The curse of cheaper oil hits some emerging markets

The Goldilocks scenario about the lower price of oil fuelling an economic boom has a few big holes, mainly when it comes to emerging markets.

Readers have been quick to write and tell me I have omitted to mention the negative consequences of cheaper oil – here is a quote from one email making a very good point:

“One of the takeaways is that that decline isn’t just a problem for the oil patch (though it is that most certainly, too). The decline is bordering on ruinous for many countries, like Nigeria, with a currency down 25% because of the drop in oil. The problem for the US (and the West) is that such countries are also wonderful breeding grounds for not only terrorist groups but also any disruptive political movement… While the American consumer gets an immediate dividend, the longer term costs may be considerable, and they may not be pocketbook-based alone.”

It is true that for oil producers in emerging markets the 50% drop in price has been nothing short of disastrous.

And things could get much worse if international investors pull the plug on emerging markets debt, a danger that analysts have been warning about for a while.

The biggest – and most bellicose so far – such oil producer is Russia, which is facing a deep recession caused by the lower price of oil.

The European Bank for Reconstruction and Development (EBRD) has forecast that Russia’s economy will shrink by 5% this year, and this will have consequences on the volatile region.

The Russian government debt is negligible, at 10% of GDP, so there is no danger of default there. But the government has already had to advance cash to state-owned companies to help them out.

The six countries that belong to the Gulf Cooperation Council – Saudi Arabia, UAE, Kuwait, Qatar, Oman and Bahrain – are in much better positions, because they had amassed big budget surpluses when the oil price was high.

Officials from Saudi Arabia have even said oil prices could go as low as $20 a barrel.

By contrast countries in Africa, particularly Nigeria as’s reader pointed out, are more exposed to the negatives.

Analysts at Bank of America Merrill Lynch slashed their growth forecast for Nigeria to 3.5% this year after last year’s projected 5.8% expansion.

Ghana and Angola look vulnerable to the sharp fall in oil prices as well. Analysts at Capital Economics expect Angola to fall into recession and “lower oil prices will add to concerns over Ghana’s precarious balance of payments position.”

African countries have taken advantage of low interest rates internationally and plenty of liquidity to issue debt, but the total is still low, at around $18 billion for sub-Saharan Africa.

There is no imminent danger of default, but “debts will almost certainly have to be rolled over,” the Capital Economics analysts warn. “Issuing states have almost a decade to prepare for this, but if a significant repayment were to coincide with an unforeseen fiscal crunch, a period of currency weakness, or political crisis, the result could be highly destabilising.”

For countries in Latin America, the consequences of the lower oil price are more severe. Venezuela – struggling with a combination of economic stagnation, shortages of basic goods and high unofficial inflation before the collapse of oil prices – is by far the worst hit.

“Not only will GDP almost certainly contract sharply, but a default on its foreign currency debt looks

increasingly likely,” Capital Economics economists predict. About 95% of Venezuela’s foreign revenues come from oil exports.

Venezuela’s yields jumped in the past few months, reflecting the increased danger of default.

Venezuela Bond Yields

Yields on Venezuelan bonds have risen. Source: Capital Economics

Brazil is struggling with stagflation and, besides the low price of oil, its economic growth “has become a victim of structural rigidities, unfavourable developments in the external sector, continued monetary tightening and, now, impending fiscal tightening,” as analysts at Societe Generale pointed out recently.

The spread of the JP Morgan EMBI Global Index over US Treasuries was at 420 basis points, despite falling over the past few days. The index tracks the performance of emerging market bonds.

“This is close to its level at the end of 2003, even though there has been a marked improvement in the average credit rating of the countries in the index since then,” analysts at Capital Economics warn.

Emerging market debt may well be one of the most warned-about bubbles in recent economic history. But if lower oil prices continue to hit some of the developing countries, there is a danger that those warnings come true.