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Inflation-linked bonds: Making sense in emerging markets

Governments should give investors what they need and issue inflation-linked bonds.

The biggest challenge facing the emerging markets is not the credit crunch; it’s inflation. Surging price rises are evident in all developing regions with buoyant economic activity, high food and energy costs and currency pegs all playing their part, depending on the specific country.

In South Africa the inflation rate is more than 10%; in Russia it’s 15%; in Argentina it is probably 20% despite what the official figures state. Inflation is becoming a headache for policymakers in Asia and the Middle East too.

Emerging markets investors are grappling with the issue too. Last month, Sinopia, an asset management subsidiary of HSBC, announced that it was raising money for what it believes are the first emerging markets funds to invest exclusively in inflation-linked bonds.

Given how some developing nations have suffered from prolonged bouts of inflation, and even hyperinflation, it’s perhaps a surprise that no dedicated fund has been established before. There are two main reasons: limited diversification of supply and insufficient liquidity.

Barclays Capital’s local-currency Emerging Markets Government Inflation-Linked index (EMGIL) has a total market capitalization of $215 billion. The size compares well with the more developed markets – the UK Government Inflation-Linked Bond index, for example, has a market cap of just over $300 billion.

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