Rising inflation that has begun to hit emerging markets will last for some time, curbing the enthusiasm for investing in countries experiencing rapid growth, some experts say.
Inflation will work insidiously to affect emerging markets equity returns in ways such as currency controls, stunted global growth and political unrest.
“It's probably the biggest concern in the emerging markets at the moment, inflation,” said Philip Poole, London-based global head of macro and investment strategy at HSBC Global Asset Management. “Certainly inflation is a political risk, and it's headline inflation that matters.”
Headline inflation includes food and gas prices, and tends to be more volatile than core inflation.
“Inflation is real and it has been rising around the globe, especially in emerging markets,” said Soonyong Park, managing director and head of global portfolio solutions at Rogerscasey Inc., Darien, Conn. “Inflation should be at the forefront of investors' concerns.”
Although the wide consensus predicts emerging markets will produce stronger returns than developed markets over the long run in most asset classes, some experts say the flood of money going into the developing world will overwhelm some governments' ability to respond to the flood of money moving into emerging markets. (Pensions & Investments, Nov. 15). In this way, inflation — and how it's dealt with — will be a key factor in picking the best markets in which to invest.
In recent months, emerging markets equity returns have trailed those of developed markets, after outpacing them for years. Many experts believe the reasons are worries over the fighting in Libya and higher commodities prices stoking inflation concerns. As the consensus thinking goes, this summer will see a fall in commodities prices and with it an easing of inflationary pressures on emerging markets. For these experts, inflation is a cyclical or short-term trend about to ease up, rather than a structural, or long-term problem.
Not everyone agrees.
Inflation is “unfortunately a structural problem that is more long term in nature, simply because it's not just commodity prices and input costs going up. In emerging markets, not only do you have input costs going up, you have high wage inflation and output gaps at zero — you have structural inflation,” said Wahid Chammas, London-based executive vice president and co-portfolio manager for emerging markets at Janus Capital International Ltd.
In a May 3 note to equity investors from Deutsche Bank AG, its emerging markets strategists said: “Investors are underestimating the extent to which inflation across many emerging markets is a structural as opposed to a cyclical phenomenon.
“Most emerging-market central banks are behind the curve on inflation, while recent dollar weakness notwithstanding, authorities across emerging markets are still generally reluctant to allow what they regard as excessive nominal appreciation of their currencies.”