Latin practice

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Policymakers in emerging markets are scrabbling wildly in the anti-inflation toolbox. Some of the choices they are making will create longer-term problems.

The scale of the challenge varies. Food accounts for between a quarter and a third of consumer price index baskets in developing economies. During the first three months of 2008, says JPMorgan, the average percentage of headline inflation explained by food was 37 per cent in Latin America and 63 per cent in emerging Asia. Similarly, rising energy prices are contributing less to inflation in Latin America than Asia.

Not only is Latin America facing less of an external inflationary shock than Asia but also its policymakers, perhaps because of recent history, seem less ambivalent about the correct response. Latin America spent decades painfully squashing runaway prices with responsible fiscal policy and inflation targets. Now many of the region's central banks are taking action. The sharp hike in policy interest rates in Brazil last May showed the central bank's determination to act pre-emptively while inflationary pressures are still relatively contained. In Chile, Colombia, Mexico and Peru rates were all raised last year.

In emerging Asia, by contrast, policymakers seem to be flailing. Rising currencies, often preferred to higher interest rates as a means of fighting inflation, are now a double-edged sword, given slowing exports. Instead, extraordinary measures such capital controls or export taxes have become common. Many countries - including India, the Philippines and Indonesia - have turned to price controls or direct and indirect fiscal subsidies.

Such choices are dangerous. Budget balances are deteriorating, and central banks are losing credibility. In response, investors are attaching a higher risk premium to emerging markets. Spreads on sovereign external debt, as measured by JPMorgan, have risen from 160 basis points over US Treasuries a year ago to about 250bps. The effects of this poor use of monetary policy tools will be felt for years to come. (FT Syndication Service)