Fixed Income
EM inflation elevated, but relatively contained
Arjun Madan
Global Portfolio Strategist
  • The gap between emerging market (EM) inflation over developed market (DM) inflation has remained contained this time, in part due to weak economic conditions, muted domestic credit creation and proactive EM central banks. Tighter EM financial conditions should anchor longer term EM inflation expectations.
  • Exchange rate (FX) weakness has led to higher inflation in select countries, but many of these currencies are already structurally undervalued. This potentially limits further inflation from the FX channel, especially if the US dollar appreciation cycle peaks.
  • EM local markets now offer relatively attractive real interest rates. Active portfolio managers can take advantage of relative value opportunities between nominal and inflation-linked bonds to navigate the challenging inflation environment.

EM inflation elevated, but still relatively contained; local markets could offer relative value

Higher inflation and in some cases, rising inflation expectations, have been a key focus for investors this year, in both emerging and developed markets. This is against a backdrop of large fiscal and monetary stimulus from governments around the world, and multiple COVID variants amid a gradual vaccine rollout.

Emerging market headline inflation1

There are several factors driving the acceleration in inflation, including base effects from the pandemic shock, supply side bottlenecks, high commodity prices, weak exchange rates (in some cases), and recovery in domestic demand.

This has raised concerns as to whether this uptick in inflation will be temporary or more long-lasting. Base effects and supply side bottlenecks should ease in time, but commodity prices or exchange rate pass-through into core inflation, and any strength in domestic demand could create longer-lasting effects, particularly if it has an impact on inflation expectations. In this paper, we go through the factors driving inflation in EM.

1. Food and energy prices

Food prices: Food prices form a much larger constituent of CPI inflation in EM economies compared to developed market countries, so these economies are more susceptible to supply shocks, both global and local.

Many of these factors are likely to be transitional so it is reasonable to expect food inflation to stabilise as EM economies open up. That said, we will need to be watchful of longer-term weather and energy price driven impacts on food prices.

The median EM economy CPI basket has roughly 25% of the basket in food, compared to less than 15% for the median DM economy, and less than 10% for the US2.

Food inflation has generally been rising across EM since the pandemic, but the causes have not been the same across these countries and the outlook varies too, depending on local factors. Countries such as Brazil and Russia have seen food inflation well above headline inflation, while there has been more variation within Eastern Europe and the Middle East. In Asia, food inflation has been high in only a few countries, e.g. India, while others such as Thailand and China have witnessed food price deflation.

Food makes up a higher proportion of CPI baskets in EM compared to DM countries3

EM food prices have been trending higher4

Energy prices: Energy prices tend to have a particularly large impact on EM, although the final effect on consumers varies as fuel prices are a politicised issue in many EM countries. Consequently, a range of regulatory interventions are in place to reduce fuel price volatility. In addition, many EM countries are large oil exporters and so benefit from an improvement in the terms of trade and fiscal balance with a rise in oil prices.

Energy prices have recovered from their lows5

Oil prices have recovered so far this year, driven by both demand and supply factors. On the demand side, we’ve seen a strong recovery, while supply has remained constrained. Oil prices now better reflect fundamentals and it is reasonable to expect at least some stability over the next 12-24 months as higher prices drive a supply and demand response. Base effects from rising oil prices should also normalise next year, helping to ease energy price inflation.

2. Exchange rate pass-through

The pass-through from weaker exchange rates to inflation can be quite high in EM countries, particularly among countries that are large importers and so any currency weakness will exert upward pressure on inflation.


1. Source: Haver. Data as at 30 September 2021

2. Sources: CEIC, Reuters, Haver and UBS. As at 31 December 2019

3. Sources: CEIC, Reuters, Haver and UBS. As at 31 December 2019

4. Sources: United Nations, Reuters/Refinitiv, Bloomberg, Capital Group calculations. As at 31 October 2021. FAO: Food and Agriculture Organisation of the United Nations

5. Source: Bloomberg. As at 1 November 2021


Risk factors you should consider before investing:
  • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.

Arjun Madan is a fixed income global portfolio strategist at Capital Group. He has an MBA from the Wharton Business School and also holds the chartered accountant and Chartered Financial Analyst® designations. Arjun is based in Los Angeles.

Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.