A tiny part of a much larger problem
Many central bankers and economists in emerging countries are not yet alarmed, saying that the surge in prices is due to external global phenomena beyond their control which will calm down when commodity prices go down. Sachin Sukla, an economist at enam research in India estimates that commodities such as grains, metals and oil account for 80% of price increases in India. His fear is whether policy makers will overreact.
However, recent rate cuts by the US Federal Reserve have exacerbated global inflation problems. Many emerging market currencies mimic the dollar, with the added bonus of capping local interest rates. And there is growing evidence that rising commodity prices are part of a larger problem.
Investment bank UBS (UBS) notes that core inflation rates are rising in emerging markets, reaching 6.8% in Latin America, 4.1% in Asia, and 8.3% in Western Europe. ballast. (Twelve months earlier, the respective rates were 5.0%, 2.4% and 5.4%). “What is most worrying about the global inflation landscape is that core and wage inflation pressures are coming together, particularly in developing countries,” said UBS economist Andrew Cates. “This is already a pressing issue at a time when monetary policy and monetary conditions in developing economies are still very loose.”
Is monetary easing to blame?
There are endless reasons to blame the low cost of money. In many emerging markets, including China, India and Russia, benchmark interest rates are actually negative. For example, China’s inflation, which totaled 7.7% last month, is above the central bank’s main lending rate of 7.47%. Among the four “BRIC” economies, only Brazil, where real interest rates are at record levels, stands out for its monetary policy tightening. Yet even there, concerns about inflation are growing.
UBS notes that in Latin America, Asia and Eastern Europe, interest rates have been consistently below nominal GDP growth over the past five years. This is in stark contrast to the situation during the 1990s, when interest rates generally matched or exceeded nominal GDP growth.
It is true that benchmark interest rates can be a poor measure of monetary conditions in many emerging markets. But other indicators are hardly more reassuring. In recent years, emerging markets including China, Russia and the Persian Gulf states have managed huge sums of money resulting from current account surpluses, building up record foreign exchange reserves (more than 1,000 billion dollars for China and $540 billion for Russia). Many economists draw the obvious conclusion that the exchange rates of these countries are undervalued. The resulting accumulation of foreign exchange reserves has contributed to the growth of the money supply, which fuels inflation.
Slower growth may be inevitable
Central banks are giving far more credence to the inflation problem and many have recently begun to take corrective action. On June 7, the People’s Bank of China raised the reserve requirement ratio for banks by one point, to 17.5%, an exceptionally high increase. On June 10, 2008, the Russian central bank raised its refinancing rate for the second time in a fortnight by a quarter of a point, to 10.75%. Central bank actions are to some extent a response to economists’ concerns that inflation is now out of control.
There may also be other basic reasons for being gloomy. The current wave of global inflation could indicate that the period of crazy growth in emerging markets has finally reached its limits. As emerging economies face growth capacity issues and resource constraints, a long period of slower growth and higher inflation may now be unavoidable. “It’s typical of what happens in a long economic cycle,” says Aslund. “This is the best economic cycle emerging markets have ever seen.” What happens next, he adds, is where policymakers can become complacent.
Indeed, a big risk is that central banks in emerging countries—accustomed to years of phenomenal growth—will be reluctant to admit that times have changed. “The problem here is that, in trying to avoid a modest slowdown, central banks are resisting raising interest rates,” Rogoff said. “But it can become extremely painful to bring inflation down in the future. It took a decade in the 80s to do that. If central banks wait too long, we are going to be in trouble again.”
