By James Carlen, Senior Portfolio Manager, Emerging Market Debt
Oil prices have been trading near their previous three year peak over the last month and this has renewed concerns about oil creating a drag on global growth, especially through the channel of depressing consumption in the major Advanced Economies. Slower global growth would be a negative factor for Emerging Market (EM) growth as it would reduce manufactured goods export demand, potentially depress other commodity prices and increase capital market volatility. To the extent that slower global growth renews concerns about the conundrum of fiscal adjustment in the midst of the recession gripping peripheral Europe, this would be an added source of financial market volatility that could impact EM markets.
Separate from the broad impact of potentially slower global growth, higher oil prices do not impact all EM countries the same. Looking at it by region:
- Most South American countries are net energy exporters (e.g. Venezuela, Colombia) or virtually balanced.
- By contrast, countries in Central America and the Caribbean are by and large significant energy importers, many with state subsidized electricity and gasoline prices to boot, so higher oil prices damage their balance of payments and their budgets.
- The Europe, Middle East and Africa region is similarly split, with Central and Eastern Europe a large energy importer, while further east and south, Russia and the Gulf States are some of the world’s largest exporters.
- In Asia, with the exception of Indonesia and Malaysia, most countries in the region are large energy importers.
The impact of higher oil prices on an importing country is fairly straightforward. Higher oil import prices damage the country’s terms of trade, act as a drag on the country’s balance of payments and hence its rate of growth. Even for an oil exporting country, the impact of significantly rising oil prices can be more nuanced, since many of these countries subsidize domestic energy consumption and not all of them are self sufficient in refined products. Thus, high oil prices may help exporting countries’ balance of payments, even if they act as a drag on fiscal resources and increase inflationary pressures.
Another potential growth head-wind for oil exporting countries is the so called ‘Dutch Disease’ phenomena, where a country experiencing a commodity export windfall sees its currency strengthen to the point that significant portions of its manufacturing economy are uncompetitive internationally, thereby driving up import levels (and partially offsetting the growth impact of higher commodity exports).
For major energy exporters like Venezuela, Russia and the Gulf States, higher energy prices are undeniably a positive factor in terms of their growth, fiscal resources and balance of payments. For much of the rest of the EM world, they can be at best a mixed blessing due to country specific impacts on budgets, inflation and balance of payments. Finally, all EM countries are impacted if higher oil prices ultimately act as a significant brake on overall global growth
Investments in foreign securities involve certain risks not associated with investments in U.S. companies, due to political, regulatory, economic, social and other conditions or events occurring in the country, as well as fluctuations in currency and the risks associated with less developed custody and settlement practices. Risks are particularly significant in emerging markets.
Investments in emerging markets present greater risk of loss than a typical foreign security investment. Because of the less developed markets and economics and less mature governments and governmental institutions, the risks of investing in foreign securities can be intensified in the case of investments in issuers organized, domiciled or doing business in emerging markets.
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