## What Drives Inflation in Asia and Why it Matters

_IMF Blog, November 1, 2010_

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## Bibliographic details
- Authors: Anoop Singh
- Published: November 1, 2010

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### Overview
- Title and author: "What Drives Inflation in Asia and Why it Matters" by Anoop Singh.
- Publication date: November 1, 2010.
- Related IMF work referenced: Regional Economic Outlook for the Asia and Pacific region, October 2010.
- Central question: What is driving inflation in Asia, how will inflationary pressures evolve, and what policy tools should policymakers use to manage the withdrawal of crisis-era stimulus while balancing low inflation and economic growth?

### Inflation pressures are building up
- Current assessment: "inflation still isn’t a ‘problem’ in Asia" but "it is on the rise in some countries in the region."
- Core inflation risk: Conditions are "ripe for rising core inflationary pressures—that is, inflation excluding volatile items such as food and energy."
- Contributing factors:
  - Economic activity in much of emerging Asia has been growing faster than expected so far in 2010.
  - 'Output gaps' have been "closing rapidly" (actual output getting close to 'potential' or maximum capacity).
  - Financial conditions "remain still quite accommodative (e.g., low interest rates, plenty of liquidity)."
- Outlook question posed: If growth continues to be robust, could inflationary pressures in Asia accelerate, or is inflation still largely a reflection of global food and energy prices?

### Changing inflation patterns across countries
- Heterogeneity in drivers:
  - China: "inflation mainly responds to food prices, as the economy’s large capacity to supply other goods and services keeps non-food inflation down."
  - India: "although commodity prices are a key factor, both the domestic supply of and demand for goods and services have a significant impact on inflation."
- Three region-wide factors highlighted:
  - First: "the combination of economic growth rates above a country’s ‘potential’ or full capacity, and easy monetary conditions (such as negative real policy rates) is usually a recipe for inflationary pressures down the road."
    - Note: 'output gaps' across the region "are closing rapidly."
  - Second: "although supply shocks (such as commodity prices) continue to matter for inflation in Asia, demand factors are also becoming increasingly important."
    - As Asian economies grow and consume more, "the role of output gaps in driving inflation rates in the region is increasing."
  - Third: When an economy is close to its 'potential', "renewed pressures on global commodity prices may be more likely to add to inflation."
    - Rationale: firms find it easier to pass onto consumers increases in production costs.
    - Additional feedback: "if emerging Asia continues to grow rapidly, this may also lead to higher commodity prices, as demand from the region has become an important driver of many of these prices."

### Policy implications and recommendations
- General implication: If "domestic demand pressures continue to become a bigger factor in core inflation, it will become increasingly important to step up the pace of policy normalization."
  - Empirical note: "this process has already started in many Asian economies, with central banks having raised their policy rates and reserve requirements since late 2009."
- Complicating factor: Recent surge in capital inflows can undermine tightening by "depressing local long-term interest rates," making policy-rate increases less effective.
  - Monetary tightening still important to manage liquidity associated with inflows, especially given prospects for monetary easing in advanced economies and "the generally limited flexibility of exchange rates here."
- Exchange rate policy: "continuing with recent steps to allow for stronger currencies would be more conducive to normalizing the policy stance and would also be more effective in managing volatile capital inflows."
- Medium-term structural policy needs:
  - Recognize that "capital inflows into emerging Asia are likely to remain strong over the medium-term" because of "better growth prospects and stronger policy fundamentals than in advanced economies."
  - Required policies to absorb flows:
    - "deepening of financial markets,"
    - "channeling such flows towards financing broader-based growth and much needed infrastructure."

*Author: Anoop Singh — November 1, 2010*

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## References

- [Regional Economic Outlook](http://www.imf.org/external/pubs/ft/reo/2010/apd/eng/areo1010.htm)

_Source: https://www.imf.org/en/blogs/articles/2010/11/01/what-drives-inflation-in-asia-and-why-it-matters_