According to the QNB (Qatar National Bank), the recent drop in oil prices is changing the risk profile of Emerging Markets (EMs). Global financial markets have made significant adjustments in the second half of 2014, including a large drop in commodity prices, the end of Quantitative Easing (QE) in the US, and a stronger US dollar.
These developments, particularly the drop in oil prices, have led to a divergence in EM performance and risks going forward. At this juncture, the most exposed countries are Russia and Ukraine, followed by other commodity producers like Brazil and South Africa. Political tensions in Ukraine are pushing the country close to the brink. If Ukraine goes down, contagion could further destabilizes Russia.
Overall, the second half of 2014 has resulted in a significant EM differentiation between those markets that have been able to take the necessary measures to reduce their current account deficits and stabilize their currencies (India and Indonesia) and those that are still struggling to contain the loss of confidence in their economies (Brazil, Russia, Ukraine and to a lesser extent South Africa). Much of the loss of confidence in the latter group has been driven by lower global commodity prices, including oil.
The improvement in financial market sentiment towards the Suspect Seven has occurred despite a steady downward revision in the outlook for these economies, with the main exception of India. According to Bloomberg consensus, real GDP growth is now expected to be 5.4% in 2014 up from 4.7% expected in June. Indonesia is the only other Suspect Seven expected to grow by over 5% in 2014.
Lower oil prices have been a key differentiator of EM performance during the second half of 2014. Brent oil prices peaked in mid-June at USD115 per barrel. Since then prices have fallen over 30% to around USD80 currently.
Another important factor that has supported EMs is further unexpected monetary easing in China and Japan, which has eased global liquidity conditions. Previously, financial markets had been concerned about the ending of QE in the US in October. However, the People’s Bank of China unexpectedly cut lending and deposit rates on 24th November. Additionally, the Bank of Japan surprised markets by expanding its QE programme at the end of October with much of the additional liquidity expected to flow to EMs in search of higher yields.
Overall, recent developments in global financial markets have helped stabilise some of the fragile EMs that were previously thought to be at risk. However, recent developments, including lower oil and commodity prices, have been less positive for commodity exporting countries, particularly Russia and Brazil, which are suffering as a result. Political tensions in Ukraine are pushing the country close to the brink. If Ukraine goes down, contagion could further destabilizes Russia.