Inflation level to touch a new high in emerging markets in 2008
Merrill Lynch has predicted that emerging markets inflation will likely rise from 5.3% in 2007 to 6.7% in 2008, the highest level since 2001. War on Inflation
By Sanjeev Sharma, TNN |
NEW DELHI: Inflation concerns are on the rise in many emerging market economies. Merrill Lynch has predicted that emerging markets (EM) inflation will likely rise from 5.3% in 2007 to 6.7% in 2008, the highest level since 2001.
Inflation does not solely explain the 7% drop in EM equities year to date.
But it has been a negative. Rising inflation induces fear of lower real returns, increased interest risk and reduced earnings. Economies with the largest upward revisions to inflation forecasts have very broadly been the worse equity performers in recent months. India, on the other hand, has fallen much more at 21% even with the lowest change in inflation forecast.
In the last nine months, there have been 156 inflation releases across EM. Of these, 99 have surprised on the upside and 57 have surprised on the downside. Asia (where equity prices are flat since July) has had the largest proportion of negative surprises. India leads EM in the highest number of negative surprises in the past nine months.
Inflation does not solely explain the 7% drop in EM equities year to date.
But it has been a negative. Rising inflation induces fear of lower real returns, increased interest risk and reduced earnings. Economies with the largest upward revisions to inflation forecasts have very broadly been the worse equity performers in recent months. India, on the other hand, has fallen much more at 21% even with the lowest change in inflation forecast.
In the last nine months, there have been 156 inflation releases across EM. Of these, 99 have surprised on the upside and 57 have surprised on the downside. Asia (where equity prices are flat since July) has had the largest proportion of negative surprises. India leads EM in the highest number of negative surprises in the past nine months.
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In contrast, Latin America (where equities are up 17% since July) had the smallest proportion of negative surprises. According to Merrill Lynch, EM equities clearly ignored the signals generated by negative inflation surprises which became progressively worse during the second half of 2007 and have aggressively played catch up this year.
It says since February 1, the inflation surprise index has improved suggesting that expectations for inflation may be beginning to overshoot. Better than expected inflation is a necessary condition for improved risk appetite and a sustained rebound in EM equity prices more likely a second half event. The markets most likely to better than expected or positive surprises in coming months are China, India and Russia. EM lead indicators predict modest deceleration in EM production growth from 10% to 7%.
There is little evidence thus far that EM growth is negatively reacting to US recession/credit crunch.
The secular bull market in emerging markets began at a time of deflation, fear and cheap value and it will end at a time of inflation, greed and expensive value, according to Merrill Lynch.
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