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September 17, 2021

Breakingviews: Emerging economies face stages of inflation grief

by Breakingviews.

Consumer prices are picking up in developed and emerging economies alike. But central bankers in the latter don’t have the luxury of waiting, like U.S. Federal Reserve Chair Jerome Powell, to see if this is a temporary phenomenon. Instead, they will have to traverse the various stages of inflation grief.

The International Monetary Fund expects inflation will accelerate to 2.4% in 2021 from 0.7% in 2020 in developed countries, and to 5.4% from 5.1% in emerging and developing ones. Rising food and energy prices, pandemic-related supply-chain disruptions and surging shipping costs are among the driving forces.

In rich countries, inflation has been too low in recent years, so a period of catch-up is less of a problem for their central bankers. It’s more of a headache for poorer countries. Food and energy typically account for a bigger chunk of their household spending, so current developments can lead to hardship for their citizens. Central banks in these countries don’t have as much credibility as the Fed or the European Central Bank and can’t afford to lose investors’ trust.

The result is a three-step process of inflation grief, says BNP Paribas’ Marcelo Carvalho. They are: denial that there’s a problem; reluctant acceptance that tighter policy is needed; and then action in the form of a series of rate hikes. Countries like Brazil, Chile and Russia are already moving on to the third stage. Others, like Turkey and Colombia, seem stuck in the first. Turkish President Tayyip Erdogan in March unexpectedly ousted central bank boss Naci Agbal, who had aggressively raised interest rates. His replacement, Sahap Kavcioglu, has been less proactive.

Investors care about inflation-adjusted returns, so are more likely to reward countries whose central banks are furthest along the three stages. The Turkish lira and Colombian peso are already among the worst-performing emerging-market currencies against the dollar so far this year. By contrast, the Russian rouble has risen against the greenback.

Granted, other factors are also at play. Rising energy and commodity prices will benefit emerging economies that export such resources and support their currencies. And it’s true that a weaker currency can give a country’s exporters a competitive edge. But a depreciating exchange rate also makes imports more expensive and makes consumer prices rise even faster. That’s the recipe for an even worse kind of grief.

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