Finance & Markets / March 24, 2020

Oil Prices and Emerging Markets

The Coronavirus pandemic has had a devastating impact on the global economy. Markets have plummeted in recent weeks, with the Dow shedding four year’s worth of gains despite rate cuts and trillion-dollar stimulus packages.

But there’s another economic situation that, due to the Coronavirus pandemic, has been somewhat overlooked: the oil price wars.

When Russia and Saudi Arabia failed to reach an agreement about limiting the exportable supply of oil, both parties reacted by flooding the market, driving prices to lows not seen since the start of the Gulf War in 1991.

This plunge has had a pronounced effect on the value of emerging currencies, especially in nations whose primary exports include oil or petroleum products.

According to SeekingAlpha, the GCC (Gulf Cooperation Council) nations will be most affected, as they “require an oil price varying between US$45-$100/bbl for fiscal breakeven points.” In Africa, the most affected country will likely be Nigeria, which will have an adverse effect on development throughout the entire continent.

Although the US dollar has depreciated due to lower oil prices, many emerging market currencies have dropped even more. This month, the dollar advanced 6% against the Russian ruble, and 4% against the Mexican peso, according to NBC.

This trend is not likely to reverse course any time soon. The Trump administration recently announced that it would begin buying oil from US companies to strengthen its strategic reserves, signalling that the US government anticipates a protracted price war.

The central banks of emerging markets are not equipped to support their own petroleum industries in a similar way. Right now, they’re faced with a difficult decision: cut interest rates to stimulate growth, or raise rates to protect their currencies. Both options have merit, but both have downsides.

Colombia, for example, is likely to follow the example set by the Federal Reserve and lower rates, which will exert downward pressure on currency valuations. Forecasts suggest that the US dollar will continue to advance against the Colombian peso, which recently passed the 4,000 COP to 1 USD mark. At the time of this writing, the peso was sitting at 4,180 to the dollar – up from 3,589 at the beginning of the month.

The currency situation may not create an ideal environment for lenders, importers, or Colombian consumers, but it does create an excellent environment for foreign investors looking to park funds in alternative assets and emerging markets. Investment in Colombia now comes at a discount, and private equity, real estate and foreign bonds will be heavily affected.

This is good news for some, but in general terms, the effect of low oil prices on emerging economies will be negative. Dr. Fatih Birol, Executive Director of the International Energy Agency, noted that emerging market income from oil and gas could fall as much as 85% this year, putting increased pressure on already-strained social support systems such as healthcare and education.

As the global economy settles in for what has already been a long and costly response to Coronavirus, the shock to oil prices may deliver a heavy and unexpected blow. Nonetheless, there is value to be found even in the most trying of economic times, and favorable currency exchange rates in emerging markets like Colombia open up a wealth of opportunities.

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