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As a group, emerging market countries have rebounded from the Great Recession in much better shape than developed economies. And driven by higher commodity prices, robust domestic consumption, and a growing middle class with buying power, the emerging market asset class appears poised for more growth heading into 2011. While investors have been focusing on the European debt crisis, however, many emerging market economies have been getting a little overheated from the rapid pace of growth, and inflationary fears are quietly becoming a daily reality.

Since the second half 2010, inflation has become a concern for emerging economies. According to the International Monetary Fund, the consumer price index of emerging markets hit bottom in the second half of 2009, and then started to rise again in 2010, igniting inflationary fears.

In many emerging market countries, food and energy prices have had a much bigger impact on overall inflation as these commodities comprise a larger share of household expenditures than developed countries. This is especially true for some Asian countries such as Indonesia, where inflation is running at 6.3%, and India, where inflation swelled into double digits before settling back to 8.3% (see table below) at the end of November

Source: Bloomberg

Inflation and price hike expectations in emerging economies can also be attributed to various reasons such as bad weather (pushing up the price of agricultural products), stimulus measures that released too much liquidity, and higher labor costs and commodity prices.

In addition to having a negative impact on consumers’ wallets, higher inflation may cause a sense of false prosperity, as well as volatility in the real estate and stock markets. And while the monetary policies of advanced economies in Europe and the U.S. may benefit their respective economies, it can also trigger capital inflows into emerging market economies, putting upward pressure on global commodity prices. In order to manage inflationary pressures, major emerging economies like Brazil have tightened monetary policies in recent months. However, this increased the interest rate gap between developed and developing economies, attracted more “hot money” and imposed more pressure on currency appreciation. In October, Brazil implemented capital controls in order to counter what it termed “a currency war” between the worlds’ major currencies.¹

In order to fuel export growth, many emerging market countries have kept a lid on appreciating currencies and aggressively intervened in foreign exchange markets by purchasing U.S. dollars and building currency reserves. However, keeping currencies “cheap” can drive up the price of imports such as oil and other raw materials, thus adding to inflationary pressures.

With the world’s biggest populations and fastest growing economies, China and India have recently led the way in trying to cap the explosive rise of the commodities markets by increasing interest rates and bank reserve requirements. Rising property and food prices, coupled with a torrid pace of lending, are signals of an inflationary bubble in China. Facing an inflation rate of 5.1%, the country recently raised interest rates for the second time in three months by 25 basis points to 5.81%.²

We believe there are still growth opportunities for investors in emerging markets due to their vast natural resources and commodity and infrastructure growth. And as living standards continue to rise in these countries, domestic demand will increase exponentially. This has huge implications for key parts of the emerging market asset class, including banks, infrastructure companies, retailers, and service industries.

But as the old saying goes, there is no gain without pain. As emerging markets continue to grow and become a more integral part of driving the global economy, they will undoubtedly have to deal with other major concerns such as surging capital inflows and the associated risk of asset bubbles, rapid currency appreciation, and last but not least—inflation. Indeed, the leaders of emerging market countries must balance concerns over higher food and housing prices that impact the lower and middle class against a desire to avoid tightening so aggressively that it inhibits future economic growth.

American Century Investments^® offers a wide variety of stock, bond, asset allocation and money market funds. Visit americancentury.com for more information: Individual Investors | U.S Investment Professionals

¹ “Rising Inflation Poses Challenge for Brazil’s New President,” Dec. 23, 2010, Financial Times.

² “China Acts to Tame Inflation with Fresh Rate Rise,” Dec. 28, 2010, Financial Times.

Investment return and principal value will fluctuate, and it is possible to lose money by investing.

International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.

The opinions expressed are those of American Century Investments and are no guarantee of the future performance of any American Century Investments portfolio. This information is not intended to serve as investment advice; it is for educational purposes only.

You should consider a fund’s investment objectives, risks, and charges and expenses carefully before you invest. The fund’s prospectus or summary prospectus, contains this and other information about the fund, and should be read carefully before investing. Investments are subject to market risk.

© 2010 American Century Proprietary Holdings, Inc.

American Century Investment Services, Inc., Distributor

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