O.T. - long, sometimes boring article about deflationary stuff in Asia from the Economeister ( economeister.com )
(Special treat -- how many times have you seen the word "baht" used repeatedly in one paragraph ?)
ANALYSTS: NORTH ASIA DEFLATION THREATENS RECOVERY
By Matthew Saltmarsh
HONG KONG (MktNews) - Deflation in some East Asian countries, particularly Hong Kong, China and Taiwan, is outpacing the effects of nominal interest rate cuts and leading analysts to fear the side-effects will hinder the already sluggish recovery prospects in the region.
"Deflation is now a North Asian phenomenon," said Jan Lee, chief economist at the HSBC Group in Hong Kong. He also placed Singapore in the same boat as the Taiwan, Hong Kong and China.
The inflationary effects from last year's sharp currency depreciations now appear to have evaporated and have been replaced by growing deflationary forces from deep recessions, slack labor markets, soft commodity prices and excess operating capacity. The rise in consumer prices generally peaked in the first quarter of 1998 in most east Asian countries.
In 1998, monetary and fiscal austerity compressed demand and prevented corporates passing on higher import prices to consumers. Similarly, weak demand and rising unemployment prevented workers from obtaining higher wages in the expectation of higher prices.
The effects of deflation (falling prices) or disinflation (declining price rises) are especially feared because as prices fall, income falls but the absolute level of debt rises. Deflation also has knock-on effects through shrinking bank credit, falling demand and declining service and manufacturing activity.
The theme of falling prices in the region became more evident in February, with the annual consumer price inflation rates falling in Indonesia, Korea, Thailand and the Philippines. The only exception was in Taiwan, where the inflation rate rose, although the increase was largely due to the Chinese New Year holidays.
Elsewhere, weak aggregate demand and excess supply are also depressing domestic wholesale prices. Korean wholesale prices fell an annual 5.9% in February, while in Taiwan they fell 7.8% and
Thailand saw a 7.0% decline in the same month. These price trends are increasingly being reflected in broader consumer price deflation.
Some also include Japan in the basket of countries facing deflation worries, although Japanese officials say they expect prices to remain stable this year.
Analysts say it seems likely that in the months ahead a number of other South-East Asian countries will join China, Hong Kong and Singapore in experiencing out-and-out deflation.
"Adjustment will intensify this year," HSBC's Lee said, adding "it will cause subdued growth going forward."
Desmond Supple, senior regional analyst at Barclays Capital in Singapore, points out that falling prices reduce the incentive for fresh investment and consumption, while the already high burden of non-performing loans in Asian banking system would rise dramatically.
Specifically, Supple noted that as governments sell the assets of failed financial institutions, downward pressure on prices will accelerate.
In Thailand for instance, the government auctioned assets with a face value of 371 billion baht ($9.9 billion) in December, but only accepted bids on half of these assets, and even then at 25% of
face value. Much of those assets were loans tied to real estate, helping to suppress prices in the local real estate market as well.
Moreover, the face value of collateral for bad loans in Thailand's banking system currently touches 3.0 trillion baht, and 1.0 trillion baht of assets may hit the market via auction. "This
highlights the extent of deflationary forces associated with bank restructuring," Supple said.
External price trends are also damaging Asian growth prospects. Export prices are declining across the region, which means that even if export volumes can begin to pick up, actual revenue from overseas sales may still decline. Also, a weak global price trend, together with overly strong regional currencies, is creating imported deflation. Import prices are falling across the region, in
both dollar and local currency terms.
"Given the external orientation of Asian economies, imported deflation is a significant threat to broader price stability going forward," said Supple.
Lehman Brothers also singles out the North Asian economies and Singapore, although Thailand is also seen by the U.S. investment house as deflating rapidly.
Consumer prices, which are key as they encompass service prices and individual purchasing, are seen by Lehmans sinking in Hong Kong from the current -1.1% to -2.0% for 1999. China is seen climbing from -1.2% now to -0.5% in 1999; Singapore prices are seen slipping from -0.5% now to -2.0% in 1999 and the same in 2000; Taiwan's CPI is seen slipping from 2.1% now to 0.2% in 1999; and Thailand is seen falling from 2.9% to -1.0% for 1999 and 2000.
The obvious policy response is to ease monetary policy at the fastest rate consistent with reasonable currency stability. Other moves that could help are bolstering the capital ratios of the banks, speeding corporate restructuring, reducing reserve requirements and guaranteeing debt rescheduling.
But there is now less room for monetary policy easing than there was. The rate cuts seen in Asia last year were taken in an environment of a weak U.S. dollar, which facilitated the aggressive
easings.
"The weakness of the U.S. dollar was a critical global factor which allowed Asian currencies to lower rates radically without damaging their currencies, although sharply rising current account
surpluses were also a shield," said Paul Schulte, regional strategist at ING-Barings, in a research report.
Another key policy response would be to reflate via fiscal spending financed by the central bank or foreign investors, according to Schulte.
Deflation is particularly worrying in Hong Kong. With its fixed currency peg, Hong Kong is unable to address the issue via a currency easing, lower prime rates and substantial deficit spending.
It is solely reliant upon asset price falls making its economy more competitive with its neighbors, therefore leading to increased investments and higher growth.
In Hong Kong, and to a lesser extent Korea, inflation is falling faster than nominal interest rates, meaning that real interest rates are rising, players say.
The rise in the real prime lending rate in Hong Kong is even more pronounced. The Hong Kong government has projected that price deflation will deepen this year, which implies that unless banks soon start to lower their nominal prime lending rates, real prime lending rate will continue to climb.
"The adjustment in Hong Kong will have to intensify this year," said HSBC's Lee. "Prices have not fallen by enough. There is more room to go."
Shulte agreed that among Asian economies, Hong Kong displays the most worrying combination of falling wages, falling prices, falling output and shrinking lending growth.
In China, despite the central bank lowering interest rates three times last year, price deflation has persisted because of weak domestic demand, a strong exchange rate in trade-weighted terms and substantial excess capacity.
In a climate of deflation, kick-starting private sector demand and restructuring the balance sheets of regional banking systems will also be far more difficult, said Barclays' Supple.
"Asian policy-makers need to proactively move towards a policy of reflation, which will entail far more aggressive monetary expansion than has been seen to date," Supple added.
He added the weak currency aspect of this policy is also essential, since weaker exchange rates will reduce imported deflation, and help compensate local currency cash-flows for the effects of export price deflation.
"When Asia undergoes this policy shift, the regional currencies will trade less as yen proxies, and more on their own terms."
--Market News, Hong Kong (tel 852-2528-6038) email matthew@mktnews.com
07:16 EST 03/10
© 1999 Market News Service, Inc.
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