Deflationary pressures across Asia are building, reaching a fresh six-year low in July.
There is no better demonstration of this than examining recent movements in producer price inflation.
In annualised terms, they’ve fallen for 41 consecutive months in China. South Korea, the Philippines, Hong Kong and Singapore have all seen prices fall for more than 30 months. Indonesia, at 4.3%, is one of the few nations to have recorded an compared to a year earlier.
Perhaps more concerning than the scale of deflation is the slow, tepid and reactionary response by central banks across the region to address the continued falls.
Morgan Stanley, in a note released earlier today, pick up on that point, suggesting that policymakers across the region need to borrow a leaf out of the central bank playbook from developed nations and ease monetary conditions further.
Here’s Chetan Ahya, Derrick Kam and Jenny Zhen of Morgan Stanley’s Asia economics team.
“Central banks in DM economies have addressed deflation risks via monetary easing – but the response from central banks in Asia ex Japan is still relatively slow. Moreover, the weakness in aggregate demand is resulting in a feedback loop where deflationary pressures are intensifying – as evident in the PPI moving even further into deflation.
In our view, the deflation challengeis deep-rooted and persistent.That could ultimately give rise to a need for a more aggressive monetary easing cycle than is being currently expected.We believe that central banks in the region will remain on an easing path as they address the deflation challenge, though the risks are still tilted towards them being more reactive rather than preemptive”.
So how can deflationary forces be turned around, and can it solely be achieved through aggressive monetary policy easing?
The answer, in short, is no.
Morgan’s believe it will take more than policy easing, and offer their own five-point plan to help address building deflationary risks across the region.
The five-point plan can be found below.
- Accept slower growth in line with changing potential growth dynamics due to structural factors such as a decline in the working age population, high level of debt and slowing productivity growth.
- Address the moral hazard risks in the banking system and/or tightening prudential norms, restructuring industries with excess capacities to ensure efficient capital allocation.
- Cut real interest rates to give the private sector incentive to borrow for productive investment.
- Initiate structural reforms to encourage productive private sector investment and improve potential growth.
- Provide temporary fiscal stimulus in cases where necessary.
Given overcapacity concerns in many sectors, particularly in China, Morgan’s also suggest that more consumption is required, rather than investment.
While it initially aided economic growth in the first few years following the global financial crisis, over-investment in many sectors created overcapacity which, in turn, created oversupply. With supply growth far greater than demand in recent years, it has merely added to deflationary pressures.
What Morgan’s are saying is that more investment in an attempt to stimulate growth may only worsen deflation further.
Alongside measures to boost consumption and stymie investment in sectors already suffering over capacity issues, they also suggest that real interest rates remain high despite recent monetary policy easing.
China, again, is at the forefront of this debate. Consumer price inflation is running at an annual rate of 1.6% at present, well below the 4.85% benchmark one-year lending rate currently implemented by the PBOC.
While it’s not only up to China to address deflationary concerns, given the sheer scale of its economy and the fact that many of the concerns touched on above are clearly evident within its economy, it clearly has a major role to play.
If policymakers continue to be reactionary rather than preemptive, it’s unlikely that the current deflationary spiral will ease anytime soon.