Deflation rears its head in Asia

Deflation rears its head in Asia

Alan Wheatley, Reuters, Tokyo

The spectre of deflation is haunting Asia, bringing the risk
of further pain to a region struggling with one of the steepest
economic downturns on record.

Economists said the unfolding shock to global demand, coupled
with a flood of goods from low-cost China, was putting heavy
downward pressure on prices and could pose serious policy
challenges if the trend persisted.

"It could cause a lot of problems. You just need to look at
Japan. It could cause banking systems to become more fragile,
borrowers to suffer even more as their debts get larger and make
life difficult for policy makers, too," said Rob Subbaraman of
Lehman Bothers in Tokyo.

The danger of deflation has come into focus after China and
Taiwan both suffered an outright year-on-year decline in consumer
prices in September.

They joined Hong Kong, which has experienced 35 straight
months of falling prices because of its fixed exchange rate,
which forces domestic prices to decline to retain
competitiveness.

Demand has taken such a hit, driving down the price of
everything from oil to computer chips, that Subbaraman saw a risk
of deflation spreading beyond Greater China.

In Singapore, for instance, year-on-year consumer price
inflation slowed to 0.8 percent in the third quarter from 1.7
percent in the second and is officially forecast to fall to less
than 0.5 percent this quarter. Wholesale prices in September fell
1.4 percent.

The slide in Asian inflation contrasts with a surge in prices
during the last recession in 1997/98. That was because fixed
exchange rates had collapsed during the 1997 financial crisis,
sending currencies into an inflationary tailspin.

Another structural factor weighing on prices is the inexorable
rise of China as the world's lowest-cost producer in most
sectors, robbing its competitors of pricing power.

Andy Xie of Morgan Stanley in Hong Kong said deflationary
pressure was particularly acute in manufacturing, where assembly
companies that have set up shop in China are now pressing their
suppliers to follow them.

"As layers of component manufacturers move to China, Chinese
labor costs work through the whole value chain and can ultimately
bring prices down by one third or more for a large number of
products that are traded in the world today," Xie said in a
recent report.

With rapid urbanization likely to keep a lid on China's labor
costs, and the home market unable to absorb its growing output,
Vincent Chan of UBS Warburg in Hong Kong said he expected China
to continue to export deflation.

"China's exports have been holding down world inflationary
pressure, and I think that's going to last a long period of
time," he said.

Low, stable inflation is good for growth because it gives
investors confidence to make long-term commitments.

But broad, sustained price falls are a curse: consumers are
tempted to postpone purchases knowing prices will get cheaper;
borrowers have to sell or earn more to repay their debts; and
declining asset prices stifle loan growth and economic activity,
locking the economy into a vicious cycle of debt deflation.