Inflation puts pressure on emerging economies
David Oakley | Monday, 7 July 2008
THE emerging economies, for so long the success story of the markets, have suffered a jolt this year.
Until the start of 2008, they had outperformed US and European markets amid talk that they had decoupled from the main western economies, which had been hit hard by the financial crisis.
The MSCI emerging stock market index saw stunning growth from the end of 2002 to the end of 2007, rising 326 per cent, sharply outperforming the S&P 500, the benchmark US index.
The price-earnings ratio of many emerging markets rose above levels seen in the developed world for the first time for many years.
But since then, there have been increasing signs that these economies are overheating and losing momentum.
Since last June 5, when Jean-Claude Trichet, the European Central Bank (ECB) president, and Ben Bernanke, the Federal Reserve chairman, began to make more hawkish noises on inflation, these fears have intensified.
Emerging market bond spreads - the best gauge of inflationary worries in these developing nations - have widened sharply in the past four weeks, with the spread over benchmark US Treasuries rising more than 50 basis points to 295bp.
Many emerging stock markets have also underperformed, with China - the world's largest developing economy - one of the biggest fallers because of fears the economy cannot sustain a 10 per cent growth rate at a time when interest rates are rising to combat inflation.
Since last June 5, the Chinese and Indian stock markets have dropped 17.3 per cent and 14.8 per cent respectively, underperforming developed indices such as the S&P 500, which fell 8.42 per cent over the same period.
Inflation is running at 7.7 per cent annually in China, while India's rate is 11.4 per cent. Both countries have raised interest rates.
Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, said: "There is certainly a growing worry about how to deal with higher inflation, particularly in some of the Asian economies, as any significant monetary tightening could put upward pressure on their exchange rates and undermine their competitiveness."
Brian Coulton, head of Europe, the Middle East and Africa sovereigns and global economies at Fitch, the ratings agency, said: "Inflation is becoming a serious concern, and this is having a big impact on the sovereign credit outlook of many emerging market economies."
Soaring oil and food prices have started to raise question marks over the emerging market world as inflation has risen persistently at a faster pace in these countries than the developed economies.
In Asia, the weak dollar has fuelled rising prices as many economies have been pegged artificially to the US currency, preventing appreciation that would have checked inflation.
In a report in May, Fitch said: "Significant chunks of the EM universe are facing underlying inflationary pressures, including in emerging Europe, parts of Asia and the Gulf."
A weighted average of consumer price inflation in the 20 largest emerging markets rose from 4.5 per cent in March 2007 to 6.9 per cent in March 2008, the agency said.
Analysts expect these economies to suffer sharp slowdowns, with stocks likely to remain under pressure - a contrast to the confident talk of the end of last year that the developing nations had decoupled from the US and Europe.
"Decoupling may be a misnomer. We have seen western policymakers raise more concerns about inflation, and this has affected the emerging market world with bond spreads widening and stock markets falling," Mr Rendell said.
Other analysts say there might be a so-called soft decoupling between the west and the emerging world whereby these economies would still be linked but not as closely. Mohamed El-Erian, co-chief executive of Pimco, the world's largest bond investor, says that in the past a 1.0 per cent fall in US growth would have led to a bigger contraction among the emerging nations.
Today, he believes a 1.0 per cent fall in US growth would see the economies of the developed nations contract by less than 1.0 per cent as they are no longer so reliant on exports to the US to underpin demand.
However, although all the emerging market economies are facing inflationary pressures and slowing growth, the resource-rich economies have been less affected by the deteriorating outlook.
Russia's stock market has only fallen 2.2 per cent since last June 5, outperforming the S&P 500, while Brazil has fallen 8.0 per cent, more less in line with the US benchmark index.
Analysts say that as long as the oil price remains high, Russia, Kazakhstan and oil-rich nations in the Gulf will remain protected from slowing growth.
Brazil and other resource- rich Latin American economies such as Mexico and Chile have benefited from monetary and fiscal discipline. These countries have raised interest rates and set strict inflation targets.
In Europe, the economies of the Czech Republic, Hungary and Poland may be more exposed as they are closely linked to the eurozone, relying heavily on exports to Germany and other western European countries.
Many analysts believe that most emerging economies, although facing tougher times ahead, are probably heading for soft landings rather than the crises that afflicted many of them a decade ago.
Much will depend on whether oil and other commodity prices stay at their current high levels. If commodity prices fall sharply at a time when the developing world is already battling high inflation, the emerging market success story will be well and truly over.
..........................................
Until the start of 2008, they had outperformed US and European markets amid talk that they had decoupled from the main western economies, which had been hit hard by the financial crisis.
The MSCI emerging stock market index saw stunning growth from the end of 2002 to the end of 2007, rising 326 per cent, sharply outperforming the S&P 500, the benchmark US index.
The price-earnings ratio of many emerging markets rose above levels seen in the developed world for the first time for many years.
But since then, there have been increasing signs that these economies are overheating and losing momentum.
Since last June 5, when Jean-Claude Trichet, the European Central Bank (ECB) president, and Ben Bernanke, the Federal Reserve chairman, began to make more hawkish noises on inflation, these fears have intensified.
Emerging market bond spreads - the best gauge of inflationary worries in these developing nations - have widened sharply in the past four weeks, with the spread over benchmark US Treasuries rising more than 50 basis points to 295bp.
Many emerging stock markets have also underperformed, with China - the world's largest developing economy - one of the biggest fallers because of fears the economy cannot sustain a 10 per cent growth rate at a time when interest rates are rising to combat inflation.
Since last June 5, the Chinese and Indian stock markets have dropped 17.3 per cent and 14.8 per cent respectively, underperforming developed indices such as the S&P 500, which fell 8.42 per cent over the same period.
Inflation is running at 7.7 per cent annually in China, while India's rate is 11.4 per cent. Both countries have raised interest rates.
Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, said: "There is certainly a growing worry about how to deal with higher inflation, particularly in some of the Asian economies, as any significant monetary tightening could put upward pressure on their exchange rates and undermine their competitiveness."
Brian Coulton, head of Europe, the Middle East and Africa sovereigns and global economies at Fitch, the ratings agency, said: "Inflation is becoming a serious concern, and this is having a big impact on the sovereign credit outlook of many emerging market economies."
Soaring oil and food prices have started to raise question marks over the emerging market world as inflation has risen persistently at a faster pace in these countries than the developed economies.
In Asia, the weak dollar has fuelled rising prices as many economies have been pegged artificially to the US currency, preventing appreciation that would have checked inflation.
In a report in May, Fitch said: "Significant chunks of the EM universe are facing underlying inflationary pressures, including in emerging Europe, parts of Asia and the Gulf."
A weighted average of consumer price inflation in the 20 largest emerging markets rose from 4.5 per cent in March 2007 to 6.9 per cent in March 2008, the agency said.
Analysts expect these economies to suffer sharp slowdowns, with stocks likely to remain under pressure - a contrast to the confident talk of the end of last year that the developing nations had decoupled from the US and Europe.
"Decoupling may be a misnomer. We have seen western policymakers raise more concerns about inflation, and this has affected the emerging market world with bond spreads widening and stock markets falling," Mr Rendell said.
Other analysts say there might be a so-called soft decoupling between the west and the emerging world whereby these economies would still be linked but not as closely. Mohamed El-Erian, co-chief executive of Pimco, the world's largest bond investor, says that in the past a 1.0 per cent fall in US growth would have led to a bigger contraction among the emerging nations.
Today, he believes a 1.0 per cent fall in US growth would see the economies of the developed nations contract by less than 1.0 per cent as they are no longer so reliant on exports to the US to underpin demand.
However, although all the emerging market economies are facing inflationary pressures and slowing growth, the resource-rich economies have been less affected by the deteriorating outlook.
Russia's stock market has only fallen 2.2 per cent since last June 5, outperforming the S&P 500, while Brazil has fallen 8.0 per cent, more less in line with the US benchmark index.
Analysts say that as long as the oil price remains high, Russia, Kazakhstan and oil-rich nations in the Gulf will remain protected from slowing growth.
Brazil and other resource- rich Latin American economies such as Mexico and Chile have benefited from monetary and fiscal discipline. These countries have raised interest rates and set strict inflation targets.
In Europe, the economies of the Czech Republic, Hungary and Poland may be more exposed as they are closely linked to the eurozone, relying heavily on exports to Germany and other western European countries.
Many analysts believe that most emerging economies, although facing tougher times ahead, are probably heading for soft landings rather than the crises that afflicted many of them a decade ago.
Much will depend on whether oil and other commodity prices stay at their current high levels. If commodity prices fall sharply at a time when the developing world is already battling high inflation, the emerging market success story will be well and truly over.
..........................................