Inflation in emerging countries has risen from 4.5% in mid-2007 to 10% one year later. The rise in the indices stems essentially from the increase in food prices (one-third of indices, on average), which in 12 months has moved from 6% to 17% year-on-year. Underlying inflation has also accelerated, though to a lesser extent, rising from 4% to 6%.

Monetary conditions remain very accommodative: monetary policies did not react to the rise in underlying inflation and the prospect of spiralling salaries until April. This is way off the mark: growth in the M2 aggregate has averaged around 20%, growth in narrow money (monetary base) has been 35%, real short-term interest rates are down (see table below), and the appreciation of emerging market currencies against the dollar which started five years ago has concealed a virtual peg against the G3 currencies, with appreciation of barely 10%. The emerging world presents a conjunction of monetary and exchange rate policies that is ill-suited to a situation reminiscent of the 1970s in OECD countries; interest rates are chasing inflation rather than halting it. In some cases, the pegging of exchange rates to the dollar (e.g. Saudi Arabia, Hong Kong) results in a monetary policy based on that of the US, which is totally inappropriate to the economic situation in the countries in question: interest rates are too low given inflationary pressures and the strength of economic growth. In other cases, efforts to limit currency appreciation in order to protect price competitiveness results, via current account surpluses and capital inflows, in the accumulation of official reserves, fuelling liquidity and credit growth (e.g. China, India). Finally, in many countries, monetary policy can simply be lax, given inflationary tensions and rising credit aggregates (e.g. Russia, South Africa).

Emerging countries are at the source of the surge in commodity costs; demand for energy runs into the buffers of rigid supply. This obviously stems from their strong growth, but also from the fact that – overall – internal prices are being kept artificially low (subsidies, ceilings), despite recent decisions in some countries (China, India, Malaysia). Excessively accommodative monetary policies play their part in this. While the rise in prices is undeniably accelerating, and not always just because of commodities, combating inflation does not appear to be an obvious priority, at least in terms of action. Interest rate hikes have admittedly been implemented, but real interest rates remain negative, generally to a more marked degree than last year, and credit aggregates show worrying trends. Of course, if is not easy to implement monetary policies that are suited to this environment. Interest rate hikes can trigger capital inflows that swell already excessive liquidity. This raises the question of the appropriateness of fixed or managed exchange rate regimes in the current context. A switch to floating exchange rates would obviously mean the abandonment of mercantilist policies and the resulting accumulation of reserves, which would have the consequence of putting a brake on purchases of US Treasuries and creating a risk of higher market interest rates in the US. Nevertheless, only the application of monetary policies better suited to the current inflationary context can slow demand for commodities, stem the rise in prices and stamp out inflationary pressures which, if they last, can have just as much influence on market interest rates.

D'Arvisenet editorial reflects the view of the Economic Research Department of BNP Paribas. It is published for information purposes only. Neither the information nor the opinion expressed constitutes an offer or solicitation to buy or sell any investments. Information contained herein has been obtained from sources believed to be reliable but BNP Paribas does not guarantee its accuracy or completeness. All opinions and forecasts are subject to change. Discretion with respect to suitability should be prudently exercised.