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Sunday, 6 June 2021

Rising US inflation a worry for emerging markets

Heightened inflation in the US is likely to spell trouble for emerging economies as rising yields squeezes countries with hefty debt loads and precarious public finances, analysts tell the Financial Times. “Emerging economies should be worrying more about US inflation than about their own,” Tatiana Lysenko, lead economist for emerging markets at S&P Global Ratings, tells the salmon-colored paper.

But why? Higher prices mean a greater likelihood that the US Federal Reserve will raise interest rates to quell inflation. Higher interest rates are bad news for emerging markets, many of whom have debt denominated in greenbacks. As yields on US debt increases, investors begin demanding higher returns on riskier EM assets, pushing up their borrowing costs. Rising rates in the US typically suck capital out of emerging economies and strengthen the greenback, leaving developing nations with weaker currencies and hurting the finances of countries holding a lot of USD-denominated debt.

We saw this earlier this year when yields on US treasuries began to creep up. As more investors began to anticipate a Fed rate hike, a sell-off in the US sovereign debt market shocked EM assets, with currencies and stocks both seeing outflows at the end of February.

One of the countries name-checked by the FT is Egypt: Egypt has one of the highest refinancing costs in the world and will need to refinance debt amounting to 38% of GDP this year. It has also refinanced at higher rates, paying an average interest rate of 12.1% on its debts, slightly above its average cost of 11.8%, according to S&P.

Inflation isn’t the only risk to EM, Lysenko says, telling the FT that if the US economic recovery diverges too abruptly and surges ahead of emerging economies, investors could react by selling EM stocks and bonds.

Some EM central banks have limited room for manoeuvre: Brazil, for example, in response to a surge in inflation has raised rates twice this year, and another hike is expected this month. The issue is that the country’s central bank can only raise rates so far without destabilizing public finances, and should the recent price growth prove to be more than just transitory, it could find itself between a rock and a hard place.

Fortunately, Egypt is not in this position: The Central Bank of Egypt is in a rather different position, facing low inflation with some of the highest interest rates in the world. Rather than facing pressure to tighten, the central bank has room to cut rates at its upcoming meeting without too much fear of provoking a surge in inflation.

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