries (in terms of inflation levels).

South and South-West Asia, the subregion historically most prone to inflation, experienced a more modest decline in inflation from 12.0% to 9.8%, which put it back roughly to the rate of price increases experienced between 2004 and 2007. The easing of price pressures was particularly evident in the Islamic Republic of Iran, the Maldives, Pakistan and Sri Lanka.

North and Central Asia generally experienced a less dramatic decline in inflation in 2009 compared with that of 2008. The largest economy in the subregion, the Russian Federation, experienced a slight decline in inflation from 14% to 12%.

Inflation in the Pacific fell from a moderate 4.4% to a low 1.9%. The Pacific includes a highly diverse range of countries that includes Australia and New Zealand as well as the Pacific Island developing economies.

Figure III.7 – Inflation rates by subregion, Asia and the Pacific, 2008 and 2009

Interest rates

In 2009, economic growth in Asia and Pacific contracted from 3.1% in 2008 to 0.5% in 2009 with large variations across countries and subregions. As the pace of economic growth slowed, the central bank discount rate came down in 20 of the 30 countries for which data are available, and stayed constant in the other 10. These reductions are likely the product of monetary action taken by central banks and governments in response to the financial crisis. The most significant reductions were in Turkey, Azerbaijan and Kyrgyzstan. The developed countries of Australia and New Zealand reduced their discount rates from 6.7% to 3.3% and 5.0% to 2.5%, respectively, while Japan held its discount rate steady at 0.3%.

Discount rate changes are primarily determined by the central bank or another authorized agency using two main considerations: 1) the pace of economic growth in the country; and 2) the presence of inflationary pressures. Even if the central bank is exclusively responsible for interest rate policy, as is the case with most developed and some developing countries, the central bank must inevitably weigh its decisions in light of the inflationary environment; and the level of economic activity in the country.

Although economic growth and inflationary pressures automatically interact, yet in some instances, difficult policy trade-offs may be involved. Central banks could be faced with having to decide whether raising the discount rate as a means of reducing inflation might in turn lead to a reduction in economic growth. This consideration depends upon the prevailing sociopolitical situation. Some societies (and Governments) can accept the possibility of high rates of inflation, while other societies are highly opposed to high inflation. A variety of other factors may also be taken into consideration when determining the interest rates, such as the size of the fiscal deficit, the cost of servicing it and the electoral timetable. Decision-makers must consider the time lag related to monetary policy.

Effective action related to interest rates can be better developed when all requisite information is available. Thus, decision-makers may decide to act only when they have a clear picture of both the future course for inflation and the level of economic activity. The balance between acting quickly and waiting to have a clear picture is also weighed by decision-makers. Some of the information that helps develop monetary policy is the existence of slack or spare capacity in the economy, such as capacity utilization in manufacturing and the level and structure of unemployment.

Figure III.8 – Central bank discount rates, Asia and the Pacific, 2008 and 2009

Exchange rates

Many Asian and Pacific currencies have been affected by turmoil in global exchange rates that began with the weakening of the United States dollar in 2008; however, as the weakening of the United States dollar eased somewhat in 2010 the Asia-Pacific currencies may by now have more stability. A few countries experienced further upward pressure (9 countries had depreciation of 1.0% or more) on their exchange rates vis-à-vis the United States dollar in 2010. Depreciation may occur for a mixture of reasons related to the economic environment (weak or stagnant exports, high imports, budget deficits and/or inflation) and the non-economic environment (primarily political uncertainty). Most exchangerate depreciations in the Asia-Pacific region were relatively small and could, in fact, be attributed to changes in short-term market sentiment. Some, on the other hand, were attributable to inflation and interest-rate differentials as, for instance, in Armenia, Georgia, the Islamic Republic of Iran, Kyrgyzstan, Pakistan, Tajikistan and Viet Nam.

The currencies of 25 countries in the region appreciated, by 1.0% or more, against the United States dollar in 2010. Prominent among countries that experienced appreciation of their exchange rates in 2010 were Australia, Indonesia and New Zealand (with more than 10% appreciation in each).

Figure III.9 – Change in average exchange rate against the United States dollar, Asia and the Pacific, 2010

The exchange rates of Azerbaijan; Kazakhstan; Hong Kong, China; Macao, China; Maldives; and Solomon Islands, remained essentially unchanged against the United States dollar in 2010. Azerbaijan and Kazakhstan are oil producers and exporters that operate with an explicit dollar peg, like other oil-exporting countries. Hong Kong, China, and Macao, China, Maldives maintain quasi-fixed pegs between their currencies and the United States dollar and, hence, experienced no change in 2010. Solomon Islands has a free-float currency that has depreciated against the US dollar over time; however, in 2010 it was coincidentally unchanged against the dollar. The Federated States of Micronesia is the only Asia-Pacific country to use the US dollar as its national currency.

Rising food-prices: the threat of inflation and impacts on the poor

Inflation, interest rates and exchange rates can be described as benign in the current Asian and Pacific economic environment. Inflation is holding at around 4% and interest rates are on the low side. Most exchange-rate fluctuations in the region result from instability in the financial markets of the developed countries (the succession of sovereign debt crises in a few EU countries and weakness of the United States dollar). However, the current regional stability could deteriorate and inflation resurge during 2011 – the potential cause being a considerable rise in food prices. In that case the policy focus in many countries would inevitably shift from supporting development to fighting inflation.

The Asia-Pacific region, and the rest of the world, is in the throes of food price increases. According to the OECD and FAO, the wheat and coarse grain prices are expected to rise by 15-40% (in real terms) by 2020; vegetable oils by 40%; and dairy prices by 16-45%.¹ Additionally, demand appears to be starting to outstrip supply as agricultural yields have stagnated over the last decade or so.

Prolonged inflation has profound social and economic impacts, the most fundamental of which are reduction in food security, increase in poverty and shift of Government resources from investment in public goods to subsidizing of consumption. Rising prices of food disproportionately affect the poor, in two ways: 1) If they are net sellers of food, their income per unit increases – however, their net income may go down if they are unable to produce as many units of food due to increases in prices or availability of inputs for agricultural production. Higher prices of other goods and services will further diminish their disposable income; and 2) If they are net buyers of food, their real incomes go down, as they switch expenditure from other goods and services to maintain a minimal consumption of foods.

In general, rises in food prices tend to affect the poor substantially, since they have less income to reallocate from other goods and services to food. Rising food prices are likely to prevent many of the poor in the region from escaping poverty. Moreover, as governments attempt to tackle the impact of higher food prices on inflation with tighter monetary policies, such as raising interest rates, economic growth could be adversely affected. Rising food prices therefore have long-term repercussions for the poor that go beyond its initial impact.

¹ Organisation for Economic Co-operation and Development (OECD) and Food and Agriculture Organization of the United Nations (FAO). Agricultural Outlook 2010-2019. Available at: http://www.agri-outlook.org/dataoecd/13/13/45438527.pdf.