Dread disease

Deflation flu could leave Asia feeling very sick

Deflation is entering Asia through the back door. Producer prices are sliding across the region - falling 8.5 per cent even in the Philippines, where GDP grew 7.8 per cent in the first quarter. Cheaper commodities are partly to blame, but the main culprit is sluggish demand from the United States. If companies can't make up the difference, they may struggle to repay growing debts.

Robust local demand, turbocharged by cheap global money, is showing up in frothy real estate prices from Bangkok and Jakarta to Singapore and Hong Kong. But domestic demand is not a major driver for manufacturers in these export-dependent economies. US consumers still largely decide what Asian producers are paid.

And, despite all the money-printing since the 2008 financial crisis, Americans' consumption remains weak.

On average, factory-gate prices in China, Taiwan, South Korea, Malaysia, Indonesia, Singapore, Thailand and the Philippines fell 3.5 per cent in April, the eighth straight month of declines.

The problem is not restricted to Asia. But while Mexican export prices are dropping at a three per cent annual pace, domestic demand is cushioning the fall - economy-wide producer prices are creeping higher. Brazil's manufacturers, meanwhile, are able to charge 5.5 per cent more for their goods than last year.

And, Asia has additional worries. In economies like Thailand and Indonesia, wages are galloping and credit in the region is at its highest level as a proportion of GDP since the 1997 financial crisis. If producers cannot offset their lack of pricing power with volume growth, corporate earnings will be squeezed, undermining companies' ability to service debt. That could spell trouble for the region's banks, especially when the era of global cheap money comes to an end.

Policymakers' options are limited. Cutting interest rates is risky when credit demand is so strong. A better idea might be to guide exchange rates lower, using a combination of capital controls and currency market intervention. That would give exporters more local-currency earnings with which to repay debt. But competitive devaluation can't work for everyone.

Having spent the last four years battling inflationary capital inflows from the West, Asia's monetary doctors must now turn their attention to the dreadful deflation disease.