Powerful
forces have combined to drive Asian equity markets to outperform their
emerging markets peers, with plummeting energy costs providing the
strongest tailwind. Ebbing oil prices could supplement a variety of
existing macro-economic catalysts, helping Asian emerging market
equities to continue to drive overall emerging market performance.
Oil prices dropped 18 percent in November—the largest monthly loss in almost six years—with WTI crude bottoming out at $63.72, extending a sustained $30 drop over the last six months. Brent crude followed the same trend, falling 3.3 percent (to $70.15 a barrel) on the London-based ICE Futures Europe Exchange, its lowest close since May 2010.
With their reliance on oil imports and consumer goods exports, Asian nations are beneficiaries of falling energy prices, and signs of a continuing oil glut—some analysts forecast that crude could drop as low as $60—is cause for optimism for four nations in particular: China, India,
South Korea and Taiwan.
Exporters reap the oil windfall
Lower energy prices mimic a global tax cut in both developed markets—see the 2.2 percent growth rate of U.S. consumer spending in the third quarter—and developing ones alike. The resultant shift of resources to consumers, the IMF estimates that every 10 percent drop in the price of oil results in a 0.2 percent boost to global GDP.
In China, which in 2013 relied on oil imports to meet 57.4 percent of its crude consumption, every $1 drop in the price of oil saves the nation $2.1 billion annually—particularly good news considering the price of its manufactured exports has remained unchanged despite the lower energy overhead.
In October, Alaskan oil was shipped for the first time ever to South Korea, where the 10 percent decline in crude oil prices translates into GDP growth of 45 basis points. For a nation where oil comprises 30 percent of total imports, the result is projected economic growth of 3.5 percent in 2014 and 3.6 percent in 2015. Similar market forces have been on display in Taiwan, where the first 10 months of 2014 saw tech-driven exports rise 3.2 percent, resulting in a trade surplus of more than $22 billion.
In India, where oil represents one-third of all imports, cheaper energy is helping to drive down inflation to 6.5 percent—a 3.5 percent drop from early 2013—hinting at a brighter economic future highlighted by a lower budget deficit and increased domestic investment.
The power of reforms
Lower fuel prices in India have also translated into political capital for new Prime Minister Narendra Modi. Elected on a pledge to revive Asia’s third-largest economy via energy security, Modi has used the slumping price of oil as a lever to reduce the burden of energy price subsidies on the nation’s fragile economy.
The bear market in oil has allowed Modi to free diesel prices from state control for the first time in a decade, reversing a long-established policy of selling fuel for less than the cost of production. Originally intended to curb inflation and make fuel more affordable in a poor nation, the policy cost India $65 billion over the past decade. Permitting refiners set individual prices is expected to free up the market for private retailers and improve the government’s balance sheet. The effect is already being felt, as the most recent forecast trimmed the nation’s deficit from 2.1 percent of GDP to 1.5 percent.
Indonesia’s new president, Joko Widodo, has acted on his own election pledge to revamp the nation’s decades-old fuel subsidy program. In mid-November, Widodo upped the price of subsidized gasoline from $.53 to $.70 per liter in an effort to free up government funds for development and ease deficit-related pressure. Widodo has also proposed a future fixed subsidy rate that will rise and fall with the price of oil, protecting Southeast Asia’s largest economy from future volatility in crude prices. As a result, Indonesia’s projected 2015 budget deficit, which is currently forecasted at 2.2 percent of GDP, is expected to drop below 2 percent.
Governments lubricating existing stimulus
Central banks have has also played a role in lifting emerging economies. On the heels of Japan’s most recent round of quantitative easing, China countered with monetary easing of its own. In a Nov. 21 announcement, the People’s Bank of China cut its one-year benchmark deposit rate from 3 to 2.75 percent, a move that spurred a global rally. While the central bank surprised many analysts with the rate cut—its first since July 2012—many traders who are bullish on China anticipate further reductions, and a subsequent stimulatory effort for the world’s second largest economy.
Similar action occurred in South Korea, where a new Finance Minister Choi Kyung-hwan has already overseen two .25-percent cuts to the interbank loan rate since his appointment in June. Not only do many fixed-income traders anticipate that the Bank of Korea will further cut interest rates as a preemptive response to possible deflation, but there is also speculation that the new central bank chief could launch the nation’s first quantitative easing program in 2015. Should he make that move, South Korea would become the first emerging market country to engage in QE.
Buyer beware
For all the optimism regarding lower oil prices, not all emerging markets stand to benefit. Falling prices in the Middle East could magnify the ever-present geopolitical instability there. In Brazil, the state-run oil company Petrobas recently committed $221 billion through 2018 to accelerate oil production—an investment made under the assumption that Brent crude would fetch $100 a barrel through 2017. That could be troubling news for a stagnant economy, with headwinds that include slowing retail sales, a weakening currency and above-target inflation.
Even some developed economies have reason to be a bit wary. The U.S. is producing crude at its fastest rate in three decades, unlocking supplies from shale formations to boost output to 9.08 million barrels a day as of late November, the highest rate since such record-keeping began in 1983. Though the International Energy Agency estimates that shale output can remain profitable at $42 a barrel, the current global oil market takes some shine off a third quarter GDP that, thanks to consumer consumption, rose by 3.9 percent.
Despite these downside risks, cheaper energy continues to power Asia’s emerging markets. Should oil prices stay low—a strong possibility considering OPEC’s refusal to decelerate output—the result could be a continued reduction of overhead for enterprise and increased purchasing power for consumers.
Exposure to a broad range of emerging market companies can be found in the iShares Core MSCI Emerging Markets ETF (IEMG) and its significant exposures in China (20.15 percent), South Korea (14.52 percent), Taiwan (12.81 percent) and India (7.57 percent).
Oil prices dropped 18 percent in November—the largest monthly loss in almost six years—with WTI crude bottoming out at $63.72, extending a sustained $30 drop over the last six months. Brent crude followed the same trend, falling 3.3 percent (to $70.15 a barrel) on the London-based ICE Futures Europe Exchange, its lowest close since May 2010.
With their reliance on oil imports and consumer goods exports, Asian nations are beneficiaries of falling energy prices, and signs of a continuing oil glut—some analysts forecast that crude could drop as low as $60—is cause for optimism for four nations in particular: China, India,
South Korea and Taiwan.
Exporters reap the oil windfall
Lower energy prices mimic a global tax cut in both developed markets—see the 2.2 percent growth rate of U.S. consumer spending in the third quarter—and developing ones alike. The resultant shift of resources to consumers, the IMF estimates that every 10 percent drop in the price of oil results in a 0.2 percent boost to global GDP.
In China, which in 2013 relied on oil imports to meet 57.4 percent of its crude consumption, every $1 drop in the price of oil saves the nation $2.1 billion annually—particularly good news considering the price of its manufactured exports has remained unchanged despite the lower energy overhead.
In October, Alaskan oil was shipped for the first time ever to South Korea, where the 10 percent decline in crude oil prices translates into GDP growth of 45 basis points. For a nation where oil comprises 30 percent of total imports, the result is projected economic growth of 3.5 percent in 2014 and 3.6 percent in 2015. Similar market forces have been on display in Taiwan, where the first 10 months of 2014 saw tech-driven exports rise 3.2 percent, resulting in a trade surplus of more than $22 billion.
In India, where oil represents one-third of all imports, cheaper energy is helping to drive down inflation to 6.5 percent—a 3.5 percent drop from early 2013—hinting at a brighter economic future highlighted by a lower budget deficit and increased domestic investment.
The power of reforms
Lower fuel prices in India have also translated into political capital for new Prime Minister Narendra Modi. Elected on a pledge to revive Asia’s third-largest economy via energy security, Modi has used the slumping price of oil as a lever to reduce the burden of energy price subsidies on the nation’s fragile economy.
The bear market in oil has allowed Modi to free diesel prices from state control for the first time in a decade, reversing a long-established policy of selling fuel for less than the cost of production. Originally intended to curb inflation and make fuel more affordable in a poor nation, the policy cost India $65 billion over the past decade. Permitting refiners set individual prices is expected to free up the market for private retailers and improve the government’s balance sheet. The effect is already being felt, as the most recent forecast trimmed the nation’s deficit from 2.1 percent of GDP to 1.5 percent.
Indonesia’s new president, Joko Widodo, has acted on his own election pledge to revamp the nation’s decades-old fuel subsidy program. In mid-November, Widodo upped the price of subsidized gasoline from $.53 to $.70 per liter in an effort to free up government funds for development and ease deficit-related pressure. Widodo has also proposed a future fixed subsidy rate that will rise and fall with the price of oil, protecting Southeast Asia’s largest economy from future volatility in crude prices. As a result, Indonesia’s projected 2015 budget deficit, which is currently forecasted at 2.2 percent of GDP, is expected to drop below 2 percent.
Governments lubricating existing stimulus
Central banks have has also played a role in lifting emerging economies. On the heels of Japan’s most recent round of quantitative easing, China countered with monetary easing of its own. In a Nov. 21 announcement, the People’s Bank of China cut its one-year benchmark deposit rate from 3 to 2.75 percent, a move that spurred a global rally. While the central bank surprised many analysts with the rate cut—its first since July 2012—many traders who are bullish on China anticipate further reductions, and a subsequent stimulatory effort for the world’s second largest economy.
Similar action occurred in South Korea, where a new Finance Minister Choi Kyung-hwan has already overseen two .25-percent cuts to the interbank loan rate since his appointment in June. Not only do many fixed-income traders anticipate that the Bank of Korea will further cut interest rates as a preemptive response to possible deflation, but there is also speculation that the new central bank chief could launch the nation’s first quantitative easing program in 2015. Should he make that move, South Korea would become the first emerging market country to engage in QE.
Buyer beware
For all the optimism regarding lower oil prices, not all emerging markets stand to benefit. Falling prices in the Middle East could magnify the ever-present geopolitical instability there. In Brazil, the state-run oil company Petrobas recently committed $221 billion through 2018 to accelerate oil production—an investment made under the assumption that Brent crude would fetch $100 a barrel through 2017. That could be troubling news for a stagnant economy, with headwinds that include slowing retail sales, a weakening currency and above-target inflation.
Even some developed economies have reason to be a bit wary. The U.S. is producing crude at its fastest rate in three decades, unlocking supplies from shale formations to boost output to 9.08 million barrels a day as of late November, the highest rate since such record-keeping began in 1983. Though the International Energy Agency estimates that shale output can remain profitable at $42 a barrel, the current global oil market takes some shine off a third quarter GDP that, thanks to consumer consumption, rose by 3.9 percent.
Despite these downside risks, cheaper energy continues to power Asia’s emerging markets. Should oil prices stay low—a strong possibility considering OPEC’s refusal to decelerate output—the result could be a continued reduction of overhead for enterprise and increased purchasing power for consumers.
Exposure to a broad range of emerging market companies can be found in the iShares Core MSCI Emerging Markets ETF (IEMG) and its significant exposures in China (20.15 percent), South Korea (14.52 percent), Taiwan (12.81 percent) and India (7.57 percent).
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