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Korean rate rise shows turning Asian economic tide

TOKYO: Higher short-term Korean interest rates are a sign of things to come in Asia and highlight central bankers' dilemma -- whether to bear down on inflation through monetary or exchange rate policy, economists said on Thursday.

In announcing that it will guide its overnight call rate to five percent from 4.75 percent, the Bank of Korea said it was acting not to nip inflation in the bud but to narrow a destabilising gap between short-term rates and bond yields.

Nevertheless, as Asia recovers briskly from the financial crisis that started in 1997 and plunged the region deep into recession, economists said the risks of the eternal trade-off for policy-makers between growth and inflation were slowly shifting.

"Last year was the year of turnaround based on trade surpluses but people's attention now is beginning to focus, rightly or wrongly, on the inflationary consequences of that," said Graham Courtney, executive director for Asian economics at Warburg Dillon Read in Tokyo.

"It may be too early, but attention seems to be moving a little bit away from growth -- which is taken as a given and to inflation, certainly in places like Korea," he said.

No one is forecasting sharply higher interest rates: output has not yet regained pre-crisis levels, excess industrial capacity still has to be worked off and borrowing costs need to be held down to nurse weak banking systems back to health.

Korea, moreover, is well ahead in the regional recovery stakes: the central bank expects 10 percent growth this year, about the same scorching pace as in 1999.

"Over the course of the year we would expect only a mild tightening across the region," said P.K. Basu, chief economist for Southeast Asia at Credit Suisse First Boston in Singapore.

In Singapore, for instance, unit labour costs are falling quite sharply as a result of continued productivity growth.

Nevertheless, the Monetary Authority of Singapore is likely to engineer a rise in its local dollar in the second quarter sufficient to nudge interbank rates up by half a percentage point, Basu said.

BEHIND THE CURVE?

Some economists believe structural reforms and deregulation in Asia, coupled with the downward pressure that the boom in electronic commerce will put on prices, means interest rates will be able to stay lower for longer.

But Russell Jones, chief economist for non-Japan Asia at Lehman Brothers in Tokyo, is less sanguine. He is worried that political pressures will prevent central banks in the region from seizing a historic opportunity to lock in price stability.

The cost of borrowing will indeed rise over the next 12 to 18 months, but not by enough to keep prices stable. "Central banks in Asia are likely to be behind the curve," he said.

The dilemma facing central bankers is already apparent in some countries' exchange rate management. Malaysia is an acute case. With the ringgit pegged at a very competitive level of 3.80 per dollar, the country is enjoying big current account surpluses that are fuelling rapid money growth.

To stop this excess liquidity from kindling inflation, a number of economists believe Malaysia will sooner or later have to consider ending its fixed exchange rate regime.

"From some time later in 2000, we expect the need for a revised exchange rate regime should become more pressing," Courtney at WDR said.

Taiwan, by contrast, has successfully kept a lid on imported inflation by allowing the local dollar to rise against the yen, Courtney argued.

In the case of Korea, Desmond Supple, economics director for Barclays Capital in Singapore, said future monetary tightening was likely to occur primarily through the exchange rate too. Letting the won firm against the dollar would hold down import costs.

But Supple said the task of juggling the levers of monetary policy was being complicated by the weak trend of the yen as Japan is a big competitor of Korea's in third markets.

"Tightening monetary policy due to inflationary concerns does pose an export growth constraint on the economy because yen/won is often a more crucial variable in determining export competitiveness," Supple said.-Reuters