Economic Letter from Asia: Some Food for Thought

Investor sentiment has come under pressure following some messaging from the Fed last week to suggest that US interest rates could likely stay higher for longer. As expected, however, Asia’s central banks have held their policy rates steady over the past few days. Additionally, the Bank of Japan (BoJ) left its Yield Curve Control (YCC) parameters unchanged. Meanwhile, in China, banks retained 1-year and 5-year loan prime rates (LPRs) at 3.45% and 4.2%, respectively.

Japan 10-year yields and the yen While the BoJ’s July move to allow greater yield-targeting flexibility has kept challengers to the bank’s upper yield limit at bay so far, JGB yields have been climbing closer to their new implied upper limit of 1%, albeit in a less volatile manner than seen earlier this year. Japan’s 10-year yields have faced upward pressures of late, likely in anticipation of additional YCC tweaks ahead, and on speculation of imminent policy normalization by the central bank.

The yen has faced downward pressure, however, given Japan’s unfavorable yield differentials with other major economies. Against the dollar, the yen has weakened by more than 10% so far this year, as the 2-year yield differential between the US and Japan approached historically-wide levels (chart 2).

China’s policy easing moves China did not instigate any further monetary policy easing moves this week, as it kept its 1-year and 5-year LPRs unchanged. But this follows some broad steps to loosen monetary policy in recent weeks via cuts to its 7-day reverse repo rate, 1-year medium-term lending facility rate, and 1-year LPR in August. The required reserve ratio was additionally lowered for most banks in September. While China’s additional easing moves may come as good news, latest easing moves are still better-characterized as modest, with much uncertainty on growth still stemming from e.g. China’s floundering property sector.

Inflation risks lie ahead Resurgent inflation continues to present a real and present danger to most Asian economies, even after significantly-softer price pressures through most of this year. For one, energy prices, which helped drive down inflation in most Asian economies between mid-2022 and earlier this year, are likely to add upside pressures moving forward – barring domestically-enacted energy subsidies and price controls – given the recent surge in crude oil prices.

Energy matters aside, Asian economies face an added inflation threat from food prices, particularly from that of rice. The latter stems in large part from the impact of India’s export ban. India froze exports of non-basmati white rice in July over concerns of poor harvests due to El Nino effects. Following the ban, the UN Food and Agriculture Organization logged a near-10% increase in its All Rice Price Index in August. For context, India is the world’s largest supplier of rice to the world, accounting for about 40% of global exports in 2022, while Asia is the world’s largest rice consumer, comprising over 90% of global demand.

Apart from inflation risks stemming from food and energy prices, imported inflation – spurred by protracted bouts of domestic currency depreciation – poses a lingering threat to efforts by regional central banks to tackle inflation. Most Asian currencies underwent a renewed bout of weakness this year, clocking significant net year-to-date losses against the dollar. The exception is the Indonesian rupiah, which continues to net a positive (but diminishing) carry over the dollar, and the Indian rupee, which has been supported in part by strong capital inflows from foreign investors.

Foreigner inflows to India Delving deeper, foreign institutional and portfolio investors have poured around a net $19 billion into India’s financial markets so far this year, lending support to the Indian rupee and to India’s FX reserves. The year’s substantial net inflows into India contrasts with net outflows of about $16 billion seen by the end of last year, with most of the year’s net inflows so far allocated to Indian equities, followed by debt instruments.