Look out for emerging markets inflation
(James Saft is a Reuters columnist. The opinions expressed are his own)
Emerging markets could be the first to suffer destabilizing inflation, courtesy of a strong economic rebound, a weak dollar and extremely loose monetary policy in the developed world.
Inflation, in faster growing emerging markets, was not high on the list of worries even months ago, but the speed and strength of the rebound and red-hot asset markets in some places show that it may be a rising threat.
“The surprise could be that inflation in emerging markets really takes off,” Amer Bisat of hedge fund Traxis Partners said on Tuesday at a Euromoney foreign exchange conference in New York.
It is not yet a central case, but should price pressures in countries like China, Korea and Brazil take hold, it will leave policy makers in a bind and would roil financial markets.
Interest rate hikes might only attract more hot capital and may be only partially effective. Rising currencies can be self-fulfilling and higher interest rates in emerging markets make carry trades — borrowing in dollars, for example, and reinvesting in something like Korean won — all the more attractive.
Other methods of stemming currency appreciation, which stokes inflation, may also become more popular; Brazil in October imposed a 2 percent tax on foreign inflows into equities and fixed-income instruments designed to keep the real from appreciating too quickly.
The problem is that China is too big. Inflation in the cities will have a ripple effect on the rural areas. When the cost of real estate escalates in cities, the manufacturing cost increases, the farmers will have to pay more for products and services originate in cities.
This will cause the rich-poor gap to widen between city-folks, and rural folks.