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To fight inflation, Asia needs to tighten fiscal policy
Comment in today's Financial Times
Asia risks drowning in inflation. Although it is easy to shrug off the spike in oil and food costs as temporary, something
much more profound is going on. Core prices are now accelerating sharply as well, threatening to kick off a wage-price
spiral. Investors and policy-makers ignore this at their peril. Unless something is done urgently, the hit from inflation
will cut short Asia's impressive recovery.
Monetary policy, in its usual form, no longer works. Raising rates simply draws in more capital, leaving financial conditions
highly stimulative. Currency appreciation, of the size needed to cut off those funds, would be too disruptive. Capital controls
could square the circle, but these are never watertight. Meanwhile, to some, regulatory tightening has become a valid
alternative, yet this is difficult to calibrate and best serves as a complementary, rather than primary, tool to tackle inflation. In
short, the hands of central bankers are tied.
The answer, therefore, is fiscal. Taxes need to go up and spending cut. This would curtail demand and, ultimately, price
pressures. Alas, there is a curious preference, driven presumably by politics more than by sober considerations of public
policy, to push fiscal levers in a downturn but leave them largely untouched when economies improve. A more symmetric use
of fiscal policy is now required to temper growth and inflation.
Yet, instead of tightening up fiscally, Asian governments are heading into the opposite direction. Across the region,
governments will continue to run sizeable deficits over the coming year. The only exceptions are Singapore and Hong Kong.
But, even here, the budgets announced in recent days are surprisingly accommodative. Whatever recent improvements in fiscal
balances there have been in Asia, these were driven by a cyclical bounce in revenues, rather than an active curtailment of the
fiscal impulse.
With inflation stirring, officials have quickly shored up price controls and padded subsidies to cushion the blow. These
measures are costly; and, far from addressing the underlying issue, they merely kick the inflation can down the road. Farmers
will not grow more if their prices are controlled, and car owners will happily continue driving unless the cost of petrol rises.
What's more, by easing the blow, growth will barrel ahead unimpeded, eventually sparking a much broader rise in prices that
hurts everyone.
A pinch from the taxman, therefore, is just what Asia needs. A hike in income tax rates, for example, would weigh on the
purchasing power of households and rein in inflation expectations. Alternatively, rather than join the race to the bottom, a little
tweak to corporate tax rates would help temper private investment. Put bluntly: if officials cannot fine-tune corporate activity
by adjusting the cost of funding, they may still tinker with the effective tax rates that firms pay.
Most governments maintain ambitious programs to build out infrastructure and social programs. In themselves, of course, these
may well be justified, since they help to raise the productive potential of local economies and drive down excessive saving
rates among households. But not all these programs are instantly required, nor do they deny the possibility of substantial
surpluses; spending may continue, if deemed necessary, as long as increased revenue collection produces the needed tightening
effect.
Apart from curtailing demand, pushing up fiscal savings at a time of possibly excessive private re-leveraging carries another
huge advantage: it provides resources to clean up any financial mess that the current boom may leave behind. Arguably, one
complication in the West was that fiscal positions were in many cases already over-stretched when the global financial crisis
erupted, limiting the option for more aggressive and sustained fiscal action. Asia should be better prepared.
There is also a need to plan for the aging of populations. In countries such as Korea, China, Hong Kong, and Taiwan, this
will inevitably slow growth over the coming decade and thus lay bare hitherto unanticipated fiscal challenges. Elsewhere, in
countries not afflicted with the burden of a rapidly graying citizenry such as India and much of Southeast Asia, aggressive
fiscal tightening would offer a chance to finally achieve meaningful consolidation of the public purse.
The hitch with fiscal tightening, of course, is that it is politically unpalatable on two fronts. Domestically, taxes are easily cut,
and subsidies offered, but the reverse is much harder to achieve. In Asia, moreover, politicians are now often called upon to
alleviate the growing income inequality that cheap money, and the concomitant rally in asset prices, inevitably created. But
leaving inflation simply to fester would only worsen the plight of the region's poor.
Internationally, fiscal tightening in Asia may run into vigorous objections that the region is not pulling its weight in global
rebalancing. Such criticism, however, holds little water. The world would hardly benefit if Asia drowns in a sea of inflation.
Moreover, tempering price pressures in the region helps Western consumers, too, who, in addition to struggling with high
unemployment and considerable debt, are now also facing an unwelcome rise in their cost of living sparked in part by rampant
demand in Asia.
Frederic Neumann
Co-head of Asian Economics
A version of this article appeared into today's Financial Times
The full URL is:
http://www.ft.com/cms/s/0/64cb2c32-4441-11e0-931d-00144feab49a.html#axzz1FOBnMMXN
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
To fight inflation, Asia needs to tighten fiscal policy
Comment in today's Financial Times
Asia risks drowning in inflation. Although it is easy to shrug off the spike in oil and food costs as temporary, something
much more profound is going on. Core prices are now accelerating sharply as well, threatening to kick off a wage-price
spiral. Investors and policy-makers ignore this at their peril. Unless something is done urgently, the hit from inflation
will cut short Asia's impressive recovery.
Monetary policy, in its usual form, no longer works. Raising rates simply draws in more capital, leaving financial conditions
highly stimulative. Currency appreciation, of the size needed to cut off those funds, would be too disruptive. Capital controls
could square the circle, but these are never watertight. Meanwhile, to some, regulatory tightening has become a valid
alternative, yet this is difficult to calibrate and best serves as a complementary, rather than primary, tool to tackle inflation. In
short, the hands of central bankers are tied.
The answer, therefore, is fiscal. Taxes need to go up and spending cut. This would curtail demand and, ultimately, price
pressures. Alas, there is a curious preference, driven presumably by politics more than by sober considerations of public
policy, to push fiscal levers in a downturn but leave them largely untouched when economies improve. A more symmetric use
of fiscal policy is now required to temper growth and inflation.
Yet, instead of tightening up fiscally, Asian governments are heading into the opposite direction. Across the region,
governments will continue to run sizeable deficits over the coming year. The only exceptions are Singapore and Hong Kong.
But, even here, the budgets announced in recent days are surprisingly accommodative. Whatever recent improvements in fiscal
balances there have been in Asia, these were driven by a cyclical bounce in revenues, rather than an active curtailment of the
fiscal impulse.
With inflation stirring, officials have quickly shored up price controls and padded subsidies to cushion the blow. These
measures are costly; and, far from addressing the underlying issue, they merely kick the inflation can down the road. Farmers
will not grow more if their prices are controlled, and car owners will happily continue driving unless the cost of petrol rises.
What's more, by easing the blow, growth will barrel ahead unimpeded, eventually sparking a much broader rise in prices that
hurts everyone.
A pinch from the taxman, therefore, is just what Asia needs. A hike in income tax rates, for example, would weigh on the
purchasing power of households and rein in inflation expectations. Alternatively, rather than join the race to the bottom, a little
tweak to corporate tax rates would help temper private investment. Put bluntly: if officials cannot fine-tune corporate activity
by adjusting the cost of funding, they may still tinker with the effective tax rates that firms pay.
Most governments maintain ambitious programs to build out infrastructure and social programs. In themselves, of course, these
may well be justified, since they help to raise the productive potential of local economies and drive down excessive saving
rates among households. But not all these programs are instantly required, nor do they deny the possibility of substantial
surpluses; spending may continue, if deemed necessary, as long as increased revenue collection produces the needed tightening
effect.
Apart from curtailing demand, pushing up fiscal savings at a time of possibly excessive private re-leveraging carries another
huge advantage: it provides resources to clean up any financial mess that the current boom may leave behind. Arguably, one
complication in the West was that fiscal positions were in many cases already over-stretched when the global financial crisis
erupted, limiting the option for more aggressive and sustained fiscal action. Asia should be better prepared.
There is also a need to plan for the aging of populations. In countries such as Korea, China, Hong Kong, and Taiwan, this
will inevitably slow growth over the coming decade and thus lay bare hitherto unanticipated fiscal challenges. Elsewhere, in
countries not afflicted with the burden of a rapidly graying citizenry such as India and much of Southeast Asia, aggressive
fiscal tightening would offer a chance to finally achieve meaningful consolidation of the public purse.
The hitch with fiscal tightening, of course, is that it is politically unpalatable on two fronts. Domestically, taxes are easily cut,
and subsidies offered, but the reverse is much harder to achieve. In Asia, moreover, politicians are now often called upon to
alleviate the growing income inequality that cheap money, and the concomitant rally in asset prices, inevitably created. But
leaving inflation simply to fester would only worsen the plight of the region's poor.
Internationally, fiscal tightening in Asia may run into vigorous objections that the region is not pulling its weight in global
rebalancing. Such criticism, however, holds little water. The world would hardly benefit if Asia drowns in a sea of inflation.
Moreover, tempering price pressures in the region helps Western consumers, too, who, in addition to struggling with high
unemployment and considerable debt, are now also facing an unwelcome rise in their cost of living sparked in part by rampant
demand in Asia.
Frederic Neumann
Co-head of Asian Economics
A version of this article appeared into today's Financial Times
The full URL is:
http://www.ft.com/cms/s/0/64cb2c32-4441-11e0-931d-00144feab49a.html#axzz1FOBnMMXN
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