Block’s Indicator of Sustainable Growth

Back in the 1970s, stagnant economies and rising inflation on the back of three OPEC oil shocks was a major handicap to growth. 2008 has similarities with the 1970s, with recessions in both the US and UK, and the European Union and Japan not doing that much better.

In all these countries, inflation is on the rise with rising prices in both oil and foodstuffs. This is stagflation and it shows no signs of moderating.

By comparison with the stagnant growth in the industrial countries, the developing economies in Asia are still growing strongly, but governments are losing the battle to keep prices at stable levels.

Stephen Roach, the chairman of Morgan Stanley said in the Financial Times (June 12 2008), that the surging inflation rate in Asia, the world’s industrial producer has dangerous risks to the global economy.

In developing Asia, consumer prices rose by 7.5 per cent in the four months to April 2008, close to a nine and a half year high, and more than double the 3.6 per cent pace of a year ago. Food makes up a giant share in the make up of the CPI index. In China, the CPI weighting for food is 33 per cent and in India, it is even higher at 57 per cent.

The only good news in recent weeks was the UN Food and Agricultural Organization reporting in July that food commodity prices has slowed down since March 2008.

Even when you strip out food and energy prices, the inflation rate in developing Asia was still at double the rate of last year reaching 3.8 per cent in April.

Given its industrial size, the main country culprit is China with the average annual inflation rate surging 8.3 per cent in the four months ending May 2008.

The irony is that in the last decade, it was cheap Chinese exports along with tight wage growth in the west, which kept inflation under control in both America and Europe. A reversal was becoming evident in 2007, with rising Chinese export prices and 2008 is repeating the price patterns of last year. Asia is now exporting inflation to the west.

China’s inflation battle has finally been slowed, with government controls further restricting lending and raising bank reserve requirements to record levels. After April’s CPI increase of 8.5 per cent, China’s inflation rate had moderated to 7.1 per cent in June.

While Chinese food prices have finally settled down at least for now, the inflation ogre is still around, with higher prices in non-food categories. Record capital inflow into China has contributed to excess domestic liquidity, compounding the task of curbing inflation.

One area that is more difficult to control is energy prices, which as in most other Asian countries is somewhat protected by fuel subsidies, but these are slowly being reduced. China, with record electricity generation growth is forced to import ever larger quantities of coal, where prices have sharply increased over recent months.

Chinese producer prices have accelerated faster than the CPI in the last two months, reaching 8.8 per cent in June, squeezing producer margins. At the same time, higher energy prices lifting costs for the industrial sector, with wage increases and the sharply rising import bill for commodities point to additional price pressures in the months ahead.

India hasn’t been as successful as China in inflation control, with price pressures still very strong. The inflation rate in the 12 months to July 5 was a high 11.9 per cent. Inflation is now at a 13 year high well above the political comfort level of 5.5 per cent. Along with prices, interest rates have also increased reaching 8.25 per cent, its highest level in six years.

Indian salaries are expected to rise by 15 per cent a year until 2011, not a good sign of bringing inflation under control. Across the border, Pakistan’s annual inflation rate is even higher rising to an annual rate of 19.3 per cent in May.

Singapore, for long a model of consistency in high productivity growth and low inflation is now having its tough with a 26 year inflation rate high of 7.5 per cent against the background of a shrinking economy.

The International Monetary Fund expects inflation to hit 9.1 per cent in the emerging world this year and remain high at 7 .4 per cent in 2009.

The spectre of rising inflation has seen Eurozone inflation reaching a high of 4 per cent in June, double the European Central Bank target, while the US CPI rose to a 17 year high cent of 5 per cent in June. Pimco, the world’s largest bond fund is forecasting inflation to remain above central banks’ targets for several years.

Monetary Fund, emerging world, Eurozone, US CPI, global economy