Assessing the impact of the recent energy shock on EM debt markets
Heightened geopolitical risk may not be a valid reason to take a wait-and-see approach to investing in emerging market debt.
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The invasion of Iran by the US and Israel in February led to higher oiler prices, given the restrictions on the flow of oil through the Strait of Hormuz. Developments in the crisis change day to day, but even when it comes to a sustainable resolution, oil prices could remain elevated for some time. We do not believe these geopolitical tensions provide any reason for investors to be more cautious about allocating to emerging markets. For investors, the key is to not treat energy risk as a single uniform shock across EM. A practical way to consider the impact on various markets is to break them into four tiers, ranging from the potential beneficiaries to the most vulnerable importers.
- Tier 1: The energy exporters, who are clearly beneficiaries. These are countries that can see higher export revenues and improving fundamentals when oil prices rise. Examples include Nigeria, which produces around 1.5 million barrels per day and consumes roughly half a million, with refining capacity and “light, sweet” crude that can trade at a premium; Kazakhstan, which exports roughly 2 million barrels per day and consumes far less; and Saudi Arabia, which can still move significant volumes via the East–West pipeline to the Red Sea. In this tier, the improvement can show up across sovereign finances, corporate cash flows and, in some cases, local currency dynamics.
- Tier 2: The mixed beneficiaries, who export crude but also must import refined products. These countries can still see a net benefit from higher energy prices, but the picture is more complicated because they may have to import diesel, jet fuel or other refined products. Colombia is the prime example: it produces oil (around 800,000 barrels per day) but still imports refined products. Even so, if the spread remains positive, fundamentals can still improve versus the pre-shock baseline.
- Tier 3: Exposed to more risk because they are energy importers but could prove resilient because they’re rich countries. This group, which includes countries like Korea, isn’t insulated from higher energy prices, but they have the balance sheet and purchasing power to manage that because they are able to bid for cargo, absorb higher import bills and cushion the inflation impact more effectively than their poorer peers.
- Tier 4: The most vulnerable because they are lower-income energy-importing countries with limited foreign exchange reserves. For these countries, higher energy prices can quickly erode household purchasing power and heighten social and economic pressures. These are the countries to be most careful with if disruption persists for weeks and rationing intensifies, as they cannot compete for supply against richer buyers and can face sharper pressure on inflation, external accounts and growth. This group includes countries like Bolivia, Senegal and Sri Lanka. For these markets, prolonged energy disruption can accelerate demand destruction and create real stress in their economies and policy mix.
Conclusion: A vast opportunity set
The EM debt market has grown considerably over the past 25 years, evolving into a vast opportunity set with many of the characteristics investors once associated only with developed markets. As that investable universe has broadened, and as relative fundamentals have become more nuanced, the asset class is increasingly less about taking blunt “EM beta” and more about applying a full fixed income toolkit to pursue targeted sources of income, diversification and total return. In that context, EMD can merit consideration as an ongoing portfolio allocation rather than a tactical, cycle-dependent trade.
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