South Korea's central bank left interest rates on hold on Thursday, setting in all likelihood a precedent for Asian policymakers forced to respond to the global economic slump and briefly halt their battle against inflation, according to Reuters. The Bank of Korea was unambiguous in its statement, saying that while inflation would remain high, the downside risks to growth had increased. Even market analysts, who have been wrong-footed by this central bank consistently this year, had seen this coming through the past weeks as they watched a deepening debt crisis in the euro zone and rapid deterioration in prospects for the U.S. economy. Heavy losses in global financial markets in recent sessions have only added to the case for central banks to put any further tightening plans on hold for now. "It can be viewed as a temporary pause," said Park Hee-Chan, an economist with Mirae Securities. "Although there is big economic uncertainty lying ahead, from what we can see the current situation is not that desperate or dangerous." The past week's market turbulence, which has seen the Korean stock market tumble 18 percent so far this month, gives authorities a valid excuse to refrain from tightening policy. Norway did likewise this week as did Indonesia, although the latter is in a relatively healthier growth-inflation situation. Some economists worried that Korea may have missed an opportunity to raise rates. The policy rate has been steady at 3.25 percent since June, painfully below inflation running at an annual pace of 4.7 percent. But with core inflation also uncomfortably high at 3.8 percent, policy rates certainly need to be higher. Without doubt, the policy terrain for Korea and Asia's other high-growth economies has become extremely tricky after the U.S. Federal Reserve pledged this week to keep its policy rates near zero for at least two years. At worst, Asian policymakers face a long period of extremely weak demand abroad for their exports, a drying up of foreign credit and possibly another round of heavy monetary stimulus by the Fed. At home, they have to contend with high and still rising core inflation, tight capacity and labour markets, and yet also question marks about overall growth. Alongside that emerges the risk that these central banks do a volte-face on monetary tightening right now, only to find the remnants of still strong price pressures manifest themselves in uncomfortable ways in the economy. NOT DROPPING THE BALL Even under a base-case scenario in which the euro zone slows considerably and the U.S. economy cools but avoids a recession, it is possible several Asian countries that ought to be raising rates will instead hit the pause button on policy, said Yougesh Khatri, economist with Nomura Securities. The Philippine central bank governor hinted as much this week. "Even as the surge in flows could continue to complicate monetary policy, the specific timeframe provided by the Fed gives us monetary policy space," Governor Amando Tetangco said. "What we need to work double time on is strengthening domestic demand to make up for potentially slower trade, given the more negative growth outlook in the U.S. and Europe." That primarily is the worry: that the battle against inflation will be compromised in some of these countries, particularly those where the political influence is heavy. The odds are stacking up against mostly export-dependent Asia. Wall Street economists put the odds of a U.S. recession at one-in-three, while a Reuters poll of 200 economists forecast a 25 percent chance of a U.S. recession and a 30 percent possibility the Fed will launch a third round of quantitative easing. Commodity prices have fallen. The Reuters-Jefferies CRB index , a global commodities benchmark, has slid 7 percent this month. That should provide quite a bit of respite to Asia, where food and fuel can make up as much as 40 percent of the consumer price basket. But plenty of central banks are in a quandary. Australia's central bank faces high underlying inflationary pressures residing alongside weakness in sections of its economy. China's inflation at 6.5 percent is at 3-year highs, presenting a weighty dilemma for authorities who have to be careful about managing growth expectations not just within the world's second-largest economy but also in twitchy global markets whose participants keep a close watch on this last major growth engine. India's wholesale prices inflation at 9.4 percent is significantly above the Reserve Bank of India's 8 percent policy lending rate. Nomura's Khatri reckons that markets give Asian central banks less credit than they are due, citing the example of Malaysia and Singapore which had the foresight to begin raising rates in the aftermath of the financial crisis in 2010, well before inflation reared its head. "Yes, rates are still supportive, and more supportive than they ought to be if you care about just output gaps and potential inflation." "But very sensibly they had an eye on the global uncertainty and downside risk, which is manifesting. So they were sensible not to tighten too quickly," Khatri said. Indeed, Korea's central bank made clear on Thursday it had not shifted its stance, namely that of "normalising" policy. And 13 out of 16 respondents in a Reuters poll on Thursday said there would be at least one more rate rise in Korea in 2011. HSBC is in the same camp. Its base-case scenario is for global growth to recover gradually and domestic demand to remain a solid prop for the Asian economies. "We still view inflation as the dominant concern for policymakers in Asia," said Leif Eskesen, Chief Economist for India & ASEAN at HSBC.
