It warns that core inflation, a measure of price increase that excludes food and energy costs, is rising across the region - signaling that a more broad-based second-round price effect may be underway.
Even as growth moderates, there are little signs of price pressures, fuelled by high energy and food costs, subsiding. Inflation is expected to rise to 6.3%, more than double the rate of the past ten-year average inflation. This has serious implications as the average household in the region spends over fifty percent of its monthly expenditure on food and fuel.
"Rising inflation is a serious threat to the region’s sustained, strong growth as high import costs of food and fuel threaten to trigger a price/wage spiral, unleashing more inflation," says Jong-Wha Lee, Head of ADB's Office of Regional Economic Integration (OREI).
Economic growth in the People's Republic of China (PRC), the region's economic powerhouse, will slow to 9.9% in 2008 and 9.7% in 2009 from a torrid 11.9% in 2007 on the back of a gradual appreciation of the yuan, tightening policies and weakening external demand.
Growth in members of the Association of South East Asian Nations (ASEAN) is expected to ease by one percentage point to 5.5% in 2008, according to the semiannual AEM, which covers the 10 members of ASEAN; the PRC; Hong Kong, China; Republic of Korea; and Taipei,China.
The region's policymakers are caught in the pincer grips of slowing growth and rising inflation.
The report warns that despite many economies facing prospects of slower growth, failure to act firmly to rein in rising prices may lead to repeating the mistakes industrialized nations made prior to the Great Inflation of the 1970s.
To douse inflationary flames, many monetary authorities have begun tightening in recent months. But the report says many of them remain behind the curve due to country-specific constraints and weak global economic outlook. The key to anchoring future inflationary expectations is to prevent second-round price effects from working their way through economies.
AEM says limited currency flexibility across much of emerging East Asia has also tied the hands of monetary authorities in their efforts to combat inflation. In some countries, the gradual pace of appreciation has fueled anticipation of further appreciation, spur speculative capital inflows, support the already strong liquidity growth and add further inflationary pressure.
"Allowing more exchange rate flexibility can help mitigate imported inflation and at the same time reduce the cost of sterilization," says Mr. Lee. "Greater currency flexibility will also give more wiggle room to monetary authorities."
Economies with healthy fiscal positions may consider carefully designed fiscal support to cushion the poor and vulnerable from the impact of rising food and fuel prices, the report recommends. But it adds that administrative controls to tame inflation through subsidies and price-fixing will lead to problems later.
