Deflation Pricks Hong Kong's Life Raft
By Tim Condon, AsiaWise
21 Mar 2001 15:30 (GMT +08:00)
Cast your light on it, and we can see it's still gasping as exports continue to fall. There are weak looking yen staggering around, surely a sign that the Bank of Japan has been struggling to fight falling exports.
And so the sad story goes and it portends hard times for the rest of Asia.
After spending most of 2H00 in the 107-110 range, the USD/JPY moved to 114-115 in December and now is testing 123. ING Barings economics forecasts an end-2001 USD/JPY of 129.
Besides 'hard peg' economies like mainland China, Hong Kong and Malaysia, every regional currency is at risk from a depreciating yen. Investors should expect every one of them to hit levels not seen since the 1998 financial crisis.
Unlike the 1998 financial crisis, the next round of depreciations will be controlled. For one thing, Asia (ex-Japan) is a capital exporter. Every regional economy has a current account surplus. Unlike Southeast Asia and Korea in 1997, there is no excess of spending over income, or no current account deficit, being financed with volatile, short-term capital flows.
The pegged economies are going to import deflation. Weak global demand and falling export prices (in US dollar terms) will deliver a deflationary shock to mainland China and Hong Kong, not to mention Malaysia. China is barely out of deflation now, Hong Kong is still in that rut, and Malaysia is close with very low inflation. In all three economies, prices for tradables like food, clothing, furniture and other goods -- which have been the source of deflation or ebbing inflation, will fall.
Currency weakness will mean downward revisions to inflation forecasts in those three economies. The February Consensus Economics forecasts are 1.3%, 1% and 2.4% for China, Hong Kong and Malaysia, in that order.
Hong Kong is most at risk. It's had deflation for two years, though it's been subsiding steadily since July 1999. Another deflationary whack will slow that recovery pace -- meaning Hong Kong deflation will persist.
There is a false impression that Hong Kong's deflation is attributable to property prices, which hit the CPI by cutting housing rentals. Deflation, in fact, is broad based. Traded movables moved started deflating a month after non-traded goods (services) did, but the fall in traded goods prices has been nearly as steep as that in services prices.
Depreciating currencies will likely mean that prices for goods Hong Kong imports from Asia will fall. Traded goods make up 58% of Hong Kong's CPI. It's doubtful then, that non-traded goods deflation will continue to subside at the same pace as in 2H00 -- not in the face of renewed stubborn traded goods deflation.
More stubborn traded goods and overall deflation will dent consumer confidence, and slow the recovery in the residential market. That means deflation in non-traded goods will persist longer as well. Deflation raises real interest rates. Real three-month HIBOR peaked in August 1999 at over 11% and remained above 8% through 1H00. Since then, subsiding deflation has driven it lower. In January 2000, falling U.S. rates kicked in. Persistent deflation means that falling nominal interest rates will unlikely fall below 5% from their current 6%.
Hong Kong's positives include low exposure to trade and electronics exports, no exchange rate risk and a direct pass through of lower U.S. interest rates to Hong Kong rates. Deflation seriously undermines these positives.
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