Spike in commodity prices
A key channel of contagion to fixed income markets outside of Russia/Ukraine is likely to be through commodity prices. Russia is the largest exporter of natural gas and the second-largest exporter of crude oil and petroleum products. The US has now banned Russian oil imports and the UK said it will phase them out by year end. As a result, Brent oil prices have crossed US$110/bbl for the first time since 20141. Both Russia and Ukraine are important food commodity exporters and with Russia and Ukraine accounting for roughly 30% of the world’s wheat exports, wheat prices are at decade-high levels. Russia is also an important exporter of nickel, palladium, and titanium. In this paper, we look at how the increase in commodity prices might affect EM debt markets.
Macroeconomic impact of a supply driven shock to commodity prices
1. Economic growth: Tighter supply of commodities risks exacerbating supply chain bottlenecks in the global economy, while a decline in real income (initially via private consumption because of higher prices and with a lag through trade as a second income shock) will impact consumer spending on the demand side. Both of the effects will negatively impact economic growth. The reverse is true for net oil exporters as the value of exports increases, raising the economy’s profits and wages. In countries in which domestic oil prices are heavily subsidised, a rise in international oil prices will likely have a limited effect on demand or supply.
2. Inflation: The direct impact on inflation depends on the proportion of commodities in the consumer price basket. EM countries generally have a higher proportion of food and energy in their CPI baskets. As an example, food and energy make up nearly 60% of the CPI basket in India, compared to 22% in the US and 32% in the Euro area2. Another factor is government intervention. Many of the major oil exporters (such as Saudi Arabia and Kuwait) subsidise or regulate fuel prices and so higher commodity prices may not feed through to inflation as much.
3. Fiscal balance: For commodity importers, higher commodity prices can lead to a deterioration in fiscal accounts if governments subsidise commodity prices, such as in Indonesia. For commodity exporters, an increase in commodity prices will help the fiscal balance. Many EM exporters have significantly lower breakeven prices3 for oil than current prices. So, for example, Qatar only needs an oil price of $44 to break even, while Saudi Arabia needs an oil price of $674.
4. Current account balance: Commodity exporters should see an improvement in current account balances through better terms of trade. The chart below shows the net commodity exposure by country as a percentage of GDP. According to the chart, Russia, Chile, Malaysia, South Africa and Brazil are the largest beneficiaries of higher commodity prices, although they vary in the type of commodity that they are exposed to.
1. Source: IEA, Global EV Outlook 2021.
2. As at January 2022. Source: Inside EVs.
3. The price which would balance the budget
4. Source: IIF. Breakeven prices for 2022 budgets. As at 12 October 2021
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- This material is not intended to provide investment advice or be considered a personal recommendation.
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- Past results are not a guide to future results.
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