Threat to ASEAN economic recovery in 2022 and beyond – The Diplomat

Pacific money | Economy | Southeast Asia

Rising food and energy prices should dampen economic growth by reducing real private consumption and investment.

Inflation: A Threat to ASEAN's Economic Recovery in 2022 and Beyond

People on motorcycles drive past a gasoline vendor in Denpasar, Bali, Indonesia, on September 12, 2011.

Credit: Depositphotos

Rising global inflation could dampen ASEAN economic recovery in 2022. In June, the World Bank predicted in its Global economic outlook that the inflation rate in advanced economies rose from 1.9 percent to 6.95 percent annually through April, while the inflation rate in emerging market and developing countries increased from 4.23 percent to 9.37 percent in the same period. High inflation is expected to be permanent, not temporary, as Russia’s invasion of Ukraine has led to further increases in food and energy prices, hitting net food and/or energy importers particularly hard.

The surge in inflation forced central banks to tighten monetary policy to control rising prices. Tighter financial conditions, especially in large advanced economies, could reduce their outflow of foreign direct investment (FDI) to ASEAN countries. The US Federal Reserve, for example, raised the federal funds rate. interest rate that commercial banks are paying for overnight loans of reserve balances from the Fed—three times in the first half of this year, starting 0.25 percent March 2020 to 0.50 percent March of this year, then 1 percent in May and 1.75 percent in June.

A higher interest rate increases the cost of borrowing for both businesses and consumers. The higher cost of credit reduces domestic private investment and consumption, while discouraging firms from investing abroad. Foreign investors are less able to profit from expanding current projects or investing in new ones as production costs, usually financed by bank loans, rise.

FDI inflows provide largest source of external financing in the ASEAN economies. USA is the largest source of FDI inflow in ASEAN, with $35 billion (or 26 percent) of total FDI inflows to ASEAN in 2020. Reduced FDI inflows could dampen the recovery of the ASEAN economy by reducing employment opportunities for the ASEAN workforce, capital to fund private investment, and corporate tax revenue to finance government spending.

An upward trend in inflation is also observed in the ASEAN countries as a whole. The ASEAN average inflation rate increased from 0.9 percent in January 2021 to 3.1 percent in December 2021 and then to 4.7 percent in April 2022 (Figure 1). Four ASEAN countries experienced a rapid rise in inflation in the year to April. These include Indonesia (149 percent), Singapore (161 percent), Laos (206 percent) and Thailand (267 percent). Inflation fell in Malaysia, while it remained virtually unchanged in the Philippines and Vietnam.

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Unlike the Fed, ASEAN central banks have not yet responded to rising inflation with a tight monetary policy. For example, as of June 10, the Bank of Thailand maintained its policy interest rate—the rate at which the central bank charges commercial banks loans—at 0.5 percent since May 2020. This may reflect the need to support economic recovery by maintaining available financial resources for private investment and consumption. It may also reflect monetary policy restraints to reduce high inflation driven by supply-side pressures such as rising food and energy prices or labor shortages due to the COVID-19 pandemic.

However, rising food and energy prices could dampen growth in ASEAN by reducing real private consumption and investment, despite the lack of monetary tightening. Higher food prices reduce the purchasing power of households as they have to spend more money to buy the same amount of food. Food inflation could further increase the number of undernourished people in ASEAN countries, where proportion of undernourished people in total population in 2019 ranges from 5.3 percent in Laos to 6.5 percent in Indonesia, 6.7 percent in Vietnam, 7.6 percent in Myanmar, 8.2 percent in Thailand and 9.4 percent in the Philippines .

The impact of rising food prices on household consumption is expected to be particularly large in Thailand and Indonesia, as these countries experience relatively high inflation and a high share of household spending on food. share of consumer spending on food ranges from 7% in Singapore to 21% in Malaysia, 26% in Thailand, 31% in Indonesia, 39% in Vietnam and 42% in the Philippines. The risk of a decline in real household consumption may reduce investor confidence, and rising energy prices will increase transport costs. These two factors will prevent firms from expanding their business.

Global inflation becomes a threat to the ASEAN economic recovery in 2022 and beyond. This could dampen economic growth in the region by reducing FDI inflows, real private consumption and private investment. It could also lead to more widespread malnutrition, with long-term implications for human capital development in ASEAN countries.