Emerging market inflation – a big risk to global growth

The reasons behind the ugly scenes in Tunisia are down to a combination of political and economic factors, but at least part of the discontent stems from rising food and energy prices.  Public unrest in Tunisia has spread to Jordan, where thousands were protesting against the government over the weekend, and demonstrations are also spreading to Egypt (10 year US$ bonds are down 4% today, and the 30 years US$ bonds down as much as 8%).

The problem these countries face is that food and energy prices are a much bigger percentage of an emerging consumer’s shopping basket than for a developed consumer’s basket.  Food and energy therefore carry a much higher weight in domestic consumer price indices within emerging markets, which is something I discussed last year when going over some of the risks to the emerging market story (see here).

As this chart demonstrates, there’s a reasonable correlation between a country’s wealth (as measured by GDP per capita) and the weighting of food and energy in the country’s CPI basket.  Poorer countries therefore tend to be those that are most vulnerable to rising commodity prices, so of the major emerging markets I’ve looked at, food and energy constitutes over 60% of the Philippines’ consumer basket, while South Korea, Taiwan and Israel’s inflation indices have a far lower exposure.  (Note that the latter countries should probably be considered ’emerged’ rather than ’emerging’ – Taiwan in fact had a higher GDP per capita than France and Japan last year).

While GDP per capita is a good indicator of the degree that a country’s inflation rate is vulnerable to rising food and energy prices, some emerging market countries would likely welcome higher prices if they’re producers of the stuff.  This chart from Nomura plots the weighting of the food and energy component in the CPI basket for a range of emerging market countries versus the degree to which the country is an importer or exporter of food and energy, where countries to the right are net importers and countries to the left net exporters.  The country that would most likely welcome higher commodity prices is unsurprisingly Russia, while the country that is most exposed is, again, the Philippines, which happens to be the world’s biggest rice importer.
The global growth drivers India and China also flash up as being vulnerable to rising food and energy prices.  In India, the inflation rate was 8.4% year on year in December, driven by food prices climbing at 16.9% and today governor Duvvuri Subbarao warned about surging inflation, suggesting further interest rate hikes.  China’s official inflation rate is 5.1% year on year, and has only been higher in the last decade from mid 2007 to mid 2008.  I wouldn’t be surprised if China’s unofficial inflation rate was higher still, and the authorities have responded by tightening monetary policy and allowing a degree of currency appreciation, both of which should result in weaker Chinese growth.

To an extent, higher food and energy prices are a result of expansionary economic policy in the US combined with a reluctance of emerging market countries (particularly China) to allow their currencies to appreciate versus the US dollar.  Would it not be ironic if the very policies that US authorities have pursued to return the US economy to growth then proceed to be the cause of global economic weakness?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Mike Riddell

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