The entire world now seems fixated on the outcome of the Korean tensions and the European financial crisis. Even the Chinese interest rate hikes are making quite a number of headlines. Agreed, all these are key risks for global markets in general and emerging markets in particular. But there is one major risk that is quietly building up in the background. And not many are talking about its magnitude as yet.
We are talking about the potential of high 'inflation' in emerging markets.
The key worry is that expectations of high inflation in the future (due to rising food and fuel prices) can derail the economic recovery in these markets, India included. This is given that such an expectation will lead the central bankers here to raise interest rates more aggressively than is currently expected.
The Indian central bank, RBI, has already raised interest rates seven times this year to counter rising inflation (currently at around 9%). And it doesn't seem to have stopped as yet.
Many, in fact, now fear that central banks in emerging markets have been behind the curve in managing inflation. They probably have let inflation go further than they otherwise would. And this has created the risk of overheating in these economies.
Now, higher interest rates can spook emerging market assets like stocks, bonds, and currencies. And this risk is what investors must factor into their investment decisions.
High inflation can completely change the investment landscape in emerging markets like India. And you need to carefully guard against this demon.