Mainland China and India are the world’s two most populous countries. Yet in one, output is well above 2019 levels and prices are falling, while in the other, activity has tumbled and prices soared. Which provides a template for things to come?

Indian inflation has exceeded the central bank’s target range every month since March. The cause is not food prices: core inflation has been remarkably elevated, despite India experiencing the sharpest output decline of any major economy.

By contrast, China’s economy is firing on all cylinders. Yet headline consumer-price inflation has turned negative on the year and producer-price inflation remains firmly deflationary.

So, for all the chatter about possible monetary tightening in mainland China in 2021, deflation, not inflation, is currently the bigger risk.

What do these two economies, with vastly different circumstances, tell us for Asia’s inflation outlook for 2021?

Mainland China’s headline inflation is down in part because pork prices are starting to stabilise whereas India’s rate has been elevated by higher agricultural product costs.

Food prices are important for headline CPIs in Asia and there are some notable trends. Global food prices have risen at their fastest pace since July 2012 with the rise was broad-based, increasing across all food categories.

Meanwhile, the La Niña phenomenon - often associated with disruptions to food production across the region - will strengthen in coming months. But while agricultural product costs may become more volatile during the first half of 2021, this will be a temporary effect, not a more permanent inflation impulse.

However, oil prices have been recovering. If Brent crude is still around USD50 a barrel in March, that will be a 230 per cent annual increase. It would inevitably impact on headline inflation, just when global growth shifts up, so will further fuel concerns about a more persistent spurt in inflation.

But again it is important to differentiate between higher inflation statistics and persistent underlying price pressures. Oil’s impact on the headline figure will fade quickly unless crude keeps increasing.

Core price inflation is key. Goods production in most of Asia was surprisingly resilient in 2020, partly because household spending globally shifted from services towards goods. That benefitted Asia’s exports, but with vaccines now rolling out, the service sector will see the biggest improvement in demand.

Core price pressures are thus more likely to come from services. And these may indeed jump, especially if underlying supply has been impaired - say, because restaurants are closed.

However, services comprise a smaller share of many inflation baskets in Asia and many service prices are controlled by government intervention. And consumers will not tolerate sharp increases for long, especially in Asia’s emerging economies, where governments have done relatively little to support impaired household incomes.

Further, service prices are largely driven by labour costs. With wages much more flexible in Asia, especially in emerging countries, and labour markets still reeling from the pandemic, wage-driven service price inflation seems unlikely in 2021.

So, while higher inflation volatility is likely, a surge in underlying price pressures in 2021 that would worry central bankers is not. There will be a bit of India, therefore, but a bit of China too.

First published 7 December 2020.

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