Emerging Markets

25.01.16 Publication:

The year has begun with falling stockmarkets, falling oil prices and falling forecasts about growth in the world economy. What should international businesses think and do about this? There are two answers. One is to work out carefully which countries and markets are winners and which are losers. The second is to think more about politics than about economics.

It is only fairly recently – roughly speaking, the past 10 years – that analysts and economists have written about growth in the world economy as a whole. During the 1980s and 1990s they were much likelier to write about growth prospects in the “G7” group of the seven big, rich, industrialised countries, or at best about the 34 developed countries that are members of the Organisation for Economic Co-operation and Development, and would treat the rest of the world as a separate story. The rise of emerging economies, especially China, India and Brazil, is what changed that and brought in talk of global growth as a whole.

Often, however this is not helpful for anyone trying to run real businesses. The “world economy” is so large and diverse that an average or overall growth rate is fairly meaningless. It reminds me of an old joke among statisticians about a man who had his head in a hot oven and his feet in an ice-bath: “on average”, the man is supposed to have said, “the temperature is just right”.

We need to look beyond averages and overall global growth. There are some clear winners from the trends we have been seeing: prominent among them are Japan, the European Union countries, South Korea and probably India. All these countries are major importers of oil, with few alternative domestic sources of energy, so all benefit greatly from the fall in the crude oil price from $110 a barrel in June 2014 to less than $30 today, just 18 months later.

China also benefits from cheaper oil, although like the United States (and to a lesser extent Britain) it also suffers from the fall in commodity prices as it is also a producer and exporter of oil and some other commodities.

Then, the next big question is whether a country’s companies have taken on large debts denominated in US dollars. Such corporate debtors are being hit by the rise in US dollar interest rates and by the associated rise in the US$ exchange rate. A lot of companies in South-East Asia and Latin America have borrowed heavily in US dollars, and so have some Chinese companies able to borrow in Hong Kong or overseas centres. This is not true of Japan, however, nor of companies in European Union countries.

The big losers from this turmoil will be countries which are net exporters of oil or commodities, and which have a lot of companies holding high levels of dollar-denominated corporate debt. In this calculation, China is the enigma: it benefits from lower energy and commodity prices, and its companies principally hold renminbi-denominated debt, yet its economy seems to be slowing and is at the epicenter of global market worries.

The concern about China is overdone, but not entirely baseless. It is overdone because the Chinese government’s debts are relatively low, giving it plenty of fiscal room for stimulus to support economic growth, and room to absorb large quantities of bad loans if they start to emerge in the state-run banking sector. But it is not entirely overdone because total levels of corporate and household debt have risen very high in China. So there are likely to be a lot of bad loans as companies and households start to default.

The losers lead us to the politics. After the last big financial crisis in emerging markets, in 1997-98, the most dramatic consequences were seen in Indonesia, where the dictator Suharto was overthrown, and in Russia, where a debt default led to the discrediting of President Boris Yeltsin and democracy and led to the rise of Vladimir Putin.

So now that we have another slump in oil prices, as happened in 1997-98, and an emerging market financial crisis, where should we look for political consequences? By its nature, such political turmoil is unpredictable. My main bets would, however, be in Venezuela; in Brazil, now in its third year of recession; in Russia once again; and in Ghana and other commodity-dependent African countries.

The big drama would be if collapsing oil were to lead to political conflict in Saudi Arabia. Yet Saudi oil production is among the world’s cheapest, and the country’s financial reserves are vast. It is likely to prove resilient. The same cannot be said of Russia. Anyone thinking of doing business with Russia should think very very carefully about it.