Headline inflation for Asia is forecast at 2 per cent in 2021, somewhat lower than in 2020. However, this aggregate is skewed by China whose consumer price inflation is set to ease to 1.5 per cent, from 2.5 per cent in 2020.
China’s inflation is likely to be more pressing at the producer price level. In all the other economies except India, ANZ Research forecasts inflation to be higher than in 2020.
India should see milder inflation of 5.1 per cent compared with 6.2 per cent in 2020 but even so, it will be closer to the upper bound of the official target range.
The policy mix remains pro-growth. Announced budget deficits for 2021 remain high by historical levels, with the bulk of the reduction from the previous year coming from higher tax collections rather than expenditure cuts.
In some economies, the projected 2021 composition of spending is also more skewed towards development/capital spending, which has a larger multiplier on overall growth.
Fiscal policy has in fact become structurally expansionary, with some governments even extending the timeline for consolidation of public finances.
Monetary policy in the region should also remain accommodative in aggregate, but become more nuanced than in 2020. Although conventional easing has now concluded, ANZ Research does not expect any central bank to start raising policy rates until 2022.
ANZ Research maintains this view even against the backdrop of rising inflation risks and the ongoing volatility in US Treasuries. Quantitative measures to support government borrowing programmes and credit flow to SMEs should remain in play. However, their magnitude is likely to be more moderate than in 2020.
Apart from simply a smaller requirement as the recovery gains traction, quantitative easing is elevating financial stability risks or has misaligned the overall interest rate structure. These concerns call for a more-nuanced approach rather than the wholesale liquidity injections seen in 2020.
In this sense, monetary policy is likely to take a backseat to its fiscal counterpart. The problem of misaligned interest rates is perhaps starkest in India. Short-term money market rates have periodically fallen below the policy rate corridor while long-term bond yields that are critical to government finances have been rising.
The need to manage financial stability risks is becoming more pressing in some economies, thereby warranting tighter macroprudential norms.
China is predictably at the forefront of this exercise with a clear focus on stabilising the macro leverage ratio. There is a distinct concern rising leverage is the basis for asset bubbles, including that in the equities and property sector.
Even with this nuanced monetary policy backdrop, ANZ Research does not expect central banks to mechanically respond to higher inflation, even though several developments portend it.
A likely confluence of positive developments make a compelling case for inflation to rebound. These include a full re-opening of the services sector that could in turn catalyse employment and wages; the unwinding of forced and precautionary savings; accelerating money supply; and higher commodity prices.
However, the timing, extent and longevity remains unclear. Moreover, apart from India and the Philippines, inflation in the other economies is currently far from worrying levels.
The preference of central banks will be to first ensure that output gaps are closed. This approach is likely to be similar to that of the US Federal Reserve which has explicitly stated it will tolerate higher inflation for a period of time.
Yield curves in the region are not pricing in the risk of inflation and therefore can materially steepen should it fructify. This rise will not upend the growth recovery, but rather become a source of financial market volatility.
Neither is monetary policy likely to succumb to higher US bond yields. The formal normalisation of monetary policy will be a more persuasive development in the reaction function of Asian central banks. In ANZ Research’s view, the capacity to withstand higher yields on US bonds is now higher than during the 2013 taper tantrum.
Apart from Indonesia, all Asian economies are running current account surpluses. The adverse impact of higher oil prices should be attenuated by a slower recovery in non-oil imports. Various external reserve adequacy metrics have also strengthened over the course of 2020.
Overall, the region’s external health is distinctly superior to that in 2013 when both India and Indonesia found a spot in the infamous ‘fragile five’ club. ANZ Research believes current volatility in financial markets has more to do with the speed of adjustment in US bond yields than the level itself.
The pace of recovery will be uneven across economies but we are clearly past the worst. The risks to inflation are to the upside but even so, rate hikes will come about only in 2022.
Sanjay Mathur is ANZ Chief Economist, Southeast Asia
This is an edited version of a piece that appeared in the latest Asia Economic Outlook. Registered clients can click HERE to access the full report.