A risk on the horizon for some Asian economies is inflation. These are China, Hong
Kong, India, and Singapore. Our weighted average 2008 CPI inflation forecast for Asia
ex-Japan is 5.4% yoy versus consensus 3.9% (Exhibit 3). However, inflation dynamics are
varied in the region. There are two distinct group of countries which we believe face
different inflationary pressures. The economies where inflation may surprise the market on
the upside in 2008 are China, Hong Kong, India, and Singapore. In Korea, Malaysia,
Philippines, Taiwan, and Thailand we believe inflationary pressures are moderate. Our
forecasts for China and Hong Kong are very high, so the risk is likely not to our forecast,
but consensus. In India, our inflation forecasts for 2008 are below consensus, hence we
feel that both we and consensus could be surprised on the upside. In Singapore, our 2008
inflation forecast is in line with consensus. Hence the risks to our and consensus forecasts
for 2008 inflation may be tilted to the upside, in our view.
In China, Hong Kong, India, and Singapore the common ultimate drivers of inflation
are the output gap and lagged inflation. These are the economies where demand side
pressures resulting from a positive output gap are probably the strongest, labor market
have tightened rapidly, and core inflation is rising. In addition, monetary indicators in China
and India are flashing red and may induce further inflationary pressure in the next 12
months. In economies where GDP growth is at or below trend, monetary indicators are
well behaved and inflation inertia is moderate - such as in Korea, Malaysia, Philippines,
Taiwan, and Thailand - we believe the pressures on inflation are likely to be moderate,
absent any significant global shocks from food and oil prices.
What should investors focus on to gauge the momentum of inflation in the region
over the next 12 months? It may be worthwhile monitoring:
• The further narrowing of the domestic output gap, which may induce demand side
pressures on inflation, and the impact of lagged inflation on future inflation. These may
be prevalent in China, Hong Kong, India, and Singapore.
• How the volatility of money growth and the real effective exchange rate impacts the
volatility of inflation in the region. China and India stand out on the M3 growth front,
while Indonesia is susceptible to the impact of high volatility in the exchange rate on
inflation.
• Regional central banks need to continue to implement prudent monetary policies to
contain inflationary expectations.
• Rising transport costs, and unanticipated commodity price shocks from oil and food
prices may push regional inflation higher.
• Should Asian currencies weaken against the USD on the back of a continuation of global
financial market jitters, upside risks to regional inflation may ensue. In countries where
the degree of pass-through from exchange rates to inflation is visible, the risks to our
CPI inflation forecast may be tilted to the upside. These are India, Indonesia, and
Singapore. The evidence is mixed for the Philippines and Thailand.
• Asia’s impact on global dis-inflation may be moderating since the region is an important
supplier of manufactured goods to the world and costs are rising.
