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Differentiation within Emerging Markets is the Key

13 Dec
  • The sharp falls in EM equities over the past day or so have rekindled fears of a crisis across the emerging world. While several EMs do look vulnerable to the effects of low oil prices and a stronger US dollar, many of the headlines ignore the growing diversity within the emerging world. And fears of a widespread and systemic crisis across the emerging world look overdone.
  • EM financial markets have continued to decline over the past day or so. Most equity markets are down by 1-2% on the start of the day (in local currency terms). As ever, some countries have done worse than others. The equity market in Shanghai fell by 5% today, the Russian equity market is down by 3.5% since the start of the week, and the Brazilian equity market is down by closer to 4%.
  • The fall in China’s equity market, and a tumble in Greek stocks, have affected sentiment today. But more generally, investors’ concerns about EMs have centred on two developments, the fall in the price of oil and the further strengthening of the dollar. We’ve written plenty on both of these issues over the past couple of months (a full archive is available on our website), but several key points stand out.
  • First, with respect to the fall in oil prices, it is wrong to assume – as many of the headlines suggest – that all EMs stand to lose. In fact, a majority of EMs will benefit from lower oil prices. In the case of Turkey, India and South Africa, the fall in oil prices could narrow their current account deficits by 1-2% of GDP, helping to bring these down from worrisome levels. (For more details, please refer to our Africa, India and Emerging Europe services.)
  • The big losers from lower oil prices will be the major energy producers. But even here, the picture is more mixed than the headlines suggest. The Gulf economies benefit from strong balance sheets and should be able to weather the impact of falling oil revenues. Growth is likely to slow in 2015-16, but we don’t expect it to collapse.
  • Instead, the biggest vulnerabilities lie in Venezuela, where low oil prices will intensify the ongoing balance of payments crisis and, we suspect, make a default on sovereign debt more likely than not over the next 18 months (a coupon payment on US$ debt next October is the most likely crunch point).
  • In Russia, the fall in oil prices has made a grim economic outlook even worse. The most obvious way this is being felt is in a weaker ruble, which has lost 40% of its value against the US dollar over the course of this year. As a result, inflation is likely to rise by more than most anticipate. We expect the central bank to deliver further substantial interest rate hikes, including at this week’s Board meeting.
  • Meanwhile, in addition to Venezuela and Russia, we are becoming increasingly concerned about the outlook for oil producers in West Africa, in particular Angola. (See http://marketmonetarist.com/category/export-price-norm/ )
  • The second issue which has hit investor sentiment has been concern about the effect of a strong dollar on EM balance sheets. Specifically, the worry is that a rise in the dollar will lead to strains in the balance sheets of EMs which have borrowed in foreign currencies. EMs have form in this regard. After all, it was a rally in the dollar which proved to be the trigger for the series of EM crises in the 1980s and 1990s.
  • However, since then, the emerging world has undergone substantial structural changes and part of this change has been an increased tendency to borrow in local currency. As a result, while external debt has increased in dollars, when viewed as a share of GDP, the picture is less worrying. Several EMs, such as Turkey, are vulnerable. And certain sectors are exposed too, including Russian banks and corporates. But in general, fears that a strong dollar will trigger a rerun of the 1980s and 1990s look overdone.
  • There is a lot of good research out there on this subject, but the general theme is that many of the more hysterical headlines overlook the substantial and increasing diversity within the emerging world. Several EMs are vulnerable to lower oil prices and/or a strong dollar. But several EMs stand to benefit. For investors, the key remains to differentiate.
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Posted by on December 13, 2014 in Investments

 

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