The outlook for emerging market (EM) inflation has been a topic of interest for financial markets, which have shown encouragement by the resilience they have seen and the ongoing decline in headline inflation. While there is significant divergence across EMs in their inflation rates, markets expect inflation to decrease swiftly to target levels without impacting economic growth. Additionally, lower inflation is expected to pave the way for EM central banks to implement rate cuts later this year.
However, there are concerns that markets may be overly optimistic about the measures required to bring down inflation in EMs. Despite some positive signs, there is a worry that price pressures are deeply rooted in many economies and that the risks of upside inflation are substantial. As a result, central banks must remain steadfast in maintaining tight policies and acknowledge that insufficient monetary tightening now may necessitate more drastic actions in the future. This serves as a lesson from the high inflation period of the 1970s, which is still applicable today. Fiscal restraint can also assist in combating inflation, and the use of financial tools, when employed judiciously, can help improve trade-offs during periods of significant financial stress.
The success of EM central banks in achieving low inflation has contributed to the anchoring of long-term inflation expectations around announced targets. Long-term inflation expectations are less reactive to short-term developments, and there is less variation in long-term inflation forecasts among different analysts. While establishing monetary policy credibility remains an ongoing challenge, EMs are better equipped to tackle the current high inflation compared to previous periods.
During a conference, a speaker emphasized that markets may be too optimistic about the efforts required to combat inflation in EMs. Despite positive signs, there are concerns about entrenched price pressures in many economies and the substantial risks of upward inflation. Therefore, central banks must remain resolute in maintaining tight policies and recognize that inadequate monetary tightening now may lead to more severe measures in the future, as seen in the high inflation period of the 1970s. The International Monetary Fund (IMF) has predicted modest global growth and a gradual decline in inflation.
However, EM central banks must exercise caution in their use of financial tools. Expanding balance sheets while fighting inflation can create confusion regarding the stance of monetary policy, increase exposure to credit or maturity risk, and raise concerns about favoritism. Therefore, it is crucial to set a high bar for such interventions, ensuring their temporary and targeted nature.
The speaker also emphasized the importance of fiscal restraint in supporting the fight against inflation by central banks. Furthermore, the judicious use of financial tools can help improve trade-offs during periods of pronounced financial stress. The challenges faced by emerging markets are global but are intensified for these economies. Therefore, it is crucial for EM authorities to refine and strengthen their monetary, fiscal, and financial policy frameworks.
0. “Tackling High Inflation in Emerging Markets” International Monetary Fund, 17 May. 2023, https://www.imf.org/en/News/Articles/2023/05/16/sp051723-fdmd-inflation-speech-central-bank-of-Brazil
1. “IMF’s Gita Gopinath Urges Central Banks To Keep Monetary Policies Tight Over Sizeable Upside Inflation” LatestLY, 18 May. 2023, https://www.latestly.com/agency-news/business-news-upside-risks-for-inflation-sizable-central-banks-must-stay-resolute-imfs-gita-gopinath-5136183.html