3 min read.Updated: 22 Jul 2021, 01:02 AM ISTNiti Kiran
Most emerging markets face a stark growth-inflation tradeoff. A few have already tightened monetary policy this year and it may only be a matter of time before others, including India, are forced to do the same
At a time when foreign investors have become increasingly cautious about emerging market investments, India’s rank among peers slid further, the latest update to Mint’s emerging markets tracker shows. Weakened manufacturing activity, relatively sub-par exports, and high inflation led to a decline in India’s position in the league tables.
India topped Mint’s emerging markets tracker in April but the ferocious second wave brought down India’s rank to 4th in May, which slid further to 5th in June. The tracker, launched in September 2019, takes into account seven high-frequency indicators across 10 large emerging markets to help us make sense of India’s relative position in the emerging markets league table. The seven indicators considered in the tracker encompass both real activity indicators, such as the manufacturing purchasing managers’ index (PMI) and real GDP growth, and financial metrics. The final rankings are based on a composite score that gives equal weightage to each indicator.
As the delta variant rips through the developing world, most emerging markets with meagre vaccination coverage face risks of economic activity slowing down, as they are forced to impose mobility restrictions once again. India too faces the prospect of another surge in covid infections, after just having seen the worst of the second wave.
Even as emerging markets struggle to revive growth, the recovery in developed markets has fanned the fires of inflation, driving up prices of key industrial commodities and raw materials. Price pressures continue to ratchet up across the globe but the impact of higher commodity prices, one of the key drivers of inflation, has been felt more in emerging economies as food and energy form a large share of their consumption baskets.
A few emerging markets have already tightened monetary policy this year and it may only be a matter of time before others, including India, are forced to do the same. The strengthening of the dollar, amid uncertainty over Fed policy, only adds to the inflationary concerns, as a stronger dollar translates into higher prices for commodity importers.
Unlike in the case of developed markets, inflation in emerging markets such as India has not been accompanied by a strong rebound in output growth or demand. India’s manufacturing activity, as measured by the purchasing managers’ index (PMI) was resilient in April, just above the expansion mark (50) in May, before sliding to contractionary territory in June, one of the worst readings across the 10 largest emerging markets. Only Malaysia had a worse reading than India last month, the latest data show. The IHS Markit’s latest outlook report shows Indian firms are most downbeat about the prospects for profitability, improvement in employment and research and development (R&D) spending. They also see supply-chain bottlenecks and subdued market confidence as threats to the outlook.
Even as domestic demand remains subdued, Indian firms have fared worse than other emerging markets in growing exports. While Indian exports have been more robust in 2021 than in 2020, export growth has been lower than most peers.
High oil prices are another big worry for oil-importing economies such as India. The rupee depreciated 0.5% in June amid a stronger dollar and higher oil prices. Except Brazil and Russia all other currencies have underperformed the greenback. Uncertainty around Fed policy will further strengthen the dollar, putting pressure on emerging market currencies including rupee.
Apart from the recovery in global trade, one source of comfort for India lies in its huge forex buffer that insures the economy from excessive turbulence in currency markets. This also means that India’s import cover at 14 months remains in a comfortable position, even though it is lower than that of Brazil, Russia, and China.
The reserves will be put to test in the event of a 2013-like taper tantrum, when currencies of emerging market economies such as India saw a sharp fall as investors rushed to liquidate their emerging market assets in anticipation of a tapering of Fed’s asset purchase program. There are similar fears now but the difference is that the Fed is much more dovish today, and much more tolerant of inflation than it was eight years ago. Other large central banks such as the European Central Bank (ECB) have also been making dovish noises, and may in fact expand asset purchases even as the Fed slows down such purchases.
The global outlook may therefore end up being more benign than is being feared although there could still be some volatility in the weeks ahead. But domestic challenges remain, for India and for most other emerging markets. Even as they deal with the growth-inflation tradeoff, most emerging markets need to step up their vaccination campaigns to be able to avoid another deadly covid wave. For India too, efforts to fight and contain the pandemic remain key to economic revival.
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