Emerging market policymakers grappling with rising inflation
IYOUR SUMMER a few long months for the emerging world. Punitive temperatures – July was the hottest month on record in the world, according to recent analysis – stoked fires on Turkey’s Mediterranean shores and scorched Russia’s wheat fields. Covid-19 is raging in countries with low vaccination rates. Only 24% of Brazilians, 9% of Indians and 7% of South Africans are double-bitten. On top of everything else, inflation is also accelerating.
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Soaring food and energy prices have pushed inflation to unusually high levels. In Brazil, consumer prices are 9% higher than a year ago (see graph), more than double the central bank’s target. In Russia, inflation is 6.5%, well above the central bank’s 4% target. Inflation in India, which had been high in 2020, topped 6% this summer, north of the Reserve Bank’s target range. Policymakers in the poorest countries have taken a difficult path this year. The surge in high prices puts another severe test at their feet.
Growth has largely resumed, despite the continued ravages of covid-19. In parts of the emerging world, such as India, production has already returned to pre-pandemic levels. In others, like Russia, it is expected to do so by the end of the year. Soaring prices for oil, metals and agricultural products have been a boon for commodity exporters. But the recoveries have been frustrating and patchy. Better times for export industries have not always translated into a broader labor market recovery. Business is booming in Brazil’s mining towns, for example, but the unemployment rate across the country, at 14.6%, has barely declined from its pandemic peak.
This, in turn, has put pressure on governments to extend or even increase spending on relief programs. Economic growth is increasing tax revenues in many countries, improving public finances which have been battered by covid-19. Yet budget deficits remain significant. A decision in June to expand grain distributions means India’s central government is likely to borrow more than the 6.8 percent of GDP forecast in the 2022 budget. Brazil, which borrowed 13.4% of GDP last year, extended its emergency cash transfers. Chile and Colombia, which limited their borrowing to a modest 7% of GDP in 2020 last year, plan to borrow about as much or more this year, according to the Institute of International Finance, a group of bankers.
However, when you combine more money flowing through the economy with supply disruptions, the result is inflationary pressure. Central bankers in emerging markets, like their counterparts in the rich world, argue that high inflation is only temporary. But, unlike their peers in the advanced economy, some did not feel comfortable enough to wait and see. They have more recent experience with spurts of high inflation and doubt that public expectations of low inflation are as firmly anchored as in rich countries. They therefore acted forcefully to curb inflation. Brazil’s central bank raised interest rates by one percentage point on August 4, in addition to three increases of 0.75 percentage points each since March. The Central Bank of Russia also announced a one-point hike on July 23, also the fourth of the year. Mexico and Peru raised interest rates on August 12. The other central banks that have held the fire are expected to tighten in the coming months.
This desire to curb inflation may have kept the interest of foreign investors. Earlier this year, some economists feared that a meteoric recovery in America and the prospect of rising interest rates could lead to a money rush in emerging economies: an echo of the ‘taper tantrum’ of 2013 , when the Federal Reserve began to normalize monetary policy. policy after the financial crisis. A rise in US Treasury yields in February and March of this year was accompanied by a slowdown in portfolio flows to emerging markets, pointing to the worst to come.
That didn’t materialize, however, and not just because Treasury yields fell from their spring highs. It also reflects a stronger policy framework in emerging economies and greater resilience to market fluctuations. Over the past decades, they have built up foreign exchange reserves and limited their dependence on foreign currency debt. Most survived a severe squeeze in March 2020, when panicked investors flocked to havens and emerging market currencies tumbled, with minimal economic damage.
By comparison, recent exchange rate movements have been modest, which has limited the extent to which higher import prices add to inflationary pressures. Since the start of the year, the Brazilian real and the Indian rupee have depreciated by around 2% against the dollar. (The real fell nearly a quarter last year and about 20% during the 2013 turmoil.) Central bank vigilance likely helped keep investors from getting cautious.
But higher interest rates are a difficult home remedy. Large increases represent a risk to growth. Slower growth in turn hurts public coffers, even as higher interest rates increase government borrowing costs. Among the large emerging economies, the risk of crisis is perhaps most palpable in Brazil, where a loss of confidence in public finances contributed to a deep recession in 2015 and 2016. If the fiscal risk premium demanded by buyers bond market continues to rise, so the government could soon be faced with a terrible choice between cutting spending as unemployment remains high and a widespread fiscal crisis. Indeed, on August 12, Roberto Campos Neto, head of the central bank of Brazil, worried that the markets were beginning to perceive a “budgetary deterioration” which could jeopardize the economic recovery.
The recent woes only worsen the inflation problem and threatens to spread to other countries. A severe drought in Brazil has reduced the capacity of its hydropower plants and caused energy prices to skyrocket. It also threatens the production of export crops like coffee, leading to reduced supplies and higher prices. The low levels of the Paraná River have forced companies like Vale, a mining company, to cut loads of iron ore carried on barges, causing global shortages. The Russian government taxes overseas shipments of wheat, which is pushing up prices around the world.
The fever could drop later in the year, as bottlenecks ease and demand from America and China cools a bit. Yet there is also a risk of further disruption: further epidemics of covid-19, more natural disasters or social unrest, perhaps linked to rising food prices. And for exporters like Brazil, falling commodity prices lead to their own problems, such as a plummeting currency and an economic slowdown. A turn for the worse in one country could worsen investor sentiment towards other places. Emerging markets have managed the economic tensions of the past 18 months with courage. But a break from the heat can’t come soon enough. ■
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This article appeared in the Finance and Economics section of the print edition under the title “Feel the Heat”