Inflation in Emerging Markets

Which three emerging market economies and governments are most susceptible to mounting inflationary pressures over the next three months?

The three “investable” markets – excluding Argentina, Lebanon, etc. – most prone to inflation over the next three months are Turkey, Brazil, and India. In Turkey, the “unorthodox” policies of the government/CBRT that have sent the TRY down nearly 50% this year will continue to fuel price rises. India’s WPI topped 14% in November, and while retail inflation is still just below 5%, food and energy price pressures will continue to rise. INR is at particular risk from a Fed-induced EM sell-off due to large foreign stock and bond holdings, particularly after FPIs have poured into tech IPOs this year. While the BCB has hiked 725 bps since March to combat inflation and the ailing BRY, lack of investor confidence will continue to weigh on the currency and prices in the run-up to the 2022 election.

Among major emerging markets, the ones that are most susceptible to inflationary pressures are Turkey (by far the top one), Russia, and India. Currently, in all these three economies inflation rates (and particularly the core inflation) are above the rates targeted by the central banks, and it is expected that it will remain so for a while. Mexico and Brazil also have somewhat of a problem but they come behind these three countries. Among the three, Turkey is an outlier as its administration (and its central bank that lost most of its independence) do not seem to really care about inflation and push towards growth at the expense of inflation. Russia comes next, with its geopolitical problems, war threats, and volatile oil prices. India, with its upcoming elections, also bears some significant risks.

Emerging markets have been hit hard by this variant of ‘supply-disruption’ inflation (high energy and food costs), as not only are these higher weights in their CPI baskets but also inflation is not matched by strong growth numbers that would permit Central Banks to tighten earlier. While Turkey is a policy disaster quite apart from the rest of the EM universe, three additional countries that stand out as concerns are Poland, the Philippines, and Brazil. PLN & PHP have negative real rates, weak exchange rates, and are large oil importers. Brazil fares better on current real rates and oil, but currency weakness and RR deviations from long-run averages are greater. In addition, PHP is in the bottom quartile for vaccination rates, with Brazil in the middle. All three countries are a worry on inflation for 2022.