Oil Collapse Could Push Down Emerging Country Markets, Particularly Mexico

RIO DE JANEIRO, BRAZIL – The news has worsened for a number of emerging markets in recent hours. With the collapse of oil prices, the pressure on currencies and the fiscal position of countries like Brazil and Russia has increased. However, among the emerging commodity producing countries, the one that most concerns analysts is Mexico.

Emerging markets outside China had outflows in March that surpassed those of the 2008 global financial crisis as investors fled from riskier assets amid the uncertainty triggered by the coronavirus pandemic. Currencies retreated. These factors pushed these markets, which were already struggling with slow growth, rising debt levels, and limited resources to face the Covid-19.

The need for fiscal stimulus significantly burdened public accounts, leading to what Bank of America global economist Aditya Bhave described in a note to customers as an “unthinkable” increase in deficits.

In a note to clients on Tuesday, Chris Senyek of Wolfe Research stressed emerging market debt as the number one credit concern. He recalled that in this case the Federal Reserve has limited ability to intervene.

Mexican drama

Among emerging markets, Senyek said he was more concerned with Mexico, mentioning the sharp decline in the peso, the impact of declining oil prices on the government budget, and the strong attachment to the US economy, which is most likely in recession.

Emerging market currencies dropped by around 30 percent in some cases – usually an inflationary development. But low demand and a sharp drop in oil prices are deflationary, providing central bankers in emerging markets room to cut rates to record levels, recalled Jon Harrison, managing director of emerging markets at TS Lombard.

For now, slow growth and growing fiscal deficits mean a deterioration in debt dynamics in relation to GDP, with weaker currencies exacerbating risk. And on that front, Mexico is among the worst placed, Harrison says. He expects Mexican GDP to contract by as much as 12 percent this year.

Mexico is also cause for concern for other analysts. Portfolio outflows from emerging markets in the first half of April seem to have declined and other capital sources, such as foreign direct investment and banking sector flows, seem more resilient. But there is one exception: Mexican sovereign debt, according to Capital Economics market economist Edward Glossop. In his opinion, the country’s low interest in securities is due to the government’s “poor response” to the crisis and fear of capital injection into the state-owned oil giant Pemex.

Opportunity

On the other hand, analysts point out that the collapse of oil prices is good news for importers like India and China. And the prospects among the most affected commodity producers are unclear.

According to TS Lombard economist for Brazil, Wilson Ferrarezi, the Brazilian real is likely to come under pressure if there is an joinder of the worsening fiscal situation with the drop in oil, particularly due to the need for aid to royalty-dependent states, such as Rio de Janeiro. But there is a glimpse of good news, according to him: a weak currency renders Brazilian agricultural exports much more competitive.

More broadly, given the stress and tightening global financial conditions, central banks in emerging markets may advance toward quantitative easing in the style of developed countries.

However, there are major differences: developed countries have launched quantitative easing only after reaching the lowest interest rate limit, while emerging markets have started with real rates above zero, writes BofA’s Bhave. As a result, the analyst says investors may lose confidence in emerging markets as an asset class.

However, the BofA analyst notes, if there is security for traders in these countries’ bonds, the search for their yields could lower emerging market interest rates without major currency losses, thus building a favorable scenario for these economies.

Source: Estadão Conteúdo