Inflation Stalks Emerging Markets

Inflation Stalks Emerging Markets
Rising Prices Seen As Greater Threat Than U.S. Ripples

By JOANNA SLATER
April 24, 2008; Page A7

Thanks to years of strong economic growth, emerging markets have conquered many of their old demons. Now one former foe has returned to stalk these countries: inflation.
Rising prices represent a bigger economic and political challenge in these countries than the knock-on effects of the financial crisis emanating from the U.S., say analysts and investors.
GROWTH'S COST

• What's Happening: Inflation, an old foe in emerging markets, is stirring again, thanks to years of strong economic growth.
• The Impact: Anxiety about higher prices -- and efforts to stem them -- is weighing on shares in these markets.
• The Risk: Many residents in these countries are sensitive to price changes. Rising food costs could cause trouble.
Central banks in Brazil and India, seeking to tame inflation, last week took new steps to slow down lending and throttle back growth. India raised the proportion of deposits that banks must hold in reserve, and Brazil boosted its key interest rate for the first time in three years.
On Wednesday, Singapore reported that higher oil and food prices pushed inflation in March to a 26-year high. Although Singapore isn't considered a developing market, it is seen as a bellwether for other parts of Asia, which are also struggling with rising prices. Tuesday, Thailand's central bank said inflation this year could be twice what it was in 2007.
"Even if growth is coming off a bit, it's still pretty high" in most developing countries, says Punita Kumar-Sinha, who manages $2 billion in a mutual fund focused on India at Blackstone Group. "The concern is inflation, and in high-inflation environments, equity markets typically don't do very well."
Anxiety about higher prices -- and government efforts to stem them -- has weighed on shares in these markets this year. Countries where forecasts for inflation have risen sharply since November also have had some of the worst-performing stock markets in that period, according to an analysis by Merrill Lynch. Among them: China, the Philippines and Turkey.
Inflation is a particular challenge for developing-country economies because large swaths of the population are acutely sensitive to shifts in prices. Changes in the cost of food in particular are the stuff of political dynamite.
China and Vietnam are battling their highest price increases in a decade or more. India, Russia, South Africa and much of Latin America also face a growing threat from rising prices.
In a report released earlier this month, the Asian Development Bank said the risk of spiraling inflation in the region is "palpable," and noted that official figures tend to underestimate the phenomenon.
That has many investors uneasy. "Whereas everyone is kind of ready for a global slowdown, I don't think everyone is ready for inflation that is 1[%] to 2% higher in the whole emerging world than before," says Antoine van Agtmael, chief investment officer at Emerging Markets Management, which oversees $19 billion invested in developing countries. "That people haven't quite discounted yet."
Higher interest rates and government moves to put the brakes on economic growth tend to be bad for stock prices. Inflation also hurts stock prices by increasing input costs for companies and putting pressure on profit margins.
Bonds also face problems. As inflation rises, so do bond yields, driving prices lower. "We believe it is not the right time to invest aggressively" in emerging markets, wrote analysts at Barclays Capital in a recent report. There are "downside risks to bond markets from rising inflationary pressures and potential changes in monetary policy."
Edwin Gutierrez, an emerging-market bond manager at Aberdeen Asset Management in London, says he is wagering that Asian currencies will strengthen, as higher interest rates draw investors. Many governments are tacitly encouraging stronger currencies as an inflation-fighting tool, because they make imports less expensive.
The current price pressures are a far cry from the double-digit inflation rates or even hyperinflation that some emerging markets witnessed in the past, which coincided with huge debts and unrestrained spending. Instead, inflation is being stoked by people getting richer and demanding more of everything from cars to television sets to beef. It is also rising on the back of record energy prices.
One question is whether the current inflation pressures in emerging markets -- and especially the surge in the prices of staples such as rice and soybeans -- are a short-lived phenomenon. Some analysts say they expect the stresses to ease as the global economy slows in response to troubles in the U.S.
But others say inflation in many of these countries has deeper roots. "Food prices are just the tip of the iceberg," says Ifzal Ali, chief economist of the Asian Development Bank. He notes that many countries in the region haven't adequately reined in the supply of money to their economies, leading to asset bubbles.
"The age of innocence is over," he says. "The era of high growth and low inflation which we have taken for granted is finished." Mr. Ali thinks governments will have to maintain tighter monetary policy for the next 18 to 24 months to get inflation under control.