Apres le deluge

Inflation arises from popping EM asset bubbles

Money is heading out of emerging markets, thanks to the fear of a change in US monetary policy. The result is falling currencies, higher inflation and slower growth. That's bad news for emerging markets and for global growth.

The problem began with mere talk. Comments suggesting less quantitative easing from the US Federal Reserve have led to a rise in Treasury yields.

Emerging economies are vulnerable. Their markets have bubbled too much, flooded by the Fed. As the 10-year Treasury yield rises in the coming year - the current 2.15 per cent remains ultra-low - more excess liquidity will be drained from global markets.

Already the MSCI Emerging Markets stock index is down by 20 per cent since April 2011. And currencies are plunging. Brazil's real and Mexico's peso lost six per cent of their value against the dollar in May. The Indian rupee is at its lowest in almost a year; the Turkish lira at its lowest since January 2012, with political unrest another reason to sell.

Such abrupt devaluations bring higher yields on local bonds. They also threaten higher inflation, as import prices jump. The loss of foreign funds and the increase in financial uncertainty slows GDP growth. Countries which have long relied heavily on hot money flows for current account financing - Turkey is the most prominent example - are most vulnerable.

Brazil does not need hot money, but its problems are typical of emerging markets. The central bank increased its benchmark interest rate by 50 basis points on May 29, to eight per cent. It wants to bolster the real and restrict inflation, already too high at 6.5 per cent. GDP growth, a meagre 0.6 per cent in the first quarter, will suffer.

In April, the International Monetary Fund reduced its forecast for 2013 emerging market GDP growth to 5.3 per cent, scarcely better than the 5.1 per cent of 2012. A further reduction now seems likely.

The emerging countries can hardly be blamed. The inflowing tide of money caused bubbles and excess currency appreciation, and the outflow is provoking financing concerns and inflation. The Federal Reserve's monetary policy is the moon guiding the global tides. It should start to think more globally.