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USA: Is EM inflation good or bad?

USA: Is EM inflation good or bad?

Is Inflation overseas good or bad for the US? Source:

Credit Suisse today reported that a number of emerging market (EM) economies are experiencing rising inflation; and in some, central banks are countering with interest rate hikes (see excerpt below).  Might seem strange to those of us who live in a country where policy interest rates are at zero and the Federal Reserve seems to be more worried about deflation (read about its quantitative easing program here).  Well, there’s good news and bad news for the lumbering, erstwhile hegemon. 

The good news is that rising prices overseas will make US exports more competitive; the bad news, that interest rate hikes, if marked, could derail the fragile global recovery, and as a result, quell demand for US goods.  With inflation rising, countries with flexible exchange rates (e.g. Brazil) could see their currencies depreciate relative to the dollar.  If this depreciation offsets the price hikes one for one, there would be no competitiveness gain for US exports.  Nevertheless, emerging market optimism of late seems to be preventing any major depreciation of EM currencies.    

During the Washington Summit of Presidents Obama and Hu, US officials downplayed the rhetoric about China’s need to revalue its currency, instead pointing to the dragon’s rising inflation, which results in a “real” appreciation of the yuan, even as the nominal rate remains fixed.  I alluded to this process last fall in this post.  It is true that rising prices are doing some of the job of reversing China’s undervalued currency, though most economists believe more needs to be done through currency revaluation.   But, with China’s GDP growing at nearly 10% per year (versus US growth at under 3%) and its inflation rate at 4.5-5% (versus US inflation of 1.5%), the pressure to increase the value of the Chinese yuan has eased.  

But let’s put this in perspective.  With China’s per capita GDP slightly larger than a third of US per capita GDP, it is clear that China’s labor cost advantage is such that even a sizable revaluation of the yuan won’t allow US producers to compete in China.  What it will do is make China’s competitors in the emerging world, such as Vietnam, India, even Brazil, more competitive in the US market relative to China.  It should also help US producers compete with other industrialized  countries for a slice of the Chinese market; however, as President Obama has come to recognize, China’s mercantilist practices (e.g. local content requirements, subsidies, regulatory barriers) favor local over foreign firms in many Chinese markets.  Removing these obstacles seems more important to redressing the trade imbalance with China than the symbolic appreciation of the yuan against the dollar.   

As my colleague who writes the FPA’s India blog pointed out (read here), prices are rising in India as well.  As he and I have noted (read here), when prices rise in India, where poverty is rife, politicians quiver.  Food price inflation a few percentage points higher may cause central bankers to ask for a stronger cup of coffee, but in India, it means more people starve.  Hence, the Indian government is moving quickly with measures to ease this pain, and rightly so.

Many EM officials blame America’s quantitative easing for the inflation surge in their countries because of the enormous capital inflows they are experiencing.  That issue aside, will higher inflation in the EM world hurt or help the US?  This will depend on how effective central banks in these countries are at quelling a deterioration of inflation expectations.  If expectations for accelerating inflation emerge (as they did in the US in the late 1970s, compelling Jimmy Carter to appoint inflation-hawk Paul Volcker as Fed chairman), then central banks will have to ratchet up interest rates higher than they would have if they had acted sooner.  This would mean that global growth and demand for US exports would suffer.  And, with domestic demand in the US set to be in the doldrums for some time (due to retrenching governments at the federal and local levels and consumers still battling with unemployment and negative home equity), Uncle Sam badly wants export demand.  If, however, prices abroad rise modestly and global growth continues apace, the demand for relatively cheap US exports would continue to expand.  

From CSFB today:

Latin America
Brazil:              The Copom has increased the Selic basic interest rate to 11.25% in January, in line with market forecasts
Mexico:            Congress ratified key appointments for the Ministry of Finance; the latest market survey on inflation will be released today
Venezuela:      PDVSA President and Energy Minister Rafael Ramirez said during a press conference yesterday that Venezuela exports an average of 2.3mn bpd of oil annually out of about 3.0mn bpd produced
Europe, Middle East and Africa
Poland:            The MPC raised the policy rate by 25bps to 3.75% yesterday, as expected
Russia:             Inflation accelerated further in mid-January, likely putting the official end-2011 target out of reach and increasing the chances for a rate hike later this month
South Africa:    We expect the Reserve Bank to hold its policy rate at 5.5% at the end of its MPC meeting today at 1:00pm London time
Turkey:            We expect the MPC to keep the one-week repo rate unchanged at 6.50% today and make no changes to the reserve requirement ratios; the decision is due to be announced at noon London time
Non-Japan Asia
China:              4Q10 GDP rose 9.8% yoy, stronger than expected, while inflation stayed elevated at 4.6% yoy in December
India:               The prime minister has reshuffled the cabinet; a more “expansive” reshuffle is likely after the upcoming budget around end-February
Malaysia:         Rate hike is not imminent, in our view; watch fuel prices



Roger Scher

Roger Scher is a political analyst and economist with eighteen years of experience as a country risk specialist. He headed Latin American and Asian Sovereign Ratings at Fitch Ratings and Duff & Phelps, leading rating missions to Brazil, Russia, India, China, Mexico, Korea, Indonesia, Israel and Turkey, among other nations. He was a U.S. Foreign Service Officer based in Venezuela and a foreign exchange analyst at the Federal Reserve. He holds an M.A. in International Relations from Johns Hopkins University SAIS, an M.B.A. in International Finance from the Wharton School, and a B.A. in Political Science from Tufts University. He currently teaches International Relations at the Whitehead School of Diplomacy.

Areas of Focus:
International Political Economy; American Foreign Policy