Written by: Regina Chi, CFA® | AGF
As 2022 began, inflation was already a top-of-mind concern for global investors – and then Russia’s invasion of Ukraine added fuel to the fire. Suddenly, one of the world’s top commodities producers became the target of punishing sanctions from the West, and an agricultural powerhouse, Ukraine, became a war zone, cutting off its grain exports and putting global food security at risk. Now, as the war continues and sanctions against Russia seem likely to intensify, more commodities shortages and even higher prices seem like very real prospects, indeed.
In short, the global inflation picture is developing rapidly. But it’s important to note that it is not a uniform picture, especially in Emerging Markets (EM). Before the COVID-19 pandemic, inflation in EMs was generally flat to down, but from the second quarter of 2020 onwards, it has diverged – and the inflection point is stark. In Asia, inflation remains remarkably benign, while in other EMs it is following (or exceeding) the global trend.
In January, headline CPI inflation across the 11 Asian Emerging Markets we cover was in a range of 0.9% to 6%, with no economies recording inflation above a 10-year high, according to UBS Investment Bank. That compares to headline inflation of 5.7% to 10% across selected Eastern European and Latin American economies – not to mention inflation in the U.S. and euro area that hit multi-decade highs – in January.
Why the divergence? While food and energy prices have been rising sharply in EMEA (Europe, Middle East and Africa) and Latin American markets, they have been relatively subdued in Asia. As well, Asian EMs tend to have more stable currencies, and so they have been less susceptible to foreign-exchange volatility as U.S. yields have risen. Importantly, two COVID-19-related factors are at play, too – namely, economic reopening and supply chain disruptions. These factors are impacting Asia differently than they are the rest of the world.
One useful indicator is provided by mobility data, which measure the ability of a population to, basically, move around. During the worst of the pandemic in early 2020, much of Asia had higher mobility rates than the rest of the EM universe, according to UBS. Why? Because Asian countries – many of which had recent experience in epidemic control, having been deeply affected by SARS in 2002-03 – took early and effective steps to keep their economies relatively open. China’s approach was to cordon off highly infected areas. Taiwan took a different approach, acting quickly to close its borders and introduce face mask and social-distancing policies. As a result, the impact on mobility was relatively muted: the lows weren’t as low as in other countries, and so upon reopening the highs are not as high. Asian economies’ reopening has been more gradual, less binary, than in the West.
That may have helped them avoid the sudden demand shocks that have occurred elsewhere. In other EMs, governments were less willing to quarantine parts of the economy or to introduce distancing measures, even as they were more eager to return to normal. Mobility in these regions tanked during the worst of the pandemic, and now that their economies are reopening, demand – and prices – have been increasing faster than expected.
Not surprisingly, central banks in these regions are hiking rates faster, too. Since they bottomed in mid-2021, the benchmark interest rates for a basket of 11 major EMEA and Latin American markets have risen by a combined total of more than 4,000 basis points, according to UBS. And they might not be finished. The war in Ukraine and sanctions on Russia will have knock-on effects on Emerging Markets, mainly through their impact on supply chains and commodity prices. Some EMs (Gulf oil producers, South Africa, Brazil) stand to benefit from higher prices, and their terms of trade may improve. But higher food and energy prices may also push up inflation enough to trigger further monetary tightening, particularly in Central Europe and Latin America.
The other big contributor to Asia’s inflation insulation is the fact that supply chain disruptions simply don’t have the same impact, because downstream dislocations have been more prominent during the pandemic. Spikes in freight rates have been much more pronounced on Asia-to-U.S. and Asia-to-Europe routes than they have been on Asia-to-Asia – or even U.S./Europe-to-Asia, according to Statista. And when there are supply chain disruptions, a greater array of alternative suppliers is available locally in South East Asia than in EMs elsewhere. While that’s in part thanks to diversification away from China in recent years, there are still some clear benefits of having geographical proximity to the second world’s largest economy. For one, China has been able to find ways to implement its “COVID zero” policy while keeping factories open, helping to mitigate supply chain disruptions.
Yet while inflation has been better contained in Asia than in other Emerging Markets or in the West, this divergence is likely to dissipate in the coming months as economies continue to reopen – and if war in Ukraine puts more pressure on energy and food prices. In that case, central banks in Asia may be forced to respond. South Korea was the first Asian country to start increasing rates, introducing its third hike in six months this past January, according to Reuters. In other Asian markets, where quantitative easing was a major pandemic-response tool – it amounted to more than 6% of GDP in the Philippines and Indonesia, according to UBS – central banks are likely to unwind their balance sheets as a first step toward policy normalization.
For investors, the fact of rising inflation in non-Asian EMs – and the prospect of it in Asia – may have several ramifications. First, they might look for opportunities in commodity-rich Emerging Markets such as Brazil, Indonesia and South Africa, which may experience improved external balances if commodity prices rise.
More generally, the way the inflation outlook in Asia evolves over the coming months is well worth paying attention to, as it is likely to be more nuanced than in other Emerging Markets or in the West. For investors seeking opportunities globally, Asia’s inflation divergence serves as a reminder that regional and local realities can make a big difference – and that not all EMs are the same.
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The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
The commentaries contained herein are provided as a general source of information based on information available as of March 21, 2022 and are not intended to be comprehensive investment advice applicable to the circumstances of the individual. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained here.
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