DAVOS, Switzerland: Emerging economies, seen as the big hope for global growth this year, are caught in a tricky dilemma: let inflation rip and hurt stability or raise rates and risk stalling their economies. Policymakers and business leaders at the World Economic Forum starting Wednesday in Davos will look at ways for emerging economies to keep the engine of growth revving without stoking inflation. Developing countries have so far been reluctant to raise the cost of borrowing, as higher interest rates would attract even more capital inflows and push up local currencies, hurting export competitiveness. Emerging nations are all too aware of their role in keeping the world economic recovery on track. The International Monetary Fund drove home that point Tuesday, saying a slowdown in these economies would deal a serious blow to global growth. Concerns are intensifying that emerging market monetary authorities may be behind the curve in tackling inflation. If inflation got out of control and aggressive policy measures became necessary, that could send these economies into a hard landing, damaging the rest of the world. “There's a real risk that being behind the curve in addressing inflation, inflation takes root and then the second round effects will be more damaging for these countries and also for the world economy,” said Michala Marcussen, head of global economics at French investment bank Societe Generale. “That's why if you think about the risks for the global economy today, the risk is more that something nasty comes out of emerging markets than advanced economies.” Investors are already becoming nervous about the prospect of inflation surprises in the emerging markets. Emerging market stocks, as measured by MSCI, hit two-week lows earlier this week, underperforming their developed market counterparts. According to its updated economic outlook, the IMF expects emerging economies to grow 6.5 percent in 2011 against a 2.5 percent expansion in the developed world. It cited inflation as the key risk for emerging economies and said tighter monetary policies were needed. “Many countries are close to potential,” IMF head of research Olivier Blanchard told a news conference. “That probably means that in a number of countries monetary policy may need to be tightened in order to maintain inflation under control.” A flood of cheap money - created as a result of ultra-easy monetary policy in the developed economies - is the root of the inflation problems in the emerging world. The Institute for International Finance expects 2011 equity portfolio flows to emerging markets to ease to $143 billion in 2011 from an estimated $186 billion last year, although they are still more than double the $62 billion annual average of 2005-9. Based on a monetary policy rule developed by US economist John Taylor, a central bank whose inflation is above target, should have positive real rates to tackle price pressures. But real rates in many emerging economies are near zero.
