(The Globe and Mail)
Diverging inflation rates across developing and industrialized countries are emerging as a new risk to the global economic recovery.
Inflationary pressures in countries such as China, India and Brazil are surging, representing the most serious threat to their rapid growth, which has led the world’s recovery from the global financial crisis.
Prices are also rising in parts of Europe, but remain relatively tame in the United States mostly due to persistently high unemployment.
Rising food and energy prices are being blamed for stoking inflation in key emerging markets, but there is also criticism that those nations have allowed their economies to overheat.
Countries are now stepping up their efforts to stamp out inflation through indirect means. On Friday, China’s central bank raised bank reserve requirements for the seventh time in a year to temper lending growth.
Some economists, though, fear such moves will eventually prove inadequate, forcing developing countries to embark on aggressive interest-rate increases. That, in turn, could spark slowdowns in both developing and industrialized countries. Canada, for example, could see demand curtailed for exports such as energy.
Nick Chamie, global head of emerging markets research at RBC Dominion Securities, argues it is high time emerging countries hiked interest rates.
“We are seeing the central banks trying to play catch-up and facing such intense inflationary pressures, in some cases, because they ran a monetary policy, set interest rates … too low for too long, on purpose,” Mr. Chamie said.
“Now they have to pay the piper. And it is time to hike rates, probably more so than what they would have had to have done if they’d just started hiking rates sooner.”
Beyond food and energy prices, inflation in emerging markets is being fuelled by robust economic growth.
Many are experiencing strong domestic demand underpinned by falling unemployment and rising wages. Low interest rates and strong credit growth are other factors.
“Unfortunately, when you are dealing with inflationary pressures and overheating of economies and possibly even asset bubbles, you need a blunt instrument like interest rate hikes,” Mr. Chamie added.
Policy-makers in China, India and South Korea are all grappling with how to counter rising prices without crimping their economies. Each are taking different approaches.
China’s central bank, on Friday, hiked banks’ reserve requirement ratio by half-a-percentage point, in a bid to curb stubbornly high inflation caused, in part, by months of loose monetary policy.
China’s Consumer Price Index hit a 28-month high of 5.1 per cent in November and the government has now made fighting inflation a key priority.
The latest increase in the percentage of deposits that banks must hold in reserve marks the seventh increase in a year and brings the ratio to 19 per cent – the highest level since reserve requirements were introduced for Chinese banks more than two decades ago.
China’s central bank also implemented a surprise interest-rate hike on Christmas Day to counter the rising costs of food and real estate.
Mark Williams, senior China economist at Capital Economics in London, believes that reserve requirements, and not interest rates, are set to become China’s primary policy tool, though he does not see inflation as a major threat.
Most other countries in Asia, however, are using interest rates as the main instrument to fight rising inflation.
India is widely expected to hike rates again this month to counter persistent double-digit food price inflation despite the fact that there are already signs there of an economic slowdown.
In South Korea, president Lee Myung Bak this month declared a “war against inflation” as prices for food and other staples have jumped sharply and the CPI hit 3.5 per cent in December.
In response, the Bank of Korea implemented a surprise interest-rate hike this week, increasing the benchmark rate by 25 basis points to 2.75 per cent, the third increase since mid 2010. (A basis point is 1/100th of a percentage point.)
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