Confidence in emerging markets is dwindling. The MSCI Emerging Markets index soared by 326% between 2002 and 2007, but this year it has slid by 16%. Asia ex-Japan has been hit worst, with a 25% decline. The trouble is that “most developing economies are grappling with, and so far failing to defeat, the inflationary effects of high food and oil prices”, says The Economist.
Ratings agency Fitch notes that a weighted average of consumer price inflation in the 20 biggest emerging markets rose to 6.9% in March from 4.5% a year earlier, while Morgan Stanley calculates that 53 of the world’s 190 countries have double-digit inflation. They are almost all in emerging markets, spanning the Middle East, Eastern Europe, Latin America and Asia, and they contain 42% of the world’s population.
Food and energy comprise a bigger share of the consumer price index in emerging states – over 40% in Thailand, Turkey and India, compared with 25% in America, says Morgan Stanley. Also contributing to inflationary pressure is the fact that many countries have directly or indirectly tied their currencies to the dollar and thus imported loose monetary conditions.
A relative dearth of truly independent central banks in pro-growth-orientated countries doesn’t help either. Turkey recently simply ditched its inflation target after failing to hit it for two years. Central banks from India to Russia have been raising rates, but policy remains loose. According to JP Morgan, the average real interest rate across emerging economies stands at 2.3%, down from 3.7% a year ago. The danger now is that, for many emerging economies, a hard landing may be the only way to squeeze out inflation, says Stephen Jen of Morgan Stanley.
Not all emerging markets have been submerging of late: Russia is only down by around 4% so far this year, while Latin America is barely in the red. High commodity prices have shored up these markets, while Latin America, stung by hyperinflation in the 1980s, has set strict inflation targets and hiked rates decisively. But it’s far too early to sound the all-clear. There is still uncertainty over how far rates will need to rise in Brazil, as Geoffrey Dennis of Citigroup points out.
The biggest risk to the region is a slide in commodity prices. Given the prospect of inflation-induced hard landings in commodity-consuming countries – which in any case seem unlikely to decouple from the ongoing slowdown in the Western world – that can hardly be discounted. With commodity prices sliding and many states battling with inflation, “the emerging market success story will be well and truly over”, says David Oakley in the FT.
Meanwhile, emerging market valuations have fallen back, but are still “historically high”, according to State Street Global Markets. Until a few days ago, the MSCI index was actually trading at a premium to the MSCI World index. A discount makes more sense, says The Economist: central banks in developing countries have a “far worse record” in walking the growth-inflation tightrope than their developed counterparts.
Meanwhile, mounting risk aversion in other Western markets bodes ill for emerging markets: a downdraft on Wall Street tends to hamper other indices, as David Fuller notes on Fullermoney.com. Until recently, emerging markets were deemed a safe haven from the financial crisis, says Jen. “How the tables have turned.”