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Travelling Asia
• Inflation has emerged in Asia. Changes in
relative competitiveness are in train,
suggesting Asia’s surpluses will erode over
time.
• China’s booming economy will be most at
risk should inflation accelerate further. But
markets may have started with an
inappropriate distribution of risk.
• Asset-driven currencies such as the AUD
are the most vulnerable. The EUR will benefit
from the credibility of its central bank…
• …but the ECB’s inflation-fighting
credentials will be challenged by diverging
monetary conditions.
• Rising global inflation will put the JPY
under selling pressure.
The challenge of inflation: The example of India
I am writing this document during a business trip to
Asia. It has been fascinating talking to our clients and
to policymakers. While Asia is clearly booming, the
clouds of inflation are appearing in the blue sky; the
outlook is no longer universally sunny.
India, which had been hoping to become a second
China because of its growth dynamics, is now
hopelessly behind the curve in respect of tackling
inflation. The RBI has allowed real rates to become
negative, the current account deficit is taking off and
the government is acting only slowly to reduce its
fiscal deficit.
Still, India is an agriculturally driven country, with the
monsoon heavily influencing the state of the
economic cycle. Last year’s good monsoon season
helped push GDP growth up to 8% but industrial
production growth has now declined to 2.7%. Rising
inflation rates will undermine India’s competitiveness,
not boding well for its already-weakening trade and
current account deficits.
Meanwhile, the RBI stands at a crossroads. Either it
understands the inflation risks and acts accordingly,
putting rates up aggressively or it remains behind the
curve.
In the first scenario, India would face a cyclical
slowdown due to rising real rates. In the second
case, India would be heading into troubled waters
where rising inflation expectations kill off inward
investment. Falling real rates would start
undermining the INR.
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Chart 1: India Behind the Curve
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Dec-06 Jul-07 Feb-08 Sep-08 Apr-09 Nov-09 Jun-10
Source: Bloomberg, BNP Paribas
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WPI (y/y, RHS)
RBI CRR
Chart 2: China Wages Relative to Output are
Rising
China Wages are a proportion of GDI
China CPI (y/y, RHS)
Mar-92 Sep-94 Mar-97 Sep-99 Mar-02 Sep-04 Mar-07 Sep-09
Source: Reuters Ecowin Pro, BNP Paribas
We discussed this topic with a well-respected Asianbased
hedge fund manager. The conclusion we
reached was that either scenario would lead to lower
share prices. Last week, the Indonesian equity
market moved into a higher volatility regime. In 2009
and especially 2010, the Indonesian market saw a lot
of inward investment and was one of the best
performers globally. That might be changing now as
inflation is on the rise. India is in the same boat as its
equity market was the main destination for foreign
inflows into the country. Since November, shares in
Bombay have lost around 10% and we wonder when
there will be a bigger correction in the FX market on
the back of this development.
China: domestically funded leverage
The other big theme is China and its satellite
economies. Looking out of the hotel room window, I
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Hans Redeker 20 January 2011
Market Mover, Non-Objective Research Section
59
www.GlobalMarkets.bnpparibas.com