Crowds gather outside restaurants at Miyashita Park in Tokyo on May 22. Japan has so far been reluctant to make drastic changes to its monetary policy to avoid causing market volatility. Photo: Bloomberg
by Tai Hui
by Tai Hui

Why Asia’s gradual Covid-19 recovery means it has less to fear from rising inflation

  • Countries like the US that went big on economic stimulus are now having to back-pedal just as sharply
  • Most Asian countries are entering their post-pandemic phase more slowly, giving supply time to catch up with demand. Plus, forex reserves are sufficient to ease anxiety over currency depreciation
The aggressive policy tightening by the US Federal Reserve and other central banks in developed economies has made many headlines lately. While some Asian central banks have already begun raising interest rates, their pace has been more moderate.
Many had assumed that Asian central banks would need to track the Fed closely, or risk currency depreciation and capital outflows. Are monetary authorities in the region behind the curve, and do they risk more trouble in the future?

The short answer is “no”. Asian economies are still highly connected to the US and European economies. However, there are some notable differences that allow Asian central banks to be more flexible in policy normalisation.

Starting with inflation, most Asian economies have seen their headline inflation rising sharply in recent months. This is not surprising, given the surge in both oil and food prices caused by the conflict in Ukraine and the ongoing global economic recovery.
A man walks past the Reserve Bank of India headquarters in Mumbai on June 8. India is one of the Asian economies that has been forced to raise interest rates more than once this year to combat inflation. Photo: AFP
There is not much central banks and monetary policy can do to address this issue. Hence, economists often strip out the food and energy components in inflation, leaving what’s known as core inflation. Even though core inflation has risen across the region, there are only a few economies where this is an immediate challenge, such as India and South Korea.
There are two broad reasons Asia’s inflation landscape is less challenging than in the US or Europe. First, the US and Europe are further along in their recovery from Covid-19. Their service sector largely went back to normal in the second half of 2021, with consumers returning to restaurants, hotels, stadiums and concerts.
Many Asian economies have only just started to roll back their Covid-19 restrictions and reopen borders. Southeast Asian economies such as Singapore, Malaysia and Thailand are leading the way. As such, domestic demand has yet to make a full recovery and hence there is room to grow without creating much inflationary pressure.
Tourists walk along the popular Khaosan Road in Bangkok on May 17. Thailand’s economy has benefited from the revival of its tourism sector this year. Photo: AFP
Second, fiscal stimulus was particularly strong in the US in 2020 and 2021. This helped to protect household income and the demand for goods and services. When the economy reopened, this pent-up demand was unleashed, while supply was slow to catch up, leading to higher prices.

In Asia, governments did provide some relief to families and businesses in 2020 but this was scaled back in 2021. Subsequently, the pent-up demand is likely to be smaller.

Nonetheless, with domestic demand in the region on a stronger footing, there will probably be some pickup in prices in the coming quarters. Indeed, some central banks are already raising interest rates pre-emptively, such as South Korea, India and Taiwan. More may well do so in the second half of the year, but gradually.

The current market expectation is for the Fed to raise its policy rate, which was zero at the start of the year, to 3.5-3.75 per cent by the end of the year. This would be some of the most aggressive policy tightening in recent decades.


US Fed raises interest rates by 0.75 percentage point, the biggest hike since 1994

US Fed raises interest rates by 0.75 percentage point, the biggest hike since 1994
Asian central banks probably won’t need to match its pace, given the local conditions. While Asian currencies have weakened against the US dollar, the magnitude of depreciation is generally smaller than for major currencies such as the euro and the pound. This suggests investors are not too concerned that Asian central banks’ measured moves may lead to an inflation problem down the road.

There are three other reasons Asian currencies’ depreciation is more muted this year. First, most are cheap relative to their own history. Second, most Asian economies run a healthy current-account surplus and have ample foreign exchange reserves. Both factors are important for reinforcing investor confidence.

Should Hong Kong raise its minimum wage to keep up with inflation?

Third, after adjusting for inflation, Asian interest rates in real terms are still attractive relative to the US dollar and other major currencies.

What about Hong Kong? Due to the dollar peg, the Monetary Authority raised its base rate, moving in lockstep with the Fed. Meanwhile, mortgage rates are linked to interbank rates, such as the Hong Kong interbank offered rate, or Hibor, which have already risen, reflecting higher borrowing costs.

While each bank sets its own prime rate according to its own business conditions, commercial banks will have to follow suit eventually as Hibor rises. A three-month Hibor rate of 3 per cent could be the point where more banks start to raise this benchmark rate.

Overall, it would be reasonable to expect mortgage payments to rise further. Given the various safeguards introduced by the HKMA to improve the property market’s resilience, such as on loan-to-value ratios and stress tests on affordability, higher rates should not create too much volatility in Hong Kong’s real estate market.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management