Revaluation pressures on emerging markets
By Stefan Wagstyl
Published: November 15 2010 17:29 | Last updated: November 15 2010 17:29
Inflation is so far away from the economic priorities of developed countries that it has been easy to underestimate the growing price worries of emerging economies. But a sharp sell-off in emerging market equities – triggered by last week’s Chinese inflation data – is a reminder that prices need watching – and in some countries require urgent policy action.
The 4.4 per cent year-on-year increase in consumer prices announced by Beijing is the highest for two years and exceeds the authorities’ 3 per cent comfort level.
In the other Bric countries inflation is even higher – 8.6 per cent in India, 7.5 per cent in Russia and 5.2 per cent in Brazil. Elsewhere, it is 10 per cent in Ukraine and 25 per cent in Venezuela.
As often with inflation, it is the poor, spending a big proportion of their income on food, who feel the most pain. Food inflation is 10.1 per cent in China, 15.7 per cent in India and 16.1 per cent in Turkey. These are numbers that politicians ignore at their peril.
A big contribution to inflation, particularly for food, comes from the commodity price boom. While this has been aggravated by speculative investments, the driver is a global resources hunger that can be addressed only by expanding production.
Unfortunately, potential investors in agriculture will not be encouraged by growing protectionist pressures, which make early farm trade liberalisation unlikely.
But there are other actions emerging market policymakers can take to counter inflation.
First, they can stick tightly to the prudent fiscal policies that most are following. And those that have allowed budget discipline to slip should continue making cuts: Malaysia for example, where the fiscal deficit this year is 5.6 per cent of GDP.
Next, credit growth needs to be controlled but not so tightly as to choke growth. This is China’s dilemma. Having boosted the economy in the 2008-09 crisis through a huge increase in loans, it is now struggling to pull in the reins.
Fears it might follow its recent interest rate increase with another rise largely prompted Friday’s market sell-off. The monetary challenge is exacerbated by the cheap money generated to boost flagging developed economies, not least Washington’s latest round of quantitative easing, to the tune of $600bn. Warnings of emerging market bubbles are multiplying, including one last week from Joseph Stiglitz, the Nobel laureate economist.
Brazil, Thailand, and Taiwan are among countries that are trying to staunch the potentially inflationary inflows through capital controls. Other nations, headed by China and India, have been slower to liberalise their external accounts and can rely on decades-old barriers. Even the International Monetary Fund now reluctantly accepts that capital controls are a necessary weapon in the policy armoury. But, as Mr Stiglitz pointed out, that leaves attractive open economies as the “focal point for all this [QE] money”.
Governments are raising interest rates to reduce the inflationary pressures but do so unwillingly for fear of hampering economic growth and making things worse by attracting more hot money. Yield, after all, is what global investors seek.
One answer lies in quicker currency appreciation. In the short term, countries do not want their currencies to rise for fear of damaging exports. That is the nub of the US-China currency dispute. But in the long term, emerging market currencies must rise to reflect these countries’ rising productivity – just as happened with Germany and Japan after 1950. Even in the short term, the loss in export competitiveness is offset by access to cheaper imports – including, significantly, food- and other dollar-priced commodities.
The currency appreciation record is decidedly mixed. While China has allowed the renminbi to rise against the dollar since it loosened its peg on June 21 – by 2.8 per cent – the renminbi’s real trade-weighted value has actually dropped – by 3.7 per cent. Compared with January 2008, the renminbi was only 3.9 per cent higher late last week on a trade-weighted basis, far behind Brazil (up 17.3 per cent) and Indonesia (18.5 per cent). Other key emerging market currencies were well down – Turkey by 5.5 per cent, India by 6.8 per cent and South Korea by a startling 15.9 per cent.
In these difficult times, there are no risk- or cost-free choices. But with inflation rising, the pressures will grow for quicker emerging market currency revaluation.