A challenging 2008 for Asia - Calories, capital and climate spur anxiety

SINGAPORE: The new year maybe a challenging one for Asian policymakers.

Year-end US closing stocks for wheat are the lowest in six decades. Soybeans in Chicago touched a 34-year peak this week. And palm oil in Malaysia climbed to a record on Wednesday.

The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc economist in Hong Kong. Growing use of food crops in-biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.

The wholesale price of pork in China has surged 53% in the past year.

"Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows," Subbaraman says.

If the US Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.

As Asian central banks raise interest rates - when the Fed is cutting them - they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region's exports.

On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.

That isn't all.

Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast growing Asian countries such as China and India.

As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal - relative to crude oil -has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.

This does not augur well for the environment.

"Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more

intensive in carbon than it would otherwise be," Gros said.

Climate-related issues will be in the spotlight in Asia next year. China's eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges would be one of the "big things to watch for" in Asia in 2008, Spire Research and Consulting" a Singapore-based advisory firm, said last week.

In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.

That will leave capital flows as Asia's No. 1 challenge in 2008. And it won't be an easy one for policymakers to tackle.

Take India example. The US$900bil economy has attracted US$100bil in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.

This has caused the rupee to appreciate more than 12% against the US dollar this year, knocking off more than three percentage points from India's inflation index, says Lombard Street Research economist Maya Bhandari in London.

China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan - the root cause of its record trade surpluses and the attendant liquidity glut - until the Olympics are out of the way.

Asian economies may, to a large extent, be insulated from the sub-prime mess. Still, 2008 won't be all fun and games. — Bloomberg

"Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation" LEHMAN ECONOMIST