Inflation and subsidy costs a rising threat to Asia

The resilience Asian economies have shown to credit market turmoil and OECD economic weakness will be tested in the months ahead by two home grown risks, Export Finance Investment Corporation (EFIC) chief economist Roger Donnelly reports in the latest World Risk Developments newsletter.

“Asia will be vulnerable if the global credit squeeze intensifies and worsens the OECD downturn. But it arguably faces the two equally important home-grown risks of rising inflation and the consequences of rising fuel and food subsidies,” he says.

Illustrating these points, Donnelly says headline inflation is now 11% in Vietnam and 9% in China. Meanwhile fuel subsidies in Indonesia could reach Rp 130 trillion (US$14.3bn) in 2008 if oil prices average US$95 a barrel.

The warnings in EFIC’s report highlight the risks to Asia’s growth prospects. Multilateral forecasters – IMF, World Bank, Asian Development Bank and the United Nation’s Asian offshoot, ESCAP – are guardedly optimistic that the region’s economies will remain resilient in the face of an OECD slowdown.

The four bodies recently shaved their Asian growth forecasts, predicting slower but still robust growth of between 7.6% and 8.5% across the region in 2008. Although healthy fundamentals in many Asian countries may provide a cushion against declining export growth, the region’s economic resilience could be threatened by inflation and subsidies.

“Inflation and subsidies will hinder the scope of Asian governments to cushion the blow of any export shocks. More flexible exchange rate regimes and better targeting of subsidies are needed to counter these problems,” Mr Donnelly says.