IS ASSET INFLATION IN ASIA OUT OF CONTROL?

Since the start of the Global Financial Crisis (GFC) or Liquidity Crisis (LC) or General FCUK UP (GFU) -as I like to call it, Asia as a whole has benefitted from the stuttering actions of Central Banks and Governments across the Western World. In a post crisis world, Asias thriving economies, fuelled by cheap labour, infrastructure development, a collective population which contributes to a large domestic consumption market have created an inflation genie. Standard Charted on 28 March 2012 issued a note to clients stating that there are three key developments affecting Asian economies. First, trade surpluses are falling in most economies, reflecting a combination of firm domestic demand and softening exports. Domestic demand is giving retailers and producers in their respective markets the ability to pass on the higher costs and either maintain or increase their margins by increasing their prices. Second, money supply and lending growth are still relatively rapid compared with nominal GDP growth, especially in Thailand, Indonesia and Malaysia. Thirdly, with international capital inflows to Asia expected to remain strong in the quarters ahead, the medium-term threat of asset inflation remains. China's efforts to cool the real-estate sector are ongoing, and Indonesia recently introduced measures to curb lending for property and vehicles. The symptoms are not that simple either, inflation in Asia is being led by a multitude of factors. The economic environment has deemed Inflation as an Enemy of the State. China is already reacting to this by suggesting less Chinese yuan (CNY) appreciation and more volatility. Premier Wen Jiabao is talking about slaying the Inflation Dragon being the key priority of the Communist Party leadership. There are numerous sources of the costs to inflation. Price inflation, through the cost of changing prices will impose menu costs, increase in the cost of raw material which indirectly reduces the monetary holdings, increased uncertainty among producers and consumers trying to determine the real cost of goods and services, tax distortions, and finally the cost of adjusting to unexpected changes in inflation. Increased and unexpected inflation redistributes money from creditors to debtors and from employees to employers. As we have seen, hyperinflation can easily wipe out the value of financial assets. This leads to reduced investment and lower economic growth. Variable inflation rates create uncertainty that affects the level of economic output. All of these inflationary problems result from price inflation of goods and services. Another inflationary problem that is often ignored is asset-price inflation in the real estate market, stock market or other areas. Asset inflation creates artificial wealth, encouraging firms and consumers to borrow beyond their capacity. When the asset inflation ends, firms and individuals are unable to pay their debts leading to declines in demand and to economic slowdowns. Asset inflation is deceptive because people feel wealthier when it occurs, but when asset values get out of line with the nations productive capacity, there will be an inevitable period of catch up in which asset prices adjust downward to their real levels. Both price and asset inflation have their costs. So, you ask the question: How does this affect us today in the post-economic meltdown of the Western World and the rebirth of the Asian Tiger?

An economic environment of increasing wages and good labour market conditions are allowing people to pay higher prices. While this is similar to a wage-price spiral, it can get out of hand if not addressed quickly enough. Then there is the very issue of food and energy prices itself. Higher prices of these staples hit hard into spending and can cause problems, in particular for the poor and those on low incomes. Thus, in many countries, there are complex subsidies in place in areas such as food, fertilizer and fuel. Many of these countries have attempted to manage their inflation by maintaining unsustainable subsidies to control their inflation. A recent example, the riots in Jakarta, Indonesia caused by the increase in fuel prices due to the removal of fuel subsidies. Soaring global oil prices have strained the Indonesias ability to pay for subsidies to keep retail fuel prices below the market values. Lets take a more focused look at China, as a case in point, where the growing influence of events in China continues to cause ripples in the global economy. In March of this year, Chinas Premier Wen Jiaboa made a statement that he was prepared to sacrifice a part of the countrys most vital asset to do so, growth. Premier Wen also needs wages for the countrys 800 million mainly low paid workers to rise quickly enough to help bridge the chasm between rich and poor. Inflation is the surest way to ignite the social unrest that most worries the Party, given that the poor spend almost every penny of their income on basic necessities, the Party and Premier Wen must do it while keeping a lid on costs. This is already being seen in the Port of Shanghai on 22 April 2011, the worlds busiest container port erupted into a violent standoff between police and truck drivers. Angered by spiking fuel costs and consumer prices, truck drivers hauling goods from the Port of Shanghai went on strike which triggered the confrontation with the police. The Port of Shanghai moved almost 80,000 containers in a day in 2010 and overtook Singapore to become the busiest port on the planet. At the time of the riots, the annual inflation rate of China had surged to 5.4%. This was the highest recorded level in more than 2 and a-half years. The potential for runaway inflation was deemed serious enough issue as many of Chinas 1.3 billion citizens are struggling to make ends meet as the price of basic necessities such as food had already surged 12% in prices from the previous year. 12 months down the track, Chinas annual inflation rate has receded to a 20 month low of 3.2%. This measured approach is necessary as any dramatic shift in policy today will have an effect on prices around the world. The rapid growth and inflation in China and other emerging markets also pose a serious challenge to policy makers in advanced economies. There are dangers if China slows down too quickly that a significant curtailing of growth threatens to drive down commodity prices and foreign investment, pushing many advanced economies back into trouble. To further exacerbate the problem, China has a shrinking labour force, mandated double digit wage hikes, an export sector that is losing its competitive edge and an insatiable thirst for raw material imports. Nomura Securities in a note to clients states that With Chinas working age population set to decline steadily from 2012 onward due to retirement, the notion that a minimum 8% GDP growth is necessary to sustain full employment and preserve social stability is now outdated. The other major issue for China is that the countrys economic ascent has been concentrated riches in the hands of an urban elite in the last decade, during which China has become the worlds second largest economy and accumulated approximately $3.2 trillion of official reserves, the largest deposit of foreign wealth on the planet.

The key concern, from a global perspective is that the inflationary shock in China has a significant effect and large impact on commodity prices, which in turn feeds rather quickly into inflation of other Asian economies. Combined with the direct effect through changes in import prices, economies in the region are all exposed to the notable inflation spillovers from China. This is most evident in the property sector of Asian economies. A recent analysis by Standard Chartered of Asian property prices highlights the pressure points in the real estate markets in Asia. The purpose of the study was to use the concept of traffic lights to put the respective real estate markets from the different countries into green, amber and red categories. It is a project management technique called Traffic Light Reporting (Real Estate TLR) used in times of crisis for ascertaining actions and events that are critical to monitoring the project. For those in red, it was deemed that the real estate prices are already too hot, and policy-makers must stop them. Singapore, Hong Kong and Beijing were at the top of this Real Estate TLR. In the case of Hong Kong and Singapore, this reflects the focus of both economies on the exchange rate, resulting in interest rates being too low for domestic needs. Thus, in both places, there is increased use of macro-prudential measures using targeted policies aimed at curbing property prices. Both governments have imposed controls on loan-to-value ratios and curbs on buying multiple properties China, too, is making use of such measures, as it faces an inflation challenge in its first-tier cities. Hence this year China is experimenting with property taxes for the first time. Premier Wen Jiabao's opening address in March 2012 to the largely rubber-stamp annual meeting of parliament, the National People's Congress (NPC), made it crystal clear that the leadership will push ahead with property tax reform. However, carefully scripted complaints from officials in the rich coastal provinces which are expected to join Shanghai and Chongqing in the property tax test have subtly forced Premier Wen to experiment on Beijing instead. Finance Minister Xie Xuren told his annual NPC news conference that China would "appropriately expand the trial" after a serious study of results from Shanghai and Chongqing. This is a good response from the Chinese Government as in the long run, China will need to use taxes and interest rates to curb property speculation. However, the subtle showdown between central and local governments will probably delay a wider roll out of the tax until next year, especially in the wealthier coastal provinces of Jiangsu, Shandong, Guangdong and Zhejiang, all of which sit near the top of analysts' lists of likely locations for stage two trials for the property tax. According to the Real Estate TLR though, property prices across China are in the amber territory and this is especially indicative of many other countries across the region. Thus Asia faces inflation challenges on two fronts: in asset prices, especially in property and equities; and in general terms, across the whole economy, impacting everyone. Central banks across the emerging world need to avoid the lethal combination of cheap money, leverage, and one-way expectations. Ignoring the effects of this is at their own peril as inflation could take off, initially in property but then across the wider economy. All the evidence (anecdotal or empirical, depending on your bias) justifies recent policy tightening by the respective governments. It also supports the case for stronger Asian currencies, as economic fundamentals are good and as a way of curbing imported inflation.

Suresh Kumar CEO and Director of Libertare Pty Limited. Suresh Kumar is a qualified civil engineer from the University of New South Wales and has a Master of Business Administration from Macquarie University. He has a strong background in engineering, project management, investment banking, property finance and real estate investment trusts. Suresh began his career in civil engineering with TY Lin Sdn Bhd in Kuala Lumpur and subsequently worked in investment banking with RHB Sakura Merchant Bankers Berhad in Malaysia. Suresh returned to Australia in 1998 to complete his MBA. He subsequently worked in Elderslie Property Group as a Senior Manager and established the Elderslie Property Syndicate in 2000. Subsequently, he worked as a Property Banker with the National Bank of Australia Limited and Abacus Funds Management Limited where he was largely involved in structuring project finance for residential and commercial development transactions. In 2005, Suresh created the RESIMAC Commercial Mortgage Fund, an A$200Million national fund based in Sydney. This fund specialised in small to medium size commercial property transactions. The RESIMAC Commercial Fund was considered the best small ticket commercial product of 2007 and was nominated for the industry award in October 2007 by the Australian Mortgage Industry. After completing his tenure at RESIMAC Limited in 2008, Suresh formed Libertare as the vehicle for his own strategy and consulting business with a team of colleagues that shared his vision. Libertare specialises in providing consultancy services in property finance, project finance, project management, asset management and strategy. Libertare is currently advising a major European Fund on the strategic direction of its assets in Malaysia and project advisory services to a major project in Indonesia and Myanmar.