Following his recent visit to the Middle East, HSBC spoke to its senior economic advisor and author Stephen King for his thoughts on the global and regional economic outlook.

How is inflation in developed markets impacting on emerging markets?

Inflationary pressures on emerging markets depend on the causes of the inflation in developed markets. Higher energy prices, for example, are a global phenomenon so are likely to raise inflation across the world. However, a domestic-rooted spike in inflation in a developed economy will most likely affect emerging markets because of the impact of tighter US or European monetary policy on the exchange rate. A stronger USD or EUR implies higher prices of imports for those emerging markets with flexible currencies.

What do you think is the biggest contributor to inflation in emerging markets? Is it the increase in money supply or external shocks? And what’s the best way to combat it?

Emerging market inflation varies from the very low — for instance, China — to the very high, such as Argentina and Türkiye. China’s slow emergence from the covid-19 pandemic alongside a reluctance to offer policy stimulus on a scale equivalent to that seen in the West explains why inflation there has been muted. Elsewhere, a reluctance to raise interest rates (or even to cut rates when inflation was already high) alongside a relaxed approach to exchange rate valuations has helped stoke inflationary pressures.

Whatever the cause of the inflation, one necessary response is usually that monetary policy will have to be tightened. “Second-round effects,” such as higher wage demands or bigger price increases can stem from faster growth in the money supply or higher energy and food prices. National governments, central banks and regulators cannot rely on hopes that external pressures will ease and carry no adverse inflationary consequences.

How important is fiscal policy / balance of payments (especially when a country suffers a current account deficit) in the context of inflation?

Going back to the first question, a country with a large external funding requirement — revealed via a large current account deficit — may be vulnerable if the cost of borrowing is rising elsewhere. If, for example, the US is raising interest rates, capital flows that might easily have gone to an emerging market with a large external deficit might now head to the US. The result is likely to be downward pressure on the emerging market currency, increasing the risk of higher imported inflation.

How sticky will inflation be going forward?

Persistently high, ‘sticky’ inflation is already greater than central banks anticipated. Many central bankers feared deflation more than inflation, thinking for too long that we were living in a Japan-style world of falling prices. Continued stickiness depends on whether policymakers have the appetite to tighten policy sufficiently to squeeze inflation out of the system. There is concern about the consequences for the “real economy” and for financial stability, although alternative remedies — such as price and wage controls — have a checkered history. As such, some policymakers are simply hoping that inflation will go away, in the anticipation that so-called “second round” effects will not materialize.

How risky are devaluation-inflation and wage-price spirals for emerging markets?

It depends on the condition the emerging market is in, and those with independent central banks are likely to fare better. So too are those markets with small current account deficits or large surpluses, as are those with healthy fiscal positions that have enough “space” to raise taxes or cut spending and which don’t have too much in the way of indexation of either prices or wages. Resorting to the “printing press” to solve a fiscal problem is problematic, as history and more recent examples across the world have demonstrated.

Those countries with robust currency pegs will likely fare well — they have a tried and tested monetary policy. For many countries in the MENAT region, this is very good news. Because of the Federal Reserve’s actions and the USD pegs, monetary conditions have become tighter, however, regional economies are in many cases strong enough to cope.

Stephen King (LinkedIn) is HSBC’s senior economic adviser and author of We Need To Talk About Inflation: 14 urgent lessons from the last 2000 years (Yale University Press). HSBC’s column appears in Enterprise every second Monday.

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