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Oil and dollar rally a perfect storm for emerging markets

Emerging markets have suffered as the oil price and the dollar have risen, but not all are affected equally.

 
Oil and dollar rally a perfect storm for emerging markets
 

Emerging markets manager James Syme has pointed to India, Indonesia, and the Philippines as the emerging market economies worst hit by the rise in the oil price.

Syme, manager of the JO Hambro Global Emerging Markets Opportunity fund, said emerging markets had been hit by rising oil prices, a strengthening US dollar, and higher global bond yields.

This combination of factors is hitting countries that have large current account deficits and those with significant oil import costs. Emerging market currencies have been generally weak against the dollar this year.

High currency account deficit oil importers, such as India, Indonesia, and the Philippines, have seen their oil import costs rise substantially this year.

Syme said in the first quarter ‘crude oil import costs rose year-on-year in India by $5 billion, in Indonesia by $1 billion, and in the Philippines by $130 million’.

Syme’s fund has Indian equities as its third largest geographic weighting at 17.9%.

‘Correspondingly, these countries have all seen currency weakness year-to-date, but so have several other emerging markets,’ he said.

He added that those three countries, along with Argentina, Turkey, Pakistan, Brazil, Chile, Peru, and South Africa had average forecast current account deficits of 2.7%, and that would worsen by 0.4% of gross domestic product for each $10 increase in the crude oil price. On top of this, their currencies had fallen by an average of 5.9% against the dollar since the turn of the year.

The worst hit currencies year-to-date have been the Turkish lira, down 11% against the US dollar and the Argentine peso, down 17.9%.

Not all emerging market countries are being negatively impacted by oil price rises, with some boasting strong enough current account balances to weather increases.

In Asia, this comprises South Korea, Taiwan, Malaysia, and Thailand, which have an average forecast current account surplus of 7.1% of GDP, and will see that worsen 0.5% for each $10 rise in crude oil.

South Korea is Syme’s second largest country weighting at 22.5% and Taiwan the fourth at 14.1%.

The third group that countries can fall into are those that produce a surplus of oil but run current account deficits. Syme (pictured) pointed to Mexico and Colombia, which produce around 600,000 barrels a day more than they consume. A $10 increase in the oil price would boost their current account balances by 0.2% and 0.7% of GDP respectively. Mexican equities make up 3.3% of Syme’s portfolio.

‘This is another reason to be more positive about Mexican assets in the run-up to July’s presidential election,’ said Syme.

Russia, a 5.4% position in Syme's fund,  is the biggest emerging market beneficiary of oil price rises.

It produces an annual 2.9 billion barrel oil surplus. Oil's move from an average price of $54 in 2017 to $77 last week is worth $67 billion to the country, or 4.3% of GDP.

‘At this oil price, Russian assets should be performing very strongly, yet the Russian ruble has fallen 7.8% against the US dollar year-to-date,’ said Syme.

‘Politics notwithstanding, if there is one emerging market that most benefits from this environment, it is Russia.’

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