Asia faces tough test as prices soar

Seoul, Jakarta: Inflation hit a seven-year high in South Korea in May, neared a decade peak in Thailand and crossed into double digits in Indonesia as Asia's policymakers grapple with their toughest test since the 1997 financial crisis.

Across the region central banks are under growing pressure to tighten monetary policy to prevent $130-a-barrel oil and soaring commodity prices from seeping into wages and other costs. Governments fear rate hikes could choke off slowing growth.

India's prime minister said he hoped Asia's third-largest economy would be able to do both - check inflation and support growth in the face of a global slowdown triggered by the fallout from US credit crisis.

"Asian central banks have not faced a scenario like this since the Asian crisis," said Huw McKay, an econ-omist at Westpac, noting that the declining gap between output and demand meant that economies would find it more difficult to grow quickly without pushing up prices.

"It's a huge challenge for them, because running monetary policy with economies running close to capacity is a job which requires a lot more finesse than running monetary policy when you have a lot of spare capacity," he said.

Nowhere has the inflation-versus-growth debate been as bitter as in South Korea, where the government has been pressing the central bank to cut rates, to help it meet an election pledge on the economy.

The central bank gained room for manoeuvre yesterday from data showing the consumer price index rose 4.9 per cent in May, the fastest rate since June 2001 and above the central bank's comfort zone. The Bank of Korea will definitely miss its inflation target if oil prices do not plunge," said Oh Suk-tae, economist at Citibank.

"So markets will expect an interest rate hike despite the fact that the government wants the Bank of Korea to ease monetary policy to boost the economy."

The inflation spike also has the government worried. The finance minister said last week the won may have fallen too fast and authorities stepped into the foreign exchange market to support the currency.

Indonesia's CPI rose in May by 10.38 per cent from a year earlier, up from 8.96 per cent the month before and the fastest pace in 20 months.

Meanwhile, Thailand's annual consumer inflation hit a near 10-year high of 7.6 per cent in May, jumping from 6.2 per cent in April.

All the results were higher than forecast and prompted economists to anticipate rises in interest rates, a bitter pill at a time when weaker global demand already threatens to set some economies across the region off their paths of robust growth.

In Indonesia, the acceleration in inflation reinforced existing expectations that the central bank will raise rates later this week for the second time this year.

The pick-up in inflation partly reflected a sharp rise at the end of May in state-controlled fuel prices to relieve pressure on government subsidies that have been hit by record oil prices, which hit a high above $135 a barrel last month but have since retreated to below $127.

"This is not the peak; inflation may accelerate further in the coming months," said Juniman, an economist at PT Bank Internasional Indonesia.

Most analysts predict Bank Indonesia will raise its key interest rate by 25 basis points to 8.50 per cent when the central bank reviews policy on Thursday, and to tighten further later this year if inflationary pressures remain high.

McKay said that relatively healthy export and consumption figures should mean that Indonesia will be able to weather a rate rise without it presenting much of a threat to growth.