The magnitude of current account deficits and the level of inflation are strongly linked, as our chart attached shows. Over our 5y observation period, countries with high average CAD also have high average inflation rates and vice versa. This should not be surprising for two reasons. First, both parameters are outputs, driven by domestic demand/GDP growth, and second, a rise in the current account deficit tends to lead to a weaker currency, pushing inflation higher as a consequence.

The outlier seems to be Russia where inflation has been much higher in the past due to steady increases in regulated prices. As these rises are gradually coming to an end, inflation should also start coming down over the coming years.

Turkey's case is also very interesting. With Turkey's inflation rising and falling with the level of the CAD, and inflation in Turkey very volatile and therefore hard to predict, we use our expectations of the CAD for 2013 to guide us to the likely inflation rate for this year. Our conclusion is that inflation will move higher again, making the 5.3% target set by the central bank very hard to achieve.

Source: bne