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EM Disinflation - Reasons, Timing, Costs

August 16, 2022

Read Time 2 MIN

Headline inflation appears to be peaking in several EMs. What are the main drivers, and is there any collateral damage elsewhere in the economy?

Peak Inflation

The latest data releases point to several emerging markets (EM), where headline inflation might be peaking. These countries are: Poland (15.6% is a likely peak), the Czech Republic (17.5%), Romania (15.05%), Russia (17.83%), Brazil (12.13%), Peru (8.81%), India (7.79%), and Thailand (7.66%). There is an important caveat though. The “peak” narrative does not always apply to underlying (core) price pressures. Some measurements of core inflation in Brazil appear to be heading south. But Poland’s core inflation surprised to the upside today, accelerating to 9.3% year-on-year in July.

EM Inflation and Slowdown

A major technical driver behind expected headline disinflation in most EMs is a base effect - we sometimes refer to it “the mother of all base effects”, because it’s so unusually high. The impact of this factor will become especially pronounced later in 2022 and in H1-23. As regards fundamental drivers, we should mention a lagged impact of the past rate hikes on domestic activity - as well as other growth headwinds, including energy disruptions in Europe related to the Russia/Ukraine war. There is a real risk that some EMs might experience an H2 growth cliff - we were alarmed by a sharp drop in July’s activity surveys in Poland, the Czech Republic, and Mexico. The latest activity prints in China were also discouraging - albeit the latter can end up being a silver lining for global inflation if it has a cooling effect on commodity prices.

EM Fiscal Adjustment

One area that is increasingly drawing attention in economic discussion is the fiscal cost of EM disinflation and potential implications for local bond markets. It is not a secret that temporary tax cuts helped to ease near-term inflation pressures in countries like Poland and Brazil. Stronger than expected GDP growth (so far) is a reason why the impact on the budget balance was relatively muted - but this might not last (if H2 growth weakness materializes). This is why we track plans to introduce additional fiscal subsidies as hawks. Just as an example, the 2023 consensus budget deficit forecast for Poland widened from 2.5% of GDP to 4% in the past six months or so. This might not seem like the end of the world, but we learned today that Indonesia wants to cut its budget deficit from 3.92% of GDP to 2.85% next year. Would investors in EM local debt consider this a better proposition? Especially if the Indonesian central bank finally starts hiking? Stay tuned!

Chart at a Glance: Poland’s Underlying Price Pressures - Still Up

Chart at a Glance: Poland’s Underlying Price Pressures - Still Up

Source: Bloomberg LP

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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