US Rate Cuts Leading to Economic Controls and Subsidies in Asia

The repeated rounds of Fed rate cuts have led the dollar to fall against most currencies save those maintaining currency pegs. While the yuan has appreciated somewhat, it hasn’t been sufficient to have much impact on Chinese trade surplus with the US (2007 was a record year). And because China and its peers are having trouble fully sterilizing their dollar purchases, the result in rampant inflation, which in turn has led to a series of interventions by the governments.

As this Bloomberg article points out, some of these measures, such as subsidies, may be making matters worse, since they encourage overconsumption of expensive goods, while letting prices rise would promote substitution or cutbacks. These practices are more widespread than most readers might realize.

From Bloomberg:

Ben S. Bernanke, the champion of free markets, is driving Asia’s governments back to controlled economies.

Under Bernanke’s chairmanship, the Federal Reserve’s steepest interest-rate cuts since 1990 are limiting his Asian counterparts’ options to curb inflation. Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines.

Such measures may backfire. Artificial price curbs and subsidies only feed more demand for oil and other commodities, and ultimately will make it harder to contain inflationary pressures worldwide, officials from the Group of Seven nations warned at their Feb. 9 meeting in Tokyo…..

In China, the worst snowstorms in five decades have stoked inflation that was already above the central bank’s target. Consumer-price gains in Sri Lanka exceeded 20 percent in January, while inflation in Singapore has reached levels not seen in a quarter century.

Bernanke’s Fed has added to Asia’s dilemma by lowering its benchmark interest rate 2.25 percentage points since September, to 3 percent. The widening spread between U.S. and Asian borrowing costs draws more foreign money into the region, threatening to feed asset bubbles. That makes central banks such as China’s and India’s loath to fight inflation by raising rates, which would open an even bigger gap.

In the past year, stampedes in China for discounted food have also caused deaths and injuries, leading the government to increase controls on basic commodity costs.

Since Jan. 15, the National Development and Reform Commission has required producers and sellers of grain, cooking oil, meat products, milk, eggs and liquefied petroleum gas to seek government approval to raise prices in an effort to cool inflation expectations and ease “social tension.”

Such measures may export Asia’s inflation to the rest of the world. Stockpiling, subsidies and price controls do nothing to rein in excess demand in Asia’s fast-growing economies, which is already pushing up food and energy costs worldwide. The G-7 in Tokyo said governments should avoid steps to artificially lower energy prices.

“There is no incentive for people to cut down on the consumption of oil or other commodities because they’re not feeling the pinch,” says Bill Belchere, an economist at Macquarie Securities Ltd. in Hong Kong. “When governments resort to stockpiling, that creates extra demand and prices will only keep rising.”

The Fed’s rapid rate-cutting leaves Asia’s policy makers with few good alternatives. China and other export-driven economies have tried to limit the appreciation of their currencies to keep their goods competitive in world markets, at the cost of higher inflation at home.

The U.S. is trying to persuade China, which has allowed the yuan to rise about 15 percent against the dollar since July 2005, to let it appreciate faster….

Singapore is reluctant to let its currency rise too rapidly, Finance Minister Tharman Shanmugaratnam told the country’s Parliament the same day. “There is a limit to how fast the Singapore dollar can appreciate without hurting our economic performance and growth, and eventually causing wages to fall,” he said. “An overly strong Singapore dollar can bring inflation down, but at the cost of lower growth and higher unemployment.”

China’s central bank, after raising rates six times in 2007, to 7.47 percent, may slow the pace this year.

“In this environment where the Fed is cutting interest rates quite aggressively, China cannot lift its own domestic interest rates forever,” says Jing Ulrich, chairwoman of China equities at JPMorgan Chase & Co. in Hong Kong.

Indian Finance Minister Palaniappan Chidambaram said on Jan. 24 that his country’s central bank would need to take into account the rate differential with the U.S. when determining policy. Five days later, the Reserve Bank of India held its main rate at 7.75 percent even as inflation accelerated.

The Philippine central bank, Bangko Sentral ng Pilipinas, last month lowered its key rate to 5 percent, the fourth cut in a row, narrowing the gap with the Fed’s benchmark.

With monetary policy neutralized, officials will “use whatever tools they have at their disposal to contain inflationary pressures,” says Mark Williams, an economist at Capital Economics Ltd. in London.

Asia’s governments have experience with the destabilizing effects of runaway prices. China’s inflation contributed to the unrest that triggered the 1989 Tiananmen Square demonstrations. Indonesia’s attempt to increase fuel costs in 1998 was the spark for protests that led to the ouster of President Suharto after almost 32 years in power.

More recently, the efforts of Myanmar’s junta to reduce oil subsidies set off the biggest anti-government protests in almost 20 years.

Price controls on basic commodities such as food and fuel have long been policy tools in nations with large populations living in poverty, including India and Indonesia. Still, Asia’s more affluent consumers in Singapore and South Korea have also been hurt by rising prices, prompting more governments to employ such instruments.

“These measures are proliferating because of the extent of the food and energy-price shocks that the region is facing,” says Robert Prior-Wandesforde, a senior economist at HSBC Holdings Plc in Singapore. “No country is really immune.”

Bulog, Indonesia’s state food company, said on Jan. 26 that it plans to sell more rice to lower the price of the grain and help the central bank meet its inflation target. Rice is the biggest component of the country’s consumer price index.

India is building stockpiles of food staples to ease supply constraints and curb inflation. The government buys food grains at guaranteed prices from farmers for distribution to the poor at subsidized rates through state-run shops.

Philippines President Gloria Arroyo last month proposed giving National Power Corp., the state-owned electricity generator, a subsidy to help cap prices.

Among Asia’s wealthier countries, Singapore last week announced plans to give cash and rebates to needy citizens to offset the highest inflation since 1982. Taiwan imposed a ceiling on gasoline and diesel prices after inflation quickened in November to a 13-year high. And South Korea is studying ways to limit increases in school tuition and heating bills.

“They’re distorting their economies, and these policies can’t last forever,” says Jan Lambregts, head of Asia research at Rabobank International in Hong Kong.

Asia’s rapid growth also means price controls can’t keep inflation bottled up for long, says HSBC’s Prior-Wandesforde.

“Rate increases are required now, and they’re falling behind the curve,” he says. “Ultimately, policy tightening will need to be bigger than it would otherwise have been.”

While a few of the region’s central banks, including Vietnam’s and Australia’s, have chosen to raise rates, “the others are just delaying the inevitable, and it’s a matter of time before they reach their `inflation pain’ threshold,” Prior-Wandesforde says.

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  1. Anonymous

    “Artificial price curbs and subsidies only feed more demand for oil and other commodities”

    This statement says it all. Commodities are the new bull market, especially food. Go corn!

    (great work!)

  2. Anonymous

    The bloomberg article is mistitled; it is unfair to blame bernanke for the results of dollar pegs. China and Singapore are actively choosing to follow the Fed and follow the dollar; they don’t have to.

    On one point US policy makers have been consistent — US monetary policy will be directed at conditions in the US, not set for the entire dollar zone.


  3. Lune

    Why don’t these countries regulate the convertibility of their currencies? I realize that free convertibility of currency is one of those IMF and western economists-backed ideas that is considered sacred by free-marketers, but many of these problems would go away if countries like India went back to their traditional currency controls which prevented speculative money from coming into (or leaving) the country. What exactly is the problem with strictly controlling capital inflows to promote “healthy” inflows (e.g. import/export, long-term capital investments, etc.) while banning “unhealthy” inflows (e.g. short-term speculative money)? It sure would beat price controls and 20%/month inflation

  4. foesskewered

    Sometimes, it’s hard to impose those controls that you mentioned, how many hot inflows label themselves as such? No one’s gonna label themselves as speculative money, you can’t set up control booths and check each transaction, as unfortunate as it sounds , checks are often on retrospective basis, and often after a problem has blown up.

    brad, true, the dollar peg is not a problem of the fed, but should these countries move away from a dollar peg it would mark another chip in the pedestal that holds the $ above the rabble. Besides, on a more pragmatic note, unless you’ve got realistic alternatives or huge pockets (read petrodollars) de-pegging is not an alternative.I’ve said in various blogs (yep, sad old blogger here) that overconsumption and a questionable attitude towards debt is a root cause of present troubles, goading the consumer to maintaining both is not a solution, as Yves has pointed out.

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