5 Reasons The Emerging Market Inflation Story Is Already Over

We mentioned this earlier, but wanted to come back to a new report from Citi on why the emerging market inflation story may be overhyped. If this is the case, it might already be time to jump back in the water after the massive outflows earlier this year.

Here’s 5 reasons we’ve already seen the worst of it:

1) Early in the cycle. Although emerging markets are growing strongly in the current global recovery, this would be very early in the global economic cycle for capacity pressures to build up and inflation to rise sharply. This is particularly true as developed economy growth rates coming out of the 2008- 9 recession remain below historical averages. A fairly sanguine attitude towards inflation at this stage of the cycle is justified by the historical record;

2) Capex. Further, any capacity pressures that may build up at this early stage of the cycle are typically relieved by capex expansion by corporates that are flush with cash on their balance sheets. A quick ‘big picture’ analysis of our bottom-up stock analysts across the emerging world shows expected capex increases of 10% in emerging markets this year, led by Latin America (+13%), and followed by CEEMEA (+11%) and Asia (+9%). These capacity increases should play a significant role in containing inflationary pressures in the emerging markets as a whole;

3) Limited signs of higher core inflation. Most attention in the emerging markets is currently being paid to the role of higher commodity prices – notably food, but also energy and metals – in pushing inflation higher. There is still only limited evidence in emerging markets as a whole of higher headline inflation (as a ‘first round’ effect) translating into higher core inflation as price pressures spill over into the broader economy and, for example, wages begin to rise significantly. Core inflation may be rising in some emerging markets (for example, Brazil), but it remains well below headline inflation in most countries, suggesting that once commodity price rises moderate, inflation should fall again;

4 ) Stronger currencies. One of the most live issues in emerging markets in the second half of 2010 was the attempts – not always successful – by EM policy-makers to resist upward pressures of their currencies (including via controls on capital inflows) arising from the structurally weak dollar. It should be remembered that rising EM currencies will make their own contribution to controlling EM inflation by holding down import prices. This process will be particularly relevant in 2011 in countries where currency gains versus the dollar are expected, such as (very helpfully) in China;

5) Better harvests? Finally, to the extent that the worst of the current inflation scare in emerging markets has arisen from rising food prices, this may be alleviated during 2011 through increased supply. The latter would arise, for example, from the economic incentive (as prices rose last year) for farmers to have planted more seed for the next grain harvest and, also, something as simple as less inclement weather. For example, a less severe drought in Russia this year should increase the output of wheat this summer, helping to push down grain prices. Clearly, this is not a scientific ‘call’ but one dependent on the resumption of more normal weather patterns.

Don’t miss: Everything you ever wanted to know about inflation but were afraid to ask >


Photo: Citi

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