The IMF has joined a rising chorus of concern over inflation in many big emerging economies. External imbalances that led to currency and bond sell-offs in emerging markets in 2013 had improved in 2014, it said in its Global Financial Stability Report, published this week, and:

Recent improvements in inflation expectations for some emerging markets provide welcome monetary policy space, and the decline in global interest rates is reflected in the performance of emerging markets assets this year. Nevertheless, inflation in several major emerging markets remains elevated and warrants caution.

There was bad news on inflation in several emerging markets this week. On Wednesday, Brazil’s statistics office said consumer prices rose above the government’s upper limit to 6.7 per cent in the 12 months to September. The same day, Turkey raised its inflation forecast for 2014 and 2015, saying it could reach 9.4 per cent by the year’s end, well above the central bank’s forecast of 5.3 per cent.

“Inflation is still a big concern”, says Daniel Tenengauzer, managing director of emerging markets research and global FX strategy at RBC Capital Markets. While the situation had eased in India and Indonesia, inflation was especially problematic in Brazil, Turkey and South Africa, he said.

The onward depreciation of emerging market currencies in anticipation of the normalisation of US monetary policy – a rise in interest rates from historic lows – is not going to ease inflationary pressures.

A raft of emerging market currencies – including the Russian rouble, Turkish lira, South African rand and Brazilian real – have hit record lows against the dollar this year.

Anticipation of rising US interest rates is not the only cause of the dollar’s ascent against these currencies of course: in the case of Russia, for example, the rouble – which had fallen as Russian companies, shut out of international capital markets, gobbled up dollars – hit a new low on fears that Moscow would impose capital controls to stem the flow. Retaliatory food import bans are pushing up inflation, meanwhile.

But the effect of depreciating currencies tends to be the same: worsening inflation, as Capital Economics observes in a note on the depreciating currencies of sub Saharan Africa.

Countries that imported more were more vulnerable to exchange rate movements. That made South Africa, Ghana and Kenya, which have the highest ratio of imports to GDP, the most vulnerable to inflation increases as a result of falling currencies.

Capital noted that:

The currencies of SSA economies have generally weakened over the past month. The South African rand has fallen the furthest. This is in part due to the country’s large current account deficit, but also the fact that the rand is the only currency that is allowed to freely float…

Because there are many factors that affect inflation other than the exchange rate, the relationship between the exchange rate and inflation is not perfect. But based on past form and our currency forecasts, we think that exchange rate movements are most likely to keep inflation high, and close to the upper limits of their target ranges, in South Africa and Kenya.

The effect on Ghana, where the cedi had strengthened after the country announced it had approached the IMF for support earlier this year, was less straightforward.

It was possible that the lagged effects of the cedi’s decline over the past year had not yet fully fed through to domestic prices, suggesting inflation could rise further. But the currency had appreciated recently, Capital noted, adding that its forecast implied that the annual change in the exchange rate would decline next year.

In Nigeria, where imports are equivalent to a smaller share of GDP, there has been an increasingly obvious relationship between a weaker currency and inflation, leading Capital to expect that inflation will stay high in the country.

Capital’s conclusion:

… we forecast continued monetary tightening in South Africa and Ghana this year and next, with Kenya likely to begin raising interest rates early next year. But rate increases are likely to be fairly gradual, particularly in South Africa where economic growth looks fragile.

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