Rising oil price adds to Asia inflation headaches

Mumbai (Reuters): Rising oil prices present a new inflationary headache for Asia and further complicate the task of policymakers grappling with broader price pressures, an uneven growth outlook and surging dollar inflows.

Central bankers in Asia are reluctant to stifle growth by raising rates and are wary of exacerbating yield differentials with western economies and Japan that would further attract potentially destabilising capital flows.

At the same time, rising prices are politically fraught in countries such as India and Indonesia, which must decide between taking the fiscal hit of offsetting fuel price increases through subsidies or pass costs onto inflation-wary consumers.

Inflation is also a big worry for global economic powerhouse China, whose leadership perceives rising costs of living as a threat to social peace and stability.

Beijing’s Christmas day rate rise – its second in two months – underscored how its focus has shifted from nurturing growth to getting prices under control and India is expected to follow, resuming a tightening cycle that has brought six rate increases since March.

Asia’s No. 1 and 3 economies can find comfort in signs that growth had sufficient momentum to withstand further policy tightening, but others – particularly those relying heavily on exports – seem less certain about next year’s prospects. Yet South Korea, Indonesia, Thailand and Philippines are all also expected to tighten monetary conditions in 2011.

While raising rates can do little to cap cost-driven or imported inflation, it can help cool overall demand and contain inflationary expectations stoked by a broad rally in commodity markets.

“It is difficult for individual countries such as South Korea to deal with inflationary pressure coming from these external cost factors,” said Lee Sung-kwon, chief economist at Shinhan Investment Corp in Seoul.

Lee said lowering tariffs on raw material imports, for example, will have a small impact on easing prices in South Korea, and expects the central bank to raise rates once each in the first and second quarters, to 3 percent from 2.5 percent now.

“Global prices of oil and raw materials will stabilise if China raises interest rates and the impact of the hikes materialise in that economy,” Lee said.

High and rising

Oil prices have risen steadily this quarter. Benchmark U.S. crude hit a 26-month high on Monday near $92 per barrel and is forecast by some analysts to be headed to $100, driven by quantitative easing in the United States and as robust growth in China and India drive demand.

A weak dollar and OPEC’s evident reluctance to increase output add to the case for costlier oil in 2011.

“We see broad price rises in soft commodities, hard commodities and black commodities (oil and coal), which have translated into imported inflation and imported cost increases,” said Chen Xingdong, Chief China Economist at BNP Paribas.

Demand for oil products in China, the world’s No.2 consumer, rose 13.9 percent annually in November, as millions more Chinese bought cars and industrial and petrochemical demand boomed, despite a two-year old fuel pricing system designed to ensure rising crude oil costs were passed on to consumers.

Beyond energy

In India, New Delhi this week deferred a decision on whether to lift the state-set price of diesel and cooking fuels, which would add to inflation, annoy the embattled ruling Congress party’s rural base and further embolden the political opposition.

Headline inflation in India was 7.48 percent in November, and the central bank’s 5.5 percent inflation target for the end of the fiscal year in March appears increasingly out of reach as food and fuel price rises accelerate.

The rise in global crude prices comes on top of high food prices and surging growth in many Asian economies.

Chen estimated that while fuels contributed 10 percent to China’s 5.1 percent November inflation, a 28-month high, food accounted for 74 percent.

Food prices, which like energy tend to be beyond the scope of monetary policy, jumped 11.7 percent in China in the year to November, while India’s food price index rose 14.44 percent on the year as of Dec. 18.

“Rising oil prices will not be the only problem for inflation. Higher food prices and wages, which are seen across Asia, will also push up inflation from the demand side,” said Nuchjarin Panarode, Economist at Capital Nomura in Bangkok.