While the current accounts of countries such as Turkey and Poland seem vulnerable, other countries are likely to benefit; for example, we have already seen a significant strengthening in the Russian rouble in line with rising oil prices, We also expect the impact on inflation would generally be manageable. Even under a worst-case scenario, with supply constraints pushing inflation-adjusted oil prices towards the highs of 2008, investors should take solace in the fact the net oil exporters make up almost one-third of both the JP Morgan local currency and hard currency benchmarks. We believe this leaves ample room for managers to position their funds defensively, should the need arise.
Our view is informed by the analysis of three key areas, set out in more depth below: firstly, we calculate the actual increase in the oil price for consumers in emerging markets; secondly, the impact of the higher prices on emerging market current accounts; and, finally, the impact the higher oil price may have on inflation, given its importance for local interest rates, and hence for local currency debt.
Current oil prices are not far off their all-time highs, reached in 2008. However, looking at the price of oil in dollars somewhat masks the real cost to a domestic economy. Based on our calculations, for most emerging markets the domestic price of oil has risen considerably and has broken through the highs reached during the Arab Spring of 2011.
In assessing the impact of higher oil on the end consumer, we should also consider inflation. Encouragingly, for most emerging markets, the price is still 15 to 30 per cent below 2008 prices. Only in Poland and Hungary is the current real price of oil higher than it was in 2008. Thus an oil price of $125 a barrel should not be particularly onerous for emerging markets, especially since this is not far off last year’s levels, when prices were driven higher by the Arab Spring.
Should we witness a worst-case scenario such as a drop in Middle East production, Turkey, Poland, Ukraine and South Africa would be most vulnerable to a sharply higher oil price.
We came to this conclusion by considering which countries are most reliant on oil imports, and to what extent their balance of payments could handle an increase in demand for foreign currency.
We then analysed World Bank and IMF data and calculated the effects on current accounts for various emerging markets of a sustained $10 increase in the price of oil. The countries which stand out are those which have large current account deficits and which are also large net importers of oil, such as the three mentioned above. For these countries, a large increase in the price of oil would be detrimental to their balance of payments.
On the other hand, countries such as Russia, Kazakhstan and even Colombia would benefit from higher oil prices, given that they are net exporters. Meanwhile, Hungary, the Philippines, Korea and Israel would suffer a large but manageable decrease to their current accounts. Going a step further and including levels of foreign reserves in our analysis reveals Turkey and Ukraine (both with low levels of reserves) to be among the most vulnerable should oil prices remain elevated.
Under more benign circumstances, when an oil price increase is driven by demand-side factors, such as an increase in global growth, we can expect the price of other commodities to also increase. Under this situation, many net importers of oil, such as South Africa, would experience an offsetting increase in the price of their exports, which would buffer an oil price shock.
We also consider the effect of an increase in oil prices on inflation across emerging markets, since this is of particular importance for local interest rates, and hence for local currency debt. We analysed the sensitivity of inflation in each country to changes in oil prices over the last three years, while also controlling for changes in exchange rates.
Our results show that, on average, a $10 increase in the oil price would add an additional 0.3 per cent to inflation in oil-importing countries. Among oil exporters, a $10 increase adds 0.2 per cent to inflation, but with an additional eight-month lag as the increase in national income takes longer to work through to final prices.
We believe the biggest increase in annual inflation would be felt in Turkey, Thailand and all four BRIC countries (Brazil, Russia, India, China). Colombia and Mexico demonstrate the lowest sensitivity to changes in the price of oil. Given current prices, which are almost flat year-on-year, we would expect a very limited effect on emerging market inflation, especially when considering the recent strength of emerging market currencies, which will bring down the cost of imported goods, including oil.
Performance of fund vs sector since launch
Source: FE Analytics
According to FE data, Peter Eerdmans’ Investec Emerging Markets Local Currency Debt portfolio is the best performing fund in its IMA Global Bonds sector since its launch in June 2006, with returns of 117.93 per cent. The average Global Bonds portfolio has returned 50.83 per cent over this period.