Your Questions Answered: How to Manage Rising Prices in Asia?

Prices are rising in Asia but pro-active measures by governments could help to keep them in check. Photo: Laurentiu Morariu
Prices are rising in Asia but pro-active measures by governments could help to keep them in check. Photo: Laurentiu Morariu

By Irfan A. Qureshi, Matteo Lanzafame

ADB economists Irfan A. Qureshi and Matteo Lanzafame answer questions about inflation in Asia and how governments can best respond.

Against the backdrop of soaring prices across the world,  inflation remains relatively low and manageable across many of Asia’s developing countries, owing to several factors. But it is important that monetary authorities in the region monitor inflation closely and not fall behind the curve.

Inflation is at 40-year highs in much of the world. In April, the inflation rate was higher than 8% in the United States, rose to 7.5% in the Euro area, and was in double digits in Latin America, Sub-Saharan Africa, and emerging economies in Europe.

Headline inflation rates in Asia’s developing countries have also been increasing since late last year. However, standing at 4.2% in April, inflation in the region remains well below the rates prevailing in other parts of the world, including advanced economies.

There are three key reasons why inflation in the region was low and manageable last year.

 While economies around the world have struggled with sharp increases in food prices, key food staples for many economies in Asia—such as rice and pork—have seen more stable or even declining prices.

Since food features prominently in the consumer basket, this has contributed to keeping inflation manageable in the region. The Caucasus and Central Asia is an exception, as economies in this subregion saw inflation rise last year partly because of increasing wheat prices.

Second, despite the region’s strong rebound in 2021—underpinned by effective pandemic containment, revived domestic demand, and solid export performance—economic recovery remains incomplete, as GDP has not caught up with its pre-pandemic trend in most regional economies. This is reflected in still-weak labor market conditions, with employment remaining below pre-COVID-19 levels and limited wage increases that have contributed to keeping inflation low.

Third, supply chain disruptions that emerged alongside the global recovery have been less severe in the region compared to other parts of the world—in particular, some advanced economies. Several factors contributed to the resilience of Asia’s supply chains. Demand in the region did not shift from services to goods as much as it did in the US, for instance.

Also, the upstream position of some regional economies—including the Republic of Korea—protected them from supply-chain bottlenecks. Asia was also less affected by rising shipping costs or labor shortages associated with pandemic-related mobility restrictions.

Recovering domestic demand and employment, combined with the spike in global commodity and energy prices, will drive inflationary trends this year and next. On average, oil prices this year could be 50% higher or more relative to 2021. Estimates suggest that this by itself could push up headline inflation this year by 2 percentage points in emerging markets, and even more for economies where transport and energy loom large in the consumer basket.

And risks for inflation are tilted to the upside. For instance, since Ukraine supplies about 50% of the world’s neon gas, the fallout from Russia’s invasion could pile pressure on the semiconductor and automotive industries in the region, by curtailing the global supply of this critical input to produce semi-conductor chips.

Similar disruptions in food commodities on account of the war could elevate inflationary pressures in the region. Prices for wheat and corn soared as Russia and Ukraine are key global suppliers. Palm oil prices also surged, because Ukraine is a large producer of sunflower oil, and the two products are substitutes. Fertilizer shortages and substitution from wheat may also push up rice prices.  If more countries turn to export bans to safeguard domestic food supplies, food protectionism could also further fuel food inflation in Asia.

Subsidies targeted at the poorest segments of the population are the most appropriate instrument to deal with energy inflation in the short run. Subsidies create fewer distortions than alternatives such as suspensions of VAT or excises on fuel—which are not only poorly targeted, but can be hard to re-install, set a bad precedent, and erode public finances.

But if there are signs that inflationary pressures are building and broadening, monetary policy should take center stage.

The nature of the current inflation episode, largely driven by a spike in global energy prices, also suggests that boosting investment in energy efficiency and renewables can reduce vulnerability to this type of price pressure in the medium-term.  In Asia, energy consumption per unit of GDP has declined over the last two decades, but it is still higher than the OECD average. In this respect, the crisis presents an opportunity for regional governments to speed up the transition to more sustainable and greener growth.

Rising prices tend to reduce consumers’ purchasing power. More uncertainty regarding inflation prospects leads to more cautious consumption behavior, typically increasing precautionary savings. This is perhaps a rational response to higher and more volatile inflation, as it helps individuals insulate themselves from the negative effects of rising prices to some extent—in particular, if the additional savings are invested in inflation-linked financial assets, which are designed to help protect investors from inflation.

But this may not be an option for the poorest, who do not have access to such financial tools. Furthermore, as not all prices rise proportionally, individuals can also change their consumption patterns to consume relatively more of those goods and services whose prices are increasing less—e.g. consuming more rice and less wheat-based foods.

But the reality is that, in the presence of an inflationary spike, these adjustments on the part of individual consumers will at most help reduce the pain.  The best way to avoid significant negative consequences for consumers is pre-empting an inflationary spike in the first place, and that is the job of central banks.

There is no shortage of reasons for monetary authorities in the region to remain vigilant against incipient inflationary pressures and not fall behind the curve. Keeping the inflation genie in the bottle may come at a cost but putting it back in would almost surely prove more costly.

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