Monday September 8, 2008

Is the world facing another stagflation?

By Fintang ng and Leong Hung Yee

The Star

Last week, South Korea and Thailand reported lower inflation for July. Amongst other East Asian economies, inflation has also fallen or was little changed from the month before. However, in the overall picture, global inflation will be markedly higher in 2008, bringing with it stagflation or rising inflation and falling growth

THE 1970s were known for stagflation due to the 1973 oil shock following a war in the Middle East that saw the Arab members of the Organisation of Petroleum Exporting Countries lowering oil production.

Today, the world might be entering another period of stagflation despite lower energy and food prices as a number of countries, especially in the euro area and Japan, have reported slower growth and stock markets continue to weaken.

This time around, the world is again facing heighten geopolitical tensions in the Middle East and other oil producing regions of the world such as Nigeria and Venezuela.

Subprime crisis

Turmoil in the financial markets, resulting from the subprime crisis in the US, continue to haunt investors.

Based on June’s prices, oil and crude palm oil (CPO) were still 99% and 32% higher respectively than the average world market prices in the same period last year. In June 2008, oil and CPO traded at about US$135 per barrel and RM3,300 per tonne, respectively.

Oil was at it highest on July 11 this year, when it traded at over US$147 per barrel while CPO was at its highest in March, when it traded at RM4,486 per tonne.

An economist with a Hong Kong-based bank told StarBiz that lower consumption from countries in the euro area and Japan did not necessarily presage a collapse in commodity prices as strong demand is still coming from emerging markets such as China and India.

Consumers entering a supermarket in Penang. In July, Malaysia’s inflation rose to 8.5% compared with 7.7% in June

“Commodities posted their best performance in more than 30 years in the first six months of this year, rising about 30%.

“In July, they had their worst month in 28 years, falling by 10%,” he said, adding that Goldman Sachs Group Inc had predicted that China’s demand for oil would grow by 5% annually.

Slower GDP growth

For Malaysia, it is the general consensus that growth would slow to between 4.5% and 5% this year compared with last year’s 6.3% while inflation, according to Bank Negara’s forecast, is expected to be between 5.5% and 6%. For the month of July, Malaysia’s inflation rose to 8.5% compared with 7.7% in June.

This of course pales in comparison to Vietnam, where inflation last month surged 28.3% amidst soaring food, housing and transportation costs. The Asian Development Bank has lowered its growth forecast for the country to 6.5% this year and 6.8% next year. Last year, the country’s economy expanded by 8.2%.

The situation is made worst by the breakdown in late July of the Doha round of talks of the World Trade Organisation because curbs on the free flow of goods and labour that this could add to the troubles of stagnating economies.

Australia and New Zealand Banking Group Ltd (ANZ) analysts led by Asia head of economics and research Paul Gruenwald said in a report that growth was slowing across most but not all of Asia with the more export-dependent open economies being the hardest hit.

“We expect growth to continue to slow into 2009 as the external environment weakens further,” he said.

Keith Wade

According to investment bank Schroders plc, on a consensus basis, global inflation is forecast to hit 4.8% while among emerging economies, which includes China, India and a slew of Southeast Asian and Latin American countries, inflation is forecast to hit 8%.

Last year, global inflation was 2.9% while emerging economies saw inflation rising to 5.2%.

US slowdown

Schroders chief economist Keith Wade said in a report that there was increasing evidence a slowdown in the US was affecting the rest of the world, with output in Europe and Japan falling in the second quarter.

“The world economy appears to be re-coupling as evidence increases of the slowdown spreading beyond the US. Both Europe and Japan recorded a fall in GDP during the second quarter and business surveys suggest that there is worse to come,” he said.

Wade said the countries of the Organisation for Economic Cooperation and Development was facing a “coordinated downturn” while pressure was mounting in emerging economies. “In terms of changes in consensus, emerging economies are now in stagflation zone: forecasts for growth are falling while those for inflation are rising,” he added.

Meanwhile, even the six-member Gulf Cooperation Council (GCC), an important oil-producing region of the Middle East, have seen investors exiting its markets as oil price dropped but inflation continued to stay high.

“Foreign institutions are exiting emerging markets as they try to cover positions in the US,” KFH Research Ltd said in a report on the GCC.