My Daily Column – Confusion in Emerging Countries

There is confusion currently on markets and mainly on emerging markets. This implies sometime strong and brutal adjustments.
Last night, such an adjustment has been seen in Russia when the central bank of Russia has increased its main interest rate from 10.5% to 17%. It was a response to the deep and dramatic drop of the ruble.
On a more general ground, we’ve seen strong movements on emerging debts and emerging exchange rates. Equity markets volatility was not restricted to emerging countries. On all these issues, the oil price issue is major. On the equity market in developed countries, short-term uncertainty hides the positive story associated with lower oil price: lower investment in the oil sector today but more consumption in the future and more investment in other sectors.

There are three elements of explanation

The first is the lower oil price.
This will be a support for developed countries in 2015 specifically in Europe but this is currently a weakness for oil-producing countries. This reflects a low momentum for the economic activity.
In the short run and that’s what investors have in mind, a low oil price is a strong cost for producers. Russia is the perfect example of this situation. Lower oil price implies lower exports revenues and a country that lost part of its attractiveness. Therefore there are no reasons to stay in for investors and this weakens the currency forcing the central bank to intervene.
The situation is worse in fact: lower oil price is a drag on growth but lower currency implies higher imported inflation. As the Central Bank of Russia has done, the temptation is to increase the interest rate. But at the beginning of the process it is usually not efficient. Today; the ruble is still downward trending even after the interest rate hike. What is said on Russia can usually be said on oil producers in emerging countries.

The second point is the absence of strong economic activity in emerging countries. Looking at PMI/Markit surveys we notice that the emerging index remains just above the threshold of 50 (50.9 in November) and that the BRIC index is marginally lower. This morning the PMI/Markit/HSBC survey has shown an index below the 50 threshold. China which has an important role in emerging countries dynamics doesn’t play it anymore. It’s like on the oil market where China from 2004 had a very important role, changing the equilibrium dynamics. This is no longer the case.
china-2014-december-pmi-hsbcLow economic prospects and an expected low oil price is a recipe for a weak economic position. It doesn’t mean that every country will be weakened but that there is no more a kind of common trend (a role played by China in a recent past) that could create conditions for stronger growth.

The third point is the monetary policy committee of the Federal Reserve which could decide to withdraw the important sentence on the “considerable period”. Removing it would implied that the Fed will change its interest rates rapidly (June 2015?) We don’t know what the Fed will say but this creates fragilities in emerging market. If the sentence disappears then this could lead to capital flows from emerging countries to the US. This would be comparable to what has happened in May 2013 when Ben Bernanke said that monetary policy normalization was nigh.
To avoid any type of risks that could hit further financial stability it would be better that tomorrow the Fed does nothing that could change expectations.

Is it more risky now or in May 2013? I think that the situation is harder to manage now due to the lower oil price and fragilities it implies for emerging countries.

That’s one of the interesting parts of the story: for a decade emerging countries following China had a major role to play. Now the balance of strength is converging to developed countries. Growth in these latter will be revigorated with lower oil price. The equilibrium is changing again but positively for developed countries.

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