Inflation a key risk to AsiaÆs economic growth

Citi says the region is in a better position to withstand external shocks, but it isnÆt decoupling from the US and the rest of the world.
Asian economic growth will likely remain strong over the next two years, with China and India continuing their impressive expansion, but inflation is a key risk factor, according to CitiÆs report on the regionÆs economic prospects.

ôHeadline inflation rates ratcheted up recently in most Asian economies on high food and energy prices,ö Citi says. ôIf these prices remain at elevated levels, core inflation rates may catch up eventually.ö

A more important risk probably lies with asset prices in Asia, Citi says.

The US Federal Reserve is expected to continue its monetary easing policy and that could mean accelerating capital inflows to Asia at a time when capital inflows within the region are also expected to rise. These could support Asian currencies and asset markets but also raise the risk of asset bubbles, Citi says.

Continued policy easing by the Fed and persistent market volatility could add downward pressure on short-term interest rates in Asia, especially in Hong Kong, Singapore and the Philippines as well as increase the probability of policy rate cuts in India and Indonesia, Citi says.

But that general policy direction could reverse if inflation rates pick up sharply. Citi expects China and Taiwan to raise interest rates in their efforts to fight high inflation.

ôThe Chinese renminbi and Indian rupee should play greater roles accommodating US dollar weakness going forward,ö Citi says.

Citi notes that the rupee has appreciated by 15.4% against the US dollar for the past year, while renminbi appreciation accelerated to an annualised pace of 16.8% for the past month.

Aside from the key risk of inflation, other factors could affect the regionÆs growth over the next two years, notably the threat of a US recession, the return of the bird flu, and persistent high oil prices, Citi says.

Citi joins those who scoff at the idea that Asia is on the verge of decoupling from the US and the rest of the world.

ôDecoupling Asiaö is probably the most popular investment thesis today, Citi notes, adding that the usual evidence supporting this argument includes the growing Chinese economy and increasing intra-regional trade.

ôOur analyses suggest that correlations of economic activities and financial markets in Asian and in the US increased during the past decade,ö Citi says, adding that while intra-regional trade surged, much of it involved trade of intermediate goods.

While Citi believes Asia is not decoupling, it acknowledges that the regionÆs economies have become more robust in terms of debt structure, foreign reserves, current accounts, fiscal balances and financial institutions. ôThey are in better positions to withstand external shocks.ö
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