Emerging Markets Taking Viable Steps to Fight Global Inflation

Emerging Markets Rising Inflation

An article published on the Sify website has highlighted increasing inflation in a number of emerging markets over the last year. While this problem is also being experienced in developed markets, rising inflation is especially acute in emerging markets because food tends to account for a much larger percentage of consumer price indexes.

To add insult to injury, many countries are working close to full capacity because investment has not kept up with economic growth, which consequently pushes up wage inflation. Official statistics may actually mask the true extent of inflationary pressures in some cases, but there is evidence that the skyrocketing food and energy prices are seeping through to core inflation (in other words, having an effect on other inflationary factors).

Concern has also been raised in terms of the effect of price increases and the various official responses to the situation. Vietnam reported a year-on-year inflation rate of 25% in May, which has seen a proliferation of labour strikes in reaction to this and growth forecasts have since been cut. China is also experiencing a core problem with rising food prices. Even Egypt has hiked public sector wages by 30% in a bid to prevent social unrest. Indonesia is said to be willing to spend a fifth of its annual budget to shield citizens from energy price increases.

Without a doubt, the inflation pressures being experienced by emerging markets seem much worse than in developed countries. Such a development is certainly worrying, as measures including subsidies, price controls and export bans can only provide short term relief at best, while probably just storing up long term problems for the future.

However, there has been a responsible approach taken by various authorities in many countries affected that is somewhat encouraging. For example, Egypt’s decision to pay for the state sector’s wage hikes by curtailing tax exemptions for firms operating outside of ‘free zones’, imposing taxes on interest earned from Treasury bills and cutting state fuel subsidies.

Indonesia announced recently that it would reduce fuel subsidies by 30%, while Taiwan has decided to abandon them entirely. Continuing the trend, Malaysia and India have also decided to reduce fuel subsidies. The current policies will go a long way towards stabilizing the finances of these countries and help direct necessary resources to other parts of their economies.

While moves by central banks in South Africa to raise interest rates in a bid to quell inflation are generally considered bad news for stocks, when it comes to the long term, it is encouraging to see the increasing credibility that these banks have acquired in battling rising prices. The same policies have been applied by banks in Korea and Chile, which ensures that the responsibility for dealing with inflation is taken out of the hands of politicians.

It is important to keep the threat of inflation in context, as policy makers in some emerging markets insist that the spike in inflation is due in part to a short term supply stock in food and energy that will soon ease as higher prices lead to increased supply. There is merit to such arguments and while recent developments are concerning, inflation should not yet be seen as a ‘crisis’ that poses a threat to the overall attraction of the world’s fastest growing economies.

Some countries have also pegged their currencies to the US dollar and successive cuts in interest rates in the US have made the inflationary problems in these countries worse, while already struggling with their economies in overdrive. How long this policy remains in place depends largely on the economy in question, as well as the priority each central bank puts on inflation control.

In general, local currency appreciation and higher interest rates should really help combat inflation. It is believed that the prospect of currency appreciation will not exacerbate the problems being experienced by emerging markets by pulling in more capital, simply because there a number of emerging market currencies are still relatively undervalued.

Equity investors are concerned about emerging markets partly because of the possible severity of measures implemented by governments in an effort to cool the economy and partly because of the cost pressure that local manufacturers might face as a result of price increases. Of course, another concern is the depreciation in value of future money. However, in places like Latin America and Russia, the recent spike in global inflation has been concentrated in commodities and this has actually helped stock indexes.

While the price of commodities may drop from their peaks, these prices are not foreseen to reach extremely low levels in the near future. This is due in part to the continued demand from emerging markets and the relatively inelastic supply. Thus commodity companies should remain in a profitable position and constitute an attractive investment opportunity.

The information in this article is courtesy of Mark Mobius (“Rising inflation in emerging markets”, Sify Finance, 29 June 2008).

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