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One and done. Two, we’re through. Three, we’re free. Four, no more. Five…

At some point the central banks of India, Brazil, India, Indonesia, Turkey, and other developing countries will decide that they’ve raised interest rates enough to combat inflation. They will see (real or imaginary) signs of the slowing economic growth that they’ve been working to engineer and evidence (significant or temporary) of slowing price increases. And then they’ll end a series of interest rate increases that are at seven and counting in India and that are on track to take interest rates to 13% by the end of 2011 in Brazil.

And then the fears of higher interest rates and slowing economic growth that have been a heavy weight pushing down prices in emerging stock markets in 2010 and so far in 2011 will lift. And at least some of the cash that has flowed out of the world’s emerging stock markets to the world’s developed stock markets will reverse course. And if these emerging markets don’t begin to outperform the U.S. stock market, they will at least close the performance gap that has opened in the last nine months or more.

At some point.

Of course, the big question is When? Your answer to that will determine how far into 2011 it will be before you start to move your portfolio—which you’ve over weighted towards U.S. stocks right—back toward an increased exposure to emerging markets.

The answer to that “When?” is “Not yet.” Even for the countries with the most aggressive efforts to fight inflation. For those developing countries with less aggressive, incremental policies toward fighting inflation, I’d say the answer is “Who knows.”

The central banks that have most aggressively raised interest rates in this cycle—India and  Brazil—have yet to see convincing evidence that the interest rate increases they’ve instituted so far have slowed growth or ended the acceleration of inflation.

In India, for example, where the Reserve Bank of India next month is almost certain to bring the country’s eighth interest rate increase in the last 12 months, the economy “may” be showing signs of slowing. Industrial production grew by an annual rate of 1.6% in December, a big drop from the 3.6% rate in November, but many economists caution that this could well be a result of the pattern in last year’s industrial production, which made it easier to beat last year’s numbers in November and harder in December.

In short the December deceleration in this one measure of growth might be a sign that the bank’s interest rate increases are working—but this piece of data isn’t likely enough to convince the bank to reverse policy.

And, in fact, Reserve Bank governor Duvvuri Subbarao recently raised his projections for inflation for the fiscal year that ends in March 2011 to 7% from his earlier estimate of 5.5%.

The situation is not that much different in Brazil, which has been almost as aggressive in raising interest rates as India has. In December the Banco Central do Brazil raised its benchmark Selic interest rate 0.5 percentage points to 11.25%. So far there’s no sign that the interest rate increases have slowed inflation. In January the IPCA index rose by 0.83% for the month, increasing the annual inflation rate to 5.99%. The January increase matched that in November, which was the fastest gain in prices since April 2005.

The annual rate of 5.99% is pushing the upper limits of the Banco Central’s inflation target of 4.5%, give or take two percentage points. The futures market is pricing in another interest rate increase in March to 11.75%, and is betting on an increase to 13% by the end of 2011.

But still for investors in the case of these two aggressive central banks the smart thing to do is to check back in June or so. It’s quite possible by then that Brazilian and Indian economies will be showing clear signs of deceleration by then and that central banks might be looking at One and done or Two no more. When investors can see the end of the interest increases not too far in the future, it is certainly time to think about buying.

“When?” is harder to pin point for the rest of the emerging economies because the governments and central banks in these countries are proving to be lukewarm inflation fighters—at best.

Take a look at Indonesia to see what I mean. On February 10 the Indonesian government reported that GDP grew at a 6.9% annual rate in the fourth quarter of 2010. That was the fastest economic growth in six years.

That very welcome fast growth came with rising inflation. Inflation in 2010 was 6.96%. In 2009 the figure was 2.78%.

But while inflation was climbing, the Bank of Indonesia has been extremely reluctant to raise interest rates for fear of lowering the economy’s growth rate—even though conventional central bank wisdom says cutting growth is exactly what you have to do to slow inflation. And that cutting growth sooner rather than later makes it easier to prevent inflation from running out of control. When the bank did raise interest rates on February 4 to 6.75%, the increase was a token 0.25 percentage points. Not much when at 6.50% before the increase, interest rates were at an all time low and not much when you consider that this was the first increase in interest rates since October 2008.

And yet despite the surge in inflation and the timid response by the central bank, the economic consensus was that inflation rates would fall in the short-term because the main rice harvest begins in March. That always leads to a decline in food prices, economists noted.

Of course, a temporary, harvest-related decline in food prices really doesn’t change the inflation picture in the medium term. With the economy growing at near 7%, with overseas cash flowing into the country, and with global commodity prices climbing, Indonesia faces continued inflation from the current near 7% rate.

The central bank—if it really buys the harvest/inflation argument—is deep into very, very wishful thinking.

But there’s a lot of this going around in emerging markets. Chinese officials have repeatedly said that a good summer vegetable harvest would dramatically lower food inflation in China, removing one of the major causes for inflation that hit 5.2% in November, receded to 4.6% in December, and bounced is back to 4.9% in January. The People’s Bank of China did respond to this rise in inflation by raising its benchmark interest rate to 6.06% on February 8, but the increase was, as in Indonesia, a timid 0.25 percentage points.

The problem with this kind of slow and timid response to inflation is that, as the Federal Reserve has amply proved by its own policy mistakes, small moves like these don’t really cut inflation at all. The moves aren’t enough to change behavior or attitudes so that inflation just becomes ingrained in the economy. For example, in the late 1970s the U.S. Federal Reserve raised its benchmark interest rate repeatedly: From an effective 10.03% in December 1978 to 10.24% in May 1979 to 10.47% in July 1979 to 10.94% in August 1979.

But inflation continued to climb from 6.84% in January 1978 to 9.28% in January 1979 to 10.09% in March to 10.89% in June to 12.18% in September to 13.29% in December. 

With inflation that ingrained, the U.S. central bank finally pulled out the big guns, raising the benchmark Fed funds rate to 13.77% in October 1979 from 11.43% in September. Even that wasn’t enough and inflation continued to climb until it 14.76% in March 1980.

Which meant that the Fed had to pull out the even bigger big guns and raise interest rates in one fell swoop from 14.13% in February 1980 to 17.19% in March 1980.

That finally broke the inflation trend and by July 1980 inflation was down to a mere 13.13%. Inflation finished 1981 at 8.92% and by the end of 1982 had collapsed to 3.83%. Of course, those 17% short-term interest rates sent the U.S. economy into a major recession. U.S. GDP fell 7.9% in the second quarter of 1980 and 0.7% in the third quarter.

I’m not saying that any emerging economy is going to repeat the U.S. experience of the late 1970s and early 1980s. But I am saying that the longer inflation is allowed to grow and the longer policy is based on an exceedingly incremental series of interest rate increases, the harder it is to discern the end of the cycle of interest rate increases. And the more likely it is that the central bank will be forced out of a policy of small increases designed to preserve economic growth and into a policy of big increases that produces exactly the kind of economic slowdown the bank wanted to avoid.

That means that while by June or so investors might be able to see to the end of the interest rate increases in India and Brazil, I think they will be hard put to see evidence of any similar conclusion to inflation and interest rate increases in much of the rest of the developing world.

That doesn’t mean current economic policy in those countries is headed to inflation disaster. Just that countries pursuing this kind of incrementalism will need the cooperation of outside sources—good weather and good harvests, a decline in global commodity prices (I can’t see why this would happen short of a decline in growth in developing economies but maybe you can), a big pickup in U.S. growth that slows cash flows into developed economies—to get the kind of slowdown in inflation growth that they’re hoping for. I certainly don’t see their domestic policies producing that result.

And for investors that will make reading the course of inflation, interest rates, and economic growth in the emerging economies outside of India and Brazil as difficult to read in the second half of 2011 as they are now.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at