Emerging markets in an inflationary environment

After more than a year of rising prices, inflation remains the key economic challenge for policymakers across the world. In developed markets, central banks are raising rates, prompting fears of an upcoming recession. In emerging markets however, where the hiking cycle started early, the situation varies from region to region, with policymakers trying to maintain growth, tame inflation, while at the same time manage the impact of external shocks.

At HSBC’s 2022 Global Emerging Markets Forum, a panel of the bank’s market-leading economists discussed how each emerging market region is adapting to the challenging environment.

Asia’s emerging economies started in 2022 with a number of positive surprises to growth. This was the result of a boost to domestic consumption and investment as countries removed pandemic-related restrictions late last year, while exports remained strong for much of the region.

“Our view is that we will see growth headwinds stiffen on the domestic side, and there is clearly a sense that the reopening tailwinds will abate, with a slowdown in consumption due to the shock of higher energy and food prices, along with a cooling in the trade cycle” said Frederic Neumann, Chief Asia Economist and Co-Head Global Research Asia, HSBC.

As a result, central banks in Asia are looking more towards addressing growth risks than calming inflation. They can do this because although inflation is elevated across the region, it is less acute than in other parts of the world. Interest rate moves will therefore not be as aggressive as the Fed’s hikes.

There will be currency implications that arise from central banks not matching US monetary policy, sparking fears of currency depreciation that could exert financial pressure on Asia’s emerging markets.

“We do not think that balance sheets are vulnerable to an FX decline,” said Mr. Neumann. “Compared to the late nineties, the dollar-borrowing component is much more manageable. Asia has higher FX reserves than in the past and there are no signs of financial stress emerging.”

He pointed out several countries in the region. In South Korea, the external headwinds will be strong enough to stop the Bank of Korea’s hiking cycle, with growth expected to be below trend next year. Indonesia has removed energy subsidies, which will add to local inflationary pressure. And in India, there have been concerns over runaway inflation, but there are already signs of stabilisation in prices.

He pointed out several countries in the region. In South Korea, the external headwinds will be strong enough to stop the Bank of Korea’s hiking cycle, with growth expected to be below trend next year. Indonesia has removed energy subsidies, which will add to local inflationary pressure. And in India, there have been concerns over runaway inflation, but there are already signs of stabilisation in prices.

If there is one overarching theme for the extremely diverse Central and Eastern Europe, the Middle East, and Africa (CEEMEA) region, it is a story of economies dealing with external shocks, exposing serious domestic weaknesses that policymakers are struggling to contain, said Simon Williams, Chief Economist for CEEMEA, HSBC.

Although some of the external supply shocks are starting to fade, there is significant currency weakness across the entire CEEMEA region, which is keeping import costs high. With tight labour markets, external factors are turning into domestic concerns, as there are growing expectations that wages should keep up with rising prices.

“In particular, inflation risks are especially pronounced across Central and Eastern Europe, where the aftershock of the conflict between Russia and Ukraine is particularly pronounced,” said Mr. Williams. “Policymakers were also especially slow to react to those initial inflation pressures.”

The other side of the story for CEEMEA is commodity producers, which have benefitted from a pick-up in energy prices. The Middle East has clearly done well in 2022; and in Africa, Angola is the largest beneficiary. Mr. Williams says that it is important to differentiate between the countries that enjoy temporary relief from the high cost of oil, and those economies where the effects will be felt over the long term.

In Latin America, the focus is on the region’s largest economy. Brazil is outperforming forecasts, which had called for flat growth - or even a recession - due to the tightness in monetary policy. Now the consensus has shifted towards forecasts of 3% growth for this year. The labour market is also strong, with the unemployment rate at 9%, which is three percentage points lower than pre-pandemic levels. And when it comes to prices, there are improving dynamics, with inflation likely having peaked in April, said Ana Madeira, PhD, Chief Economist for Brazil, HSBC.

Although inflation remains the dominant economic theme, each emerging market region is approaching price rises differently. Understanding how it relates to other economic and financial developments will be key to successful emerging market investment. And going forward, investors will have to navigate a challenging macroeconomic backdrop where policymakers try to balance rate hikes with risks to growth, alongside a series of geopolitical challenges.