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We expect WPI inflation to remain in the 9.5-10 per cent range for the next few months.SONAL VARMA, NOMURA'S EXECUTIVE DIRECTOR AND INDIA ECONOMIST Asia's elaborate cross-country production network's supply-chain issues arising from the Japan catastrophe are being resolved faster than expected says Robert Subbaraman Nomura' Chief Economist, Asia in a report. This, together with easing commodity prices, could set the stage for growth to regain its vigour in early Q3 2011. Not all is well though, as inflation remains a cause for concern. Business Line spoke to Nomura's ED and India Economist, Ms Sonal Varma, to understand why inflation will remain higher than historic levels in the Asian region. Excerpts from the interview: Your house call is that there could be persistently high inflation going forward in Asia. What leads to this belief? Asia as a region has been slow in terms of policy tightening because central banks have been worried about sluggish global growth and attracting too much capital inflows. So policy tightening has been slow and real interest rates in a lot of Asian countries remain negative. If you have very loose monetary policy, then the risk of that fanning inflation in any case is quite high. Second, unlike global economies where there was a very sharp decline in growth, in Asia, growth has bounced back much faster. So there is not too much slack; unemployment rates are coming down and wage growth is picking up. Three, given that food is a substantial portion of the consumers' basket in Asia, food price inflation remains high across Asia and some of the threats we are seeing in India such as rising food demand and limited supply are also visible in other Asian countries. So that will keep inflationary expectations elevated in Asia. A lot of Asian countries have also controlled domestic fuel and electricity prices. So risk of a one-off fuel and electricity price increase after remaining unchanged for long also exists for other countries in the region. Barring inflation, Nomura is of the view that the major headwinds for Asia have eased. What are the signs of such an ease? The headwinds that Asia was facing were: One, the steep increase in commodity prices that had an inflationary impact. Second, the uncertainty regarding the sovereign debt crisis and how it would be resolved. Third, signs of global growth slowing down and, if that continues, the impact that it would have on Asia. As a house, our baseline scenario is that the slowdown we are seeing globally is a temporary soft patch. And, increasingly, there are signs of capacity that was closed down because of the Japanese earthquake coming back online. For instance, auto production in Thailand has been higher than what we had anticipated. So, some of those supply-chain disruptions are getting sorted out. What threats could the sovereign debt problems in Europe pose to Asia? Our baseline assumption is that Greece will do all the required austerity measures, pass it and implement it and that the IMF/EU/ECB combination will give the €12 billion package. So the basic assumption here is that there is no contagion. The problem arises if there is a contagion from Greece to other peripheral European countries. In that scenario, there could be significant impact on European banks because they have exposure to sovereign debt of other countries, corporate loans and inter-bank loans. So in that scenario, you could see these banks pulling their credit lines to Asia. Second, if there is an impact on European growth, particularly in the core European countries, then there could, to some extent, be an impact on the Asian growth through the export channel. Third, if the European crisis leads to risk aversion, there could be capital outflows from Asia. How different or how serious is the inflationary situation in India compared with other Asian nations? In general, the inflationary problem is common across Asia. While I think the main difference is in terms of the absolute levels of inflation, if you look at the underlying drivers, the theme is very common; you have elevated headline inflation and you are seeing signs of core inflation picking up both in India and rest of the region. The only difference is that in some Asian economies prices have adjusted much faster. In India, the price adjustment, especially on the fuel side, has been very slow. And still there are losses made by the oil marketing companies while selling the petro products. If you look at the average inflation across countries, among the Asian countries, only Vietnam probably has inflation rates which are higher than India. The risk for Asian countries with high inflation is that expectations get entrenched and there also comes the risk of a wage price spiral and a risk that if countries do not tighten sufficiently there could be problem of an asset price bubble building up. What is your take on the inflation numbers for India? In the near-term, we expect inflation readings to remain high because of the fuel price pass-through. Beyond that, we expect some moderation because of global commodity prices falling. But that impact is normally felt with a lag. We expect WPI inflation to remain in the 9.5 per cent to 10 per cent range for the next few months. Even after the moderation, headline inflation both in India and Asia will remain much higher than what it was historically for reasons discussed above
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