Higher interest rates will not dampen Asian growth, says MasterCard

MasterCard International is debunking concerns that interest rates will continue to rise, choking economic growth and dampening consumer spending in 2006.

Instead, the report argues that the potential impact of rising interest rates in Asia is likely to be moderate, and that interest rates are expected to stop rising by the second half of the year.

In its latest report "2006 Interest Rate Outlook in Asia and Potential Impact on Consumer Spending," MasterCard presents a case for how weak inflation expectations and intense competitive pressure will maintain strong downward pressure on prices, along with benign demand pressures in the global economy. As the pace of interest rate increases slows and comes to a stop, the potential impact on consumption will be mild.

"The Asian monetary tightening cycle is reaching an end, with interest rates likely to peak in the second half of 2006," Dr. Yuwa Hedrick-Wong, economic advisor to MasterCard International in Asia/Pacific explains. "Consumption in Asia will also be aided by a sufficiently robust external sector in 2006. In spite of an expected slowdown in growth in China, the recovery in Japan and sustained strong capital spending in the US will keep the external sector humming through the year."

"The Fed is expected to stop the rate increases in mid-year, further bolstering the case for sustained capital spending in the US. Consumption in Asia would therefore be supported by growth in income and employment due to stable external demand," added Hedrick-Wong.

The report presented the results of an analysis on private consumption expenditure in a number of Asian economies. It found that while the potential impact of rising interest rates is the greatest in Singapore, the view that interest rates have already peaked in Singapore and are likely to ease this year means there is virtually no risk posed to consumption or investment spending.

Impact across the other Asian economies was also expected to be minimal, with the cumulative effect of an increase in interest rate on private consumption expenditure smallest in Thailand Japan, which is showing signs of a sustained recovery, is unlikely to be affected as there is no expected change in interest rates.

Limited Monetary Tightening in Asia: Global Inflationary Forces Remain Muted Output gaps are falling almost everywhere in Asia and the lagged effects of higher oil prices will work their way through to higher prices in 2006. While this will lead to some pressure for interest rates to rise in the short term, resulting in some monetary tightening in the G3 economies, the degree of tightening will be more modest than many currently expect.

There are significant mitigating factors that continue to put substantial downward pressure on inflation. Trade liberalization and the entry of formerly-closed economies into the world-trading system are producing an ongoing intensification of trade competition which seriously constrains pricing power and hence inflation.

This damper on global inflation is strengthening because China’s exports of its huge inventories of finished goods will provide intense trade competition as Chinese producers cut prices to gain market share.

The service sector has also become more exposed to trade competition and the increasing competitive advantage of India, China and Southeast Asia in more service areas will limit service sector inflation.

With services accounting for about 70 percent of the consumer price index in most developed countries, the dampening effect on inflation will be significant.

Interest rate policy is also not the only tool to look at in order to determine the outlook for overall monetary conditions. Exchange rate policy and fiscal policy are also important tools, and both a strengthening exchange rate as well as fiscal consolidation will contribute to a tighter monetary policy and control of domestic demand.

Policy rates are therefore expected to rise only moderately across Asia in early 2006 and then stop rising later in the year. Market rates to borrowers and lenders will likely follow suit.

However, rising investment rates in many parts of Asia–will tend to raise demand for loans and in doing so raise loan-deposit ratios, adding some pressure for market lending and deposit rates to rise eventually – a particular risk in India.