What happens to energy and food prices
How is inflation in emerging countries? The analysis by Arjun Madan, Fixed income global portfolio strategist of Capital Group
Higher inflation and, in some cases, rising inflationary expectations have been the areas that investors have focused on most this year, both in emerging and developed markets, in light of an environment characterized by important monetary stimuli. and taxes promoted by governments around the world, the multiple variants of COVID and the gradual distribution of vaccines. The factors behind the acceleration in inflation are diverse and include base effects related to the shock of the pandemic, supply-side bottlenecks, high commodity prices, weak exchange rates (in some cases) and recovery in domestic demand.
This has led to the question of whether the rise in inflation will be temporary or more lasting. Base effects and supply-side bottlenecks are expected to ease over time, but commodity prices or exchange rate pass-through to core inflation and any strengthening of domestic demand could lead to more lasting effects, in particular whether they impact inflation expectations. The following are the factors driving inflation in emerging markets.
Food and energy prices
Food prices: Food prices represent a much larger component of CPI (Consumer Price Index) inflation in emerging economies than in developed markets; therefore, such economies are more sensitive to supply shocks, both globally and locally. Many of these factors are likely to be transient, so it is reasonable to expect food inflation to stabilize as emerging economies open. That said, we will need to pay attention to the long-term impact that weather conditions and the price of energy will have on food prices. In the median PCI basket of an emerging economy, food accounts for about 25%, while this share is less than 15% for the median basket of a developed economy and less than 10% for the US.
Food inflation has generally increased in EMs since the pandemic, but the causes have not been the same in different countries and the outlook also varies based on local factors. Countries such as Brazil and Russia have seen food inflation rise well above headline inflation, while in Eastern Europe and the Middle East there have been greater fluctuations. In Asia, food inflation has been high only in some countries, for example in India, while others like Thailand and China have seen price deflation.
Energy prices: Energy prices tend to have a particularly significant effect on EMs, although the final effect on consumers varies as fuel prices are a political issue in many emerging countries. As a result, numerous regulatory actions have been put in place to reduce the volatility of fuel prices.
Furthermore, many emerging countries are major oil exporters; therefore, they benefit from the improvement in the trade and fiscal balance due to an increase in the price of oil. Oil prices have recovered since the beginning of the year, driven by both supply and demand factors. On the demand side, we saw a strong recovery, while supply remained limited. Oil prices now better reflect fundamentals and it is reasonable to expect at least some stability over the next 12-24 months, with higher prices triggering a reaction in supply and demand. Base effects from rising oil prices are also expected to normalize next year, helping to ease energy price inflation.
Exchange rate pass-through (ERPT)
The pass-through (pass-through) of weaker exchange rates to inflation can be quite high in EMs, particularly in countries that are large importers and where therefore any currency weakness exerts upward pressure on inflation.
Research by Goldman Sachs shows that exchange rate pass-through (ERPT) has dropped across the board in emerging countries over the past two decades. Open economies have higher pass-throughs, while economies that enjoy monetary policy credibility have lower pass-throughs. Calculations performed show the highest ERPTs in Turkey, Romania and Hungary, the lowest in Indonesia, South Korea and Mexico. Additionally, the research reveals skewed ERPT results, with a weak currency having a greater impact than a strong currency.
Overall, our reference frameworks show EM currencies close to exceptionally low levels. While this is partially justified by deteriorating growth and fiscal conditions, it is reasonable to expect the next decade to bring greater currency stability for EMs.
Credit creation in EMs
Credit creation in emerging economies remained subdued. If it persists, weak credit creation should help ease inflationary dynamics.
Weak economic recovery / EM output gap
Emerging countries, as well as developed countries, have experienced significant contractions in gross domestic product (GDP) caused by the pandemic, which in turn have generated large output gaps. What's more, the recovery in EM has significantly lagged behind that of the MS, in part due to lower fiscal spending and reduced vaccination rates. While the timing is difficult to predict, a recovery from EM supply bottlenecks should contribute to lower inflation.
Central bank reaction function and interest rate differentials
Monetary policy plays an important role in long-term inflation dynamics, especially in inflation expectations. On average, EM central banks have intervened more proactively by raising rates than MS central banks, despite weak domestic conditions. Tightening local financial conditions should help curb inflation by depressing domestic demand and defending against currency depreciation.
More generally, with the globalization of supply chains, inflation is increasingly becoming a global dynamic. Emerging countries will have to continue to pay attention to high inflation and MMT policies in developed countries, especially if the latter lead to an increase in aggregate demand in the MS without increasing supply. We think markets are likely to reward proactive central banks.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/che-cosa-succede-ai-prezzi-energetici-e-alimentari/ on Sun, 05 Dec 2021 06:08:22 +0000.