No, the fall is a net benefit. Falling commodity prices create more divergent emerging markets conditions, generally benefitting net commodity consumers at the expense of net commodity producers. Among emerging markets, net commodity importers are largely Asian, while exporters are more concentrated in Europe, Latin America, South Africa, and the Middle East. Historical relationships between commodity prices and capital markets returns have evolved, as the composition of major emerging markets indexes has become much more diversified away from commodity net producers. At the same time, emerging markets economies have become more integrated with developed markets. To the degree that developed markets benefit from lower commodity prices, emerging markets (notably Asian economies) that export non-commodity goods and services will benefit.
To generalize, cheaper commodities reduce government revenues and depress economic activity of net exporters, while providing a dividend to net importers. This wealth transfer is not symmetrical. Net commodity importers tend to have more diversified economies receiving varying benefits from lower commodity prices, while net exporters tend to be concentrated in a smaller number of countries that have less diversified economies and may suffer disproportionately.
Assessments of the impact of commodity prices on economic growth are varied, though most studies estimate that commodity declines should be a fillip to global growth (assuming the fall in commodity prices itself isn’t a sign of stalling global demand). A recent IMF study estimated that the decrease in oil prices would have a net positive impact on global growth ranging from 0.3% to 0.7% in 2015, holding all other effects constant. Benefits for countries like China that are major net importers would be especially large (0.4% to 0.7%). To the extent that currencies in commodity-importing countries have weakened relative to the US dollar, the fall in commodity prices has been blunted in local currency terms.
However, rapid and significant price changes also raise a red flag as they have the potential to unsettle investors. Falling commodity prices and the associated rising US dollar add stress to the sovereign finances of net commodity exporters that already faced weak fiscal positions, current account deficits, and heavily indebted quasi-sovereigns, particularly those with little to no foreign exchange reserves like Venezuela. Corporations that stand to lose from weak commodity prices and from falling revenues due to commodity-related capex will also be pressured, particularly those that have outstanding debt denominated in US dollars. Financial linkages present the main risk to emerging markets, and markets more broadly. The longer commodity price declines and US$ strength persist (and the more severe these trends are), the more potential for distress and unexpected economic and political outcomes. As investors sort through investment implications, market volatility and risk aversion can rise.
Given uncertainty around the magnitude and duration of continued commodity price weakness, tilting emerging markets portfolios toward Asia by adding some Asia ex Japan exposure in place of global emerging markets (GEM) equities or using a GEM manager biased toward Asia may prove more defensive. Such economies are better positioned to benefit from lower commodity prices and also tend to have limited fiscal deficits, current account surpluses, and relatively high reserves. Importantly, even as ASEAN equities are somewhat expensive, broader Asia ex Japan and emerging Asia equities are just as cheap relative to their history as emerging markets equities broadly.
We remain more cautious on emerging markets debt and currencies. Some emerging markets currencies with significant weights in the JPM GBI-EM Global Diversified Bond Index (e.g., South Africa, Turkey) may need to fall further to help countries close current account deficits, even as they are helped by weaker oil prices and have already weakened considerably. Continued US$ strength would likely pressure emerging markets debt prices as well. While local currency emerging markets debt is fairly valued, investors should understand the risk exposures inherent in owning this asset class at present. US$-denominated debt also faces risks from currency mismatches and the need for smaller corporations and countries to refinance in what may be a rising rate environment.
Overall, the fall in the price of oil and other commodities over the past year is a net benefit to the global economy and even emerging markets as a whole. Risks remain, but undervalued emerging markets equities provide a margin of safety and an Asian tilt may prove more defensive.
Celia Dallas is Cambridge Associates’ Chief Investment Strategist.
Watch for the first quarter edition of VantagePoint, out next week.