Source: The Wall Street Journal                         Date: 11 April, 2011

Asian policy makers need to make tackling inflation through preemptive action a priority, the Asian Development Bank said Wednesday, warning that several central banks may be behind the curve and that some economies are still showing signs of overheating. In its annual Asian Development Outlook report, the ADB tipped output in the region to grow solidly over the next couple of years, forecasting gross domestic product to increase 7.8% in 2011 and 7.7% in 2012, a slight moderation from 9% in 2010.

But the region faces "critical challenges" to support inclusive growth, it said--most immediately to tackle swelling inflationary pressures, but also to foster new sources of expansion, by strengthening economic links between emerging African, Asian, Latin American and Middle Eastern nations.

"Managing inflation is not easy," ADB President Haruhiko Kuroda said in a foreword to the report. He noted that inflation in the region was likely to pick up to 5.3% this year. “Many countries may already be behind the curve in fighting inflation, and some countries are showing signs of overheating. The task is complicated because lifting interest rates may induce foreign capital inflows, which can add to price pressures," he noted.

How best to tackle capital inflows is high up on the International Monetary Fund and the Group of 20 industrialized and emerging nations' list of priorities, and is likely to feature prominently at meetings of financial officials in Washington next week. Capital has flooded into developing nations as growth in emerging markets has bloomed while advanced countries have stagnated. Although inflows are desirable for investment, they can be destabilizing and may also fuel overheating and asset bubbles.

The ADB said that inflation would need to be carefully managed using a "coherent" mixture of tools, rather than relying solely on monetary policy. Exactly what measures were appropriate would depend on the circumstances in the country in question, it said. For countries with persistent current-account imbalances and misalignment between the currency's value and economic fundamentals, more flexible exchange rates may be a better option than raising interest rates or imposing capital controls, the ADB said.

"The recent surge in oil prices could undermine the global recovery, and geopolitical and other factors have heightened uncertainty about future prices," it added. It noted that food prices had hit record levels in February, and that although core inflation was still benign in industrialized nations, oil and food price pressures could fuel inflation in strongly growing developing countries.

Asia's developing countries are home to two-thirds of the world's poor — about 600 million people — who tend to spend more of their incomes on food and will be hit harder by rising food prices.

"This widens income inequality and could potentially lead to social tensions," the report said.