COVID-19 and turbulence in the oil market have been reshaping daily life, economic fundamentals and market activity for weeks. Emerging markets (EM), like the rest of the world, have been along for the ride.
As a group, there are some commonalities that may leave EM countries particularly exposed to the human and economic tolls of COVID-19. EM countries tend to have large and dense populations, poverty, weak healthcare infrastructure, weak fiscal positions, lack of access to capital by small- and medium-sized businesses, and lack of social safety nets—all vulnerabilities. But each EM economy is distinct and we are seeing evidence that there’s potential for some of the more dire headline risks to provide unexpected bright spots for some of these economies. Here’s a look at some of the risks and opportunities I see for EM economies.
Oil prices: painful for some; a respite for others
The oil market has suffered twin shocks: demand destruction caused by the pandemic and the disagreement between Russia and Saudi Arabia over production cuts. The precipitous fall in oil prices will be extremely painful for oil exporters, especially high-cost producers. Petrostates across the Middle East, Africa and Latin America that are overly dependent on oil to finance their external accounts face the risk of insolvency and an ensuing sovereign debt crisis. This is especially true of countries that budgeted high oil prices, north of $50, to issue external sovereign debt. While some of these petrostates have sizeable foreign exchange reserves, they also depend on oil revenues to finance their national budgets. Saudi Arabia, for instance, needs oil prices to be close to $80 to balance its budget.1 Furthermore, many of these governments are also responsible for the debt of their national oil companies. Plummeting oil revenues could lead these petrostates to the IMF’s door for a bailout.
On the flip side, lower oil can be a welcome respite for large oil importers such as China and India. In addition to lower oil prices, the demand destruction caused by the pandemic and unprecedented actions of central banks worldwide have a silver lining for many EM countries—potential improvement in their external balances and investment flows. Lower demand and lower oil prices could more than offset the negative impact of lower exports and reduce the net demand for foreign exchange in several EM economies. Countries such as South Africa, Indonesia and Brazil should see a marked improvement in their current account deficits this year. India should most likely see a current account surplus for the first time in nearly a decade as crude oil accounts for over 20% of India’s import bill. Even an oil exporter like Russia could see a current account surplus as lower demand helps to offset lower oil exports. EM countries that are reducing their current account deficits should see an appreciation bias to their currencies, especially due to the unprecedented expansion of balance sheets by developed market central banks. This expansion should provide support for risk assets and, to some extent, reduce volatility of portfolio flows.
Low oil prices and demand destruction caused by the pandemic should be extremely disinflationary to EM economies, which could give their central banks more room to cut real rates, even though nominal rates have already come down a lot. This should help corporate and household balance sheets during this recession. Unlike developed-world central banks, which have deployed zero interest rate policy (ZIRP) and negative interest rate policy (NIRP) tools, EM central banks will likely keep real rates positive to help provide support to their currencies and investment flows.