The recent tidings in the global market has put a question mark on the decoupling theory, which claims that a nation's economy is not impacted by the state of other economies. The subprime crisis concerned primarily the US, but had a ripple effect on almost all of the other nations due to the interdependence and interlinking of individual economies. The Emerging Economies, though, have been robust in terms of fundamentals, were severely affected by the global meltdown. Developing nations like India, China and other Southeast Asian countries have the potential to pull out the World out of the recession, but it is expected to take longer than previously thought.
What Is Pushing The Oil Prices?
Arguably, oil prices have been both cause and effect of the current economic downturn. Crude prices began their rally in 2007, hitting an all time high of over USD 140 per barrel in June 2008. Following graph represents the price trend of crude oil in years 2008 and 2009.
Source: Basket Price Archives (OPEC Website)
Crude oil price, one of the key drivers of global inflation rates, is traded internationally in New York and London. The trade is denominated in US Dollars, with major players from developed countries dominating the market, which explains the effect of Foreign Exchange Rates on the price levels of crude, up to some extent. In all market conditions, it is not easy to establish a direct correlation between US Dollar rates and crude prices, nevertheless, in the recent scenario the connection was easy to see. The main factors affecting the oil prices were:
In the wake of the subprime crisis, when the demand for US assets and investments fell, the demand for US Dollar began sliding, with a corresponding impact on the exchange rates against all of the major currencies. The investors found it prudent to invest in oil futures for hedging their Dollar positions, as rising crude prices made its a safer investment. This propelled the oil prices even further.
Speculative trading in oil futures on the expectation of further rise in prices, led to the already high prices to skyrocket.
The growth in the emerging markets has been creating demand for fuel and putting upward pressure on crude prices, though this factor has had a smaller contribution in the recent oil price rally. The rising oil prices aggravated the financial troubles of the subprime borrowers, apart from affecting every other segment, deepening the crisis to unmanageable levels.
How Are Developing Nations Affected?
Food Prices and Inflation
The low per capita income in a developing economy makes it quiet vulnerable to the inflationary pressure of oil and food prices. The diagram below, illustrating average percentage consumption on food by per capita, explains the unprecedented levels of inflation in the emerging economies during 2007-2008, directly impacted by the food prices.
Main factors exerting price pressure on commodities market in general and food prices in particular, were crude oil prices and commodities markets. The supposed commodities hedging soon took the form of speculative trading in futures creating a virtual food crisis and pushing millions of people below the poverty line across the globe. According to Center for Research on Globalization (CRG), Montreal, by the year 2008, the average price of rice had risen by 217%, wheat by 136%, maize by 125%, and soy beans by 107%, over the 2006 price levels.
Foreign investment through FII route has become a major source of liquidity and volumes in the capital markets of the Emerging Economies, especially, in countries like India and China. This mode of investment largely remains risky, since, it can be liquidated anytime. In fact, the FII activities often set the tone of the capital markets. As the financial crisis grew in magnitude in late 2007, the FIIs began liquidating their holdings in the foreign countries for meeting their obligations back home. The heavy selling by FIIs made created a sudden hiatus in the capital markets, causing the indices to dip steeply, and wiping out investors’ savings in no time.
Consumer Confidence and Consumption
In an attempt to take the essential lessons from the US economy, other nations started resorting to a more cautious, and even conservative approach towards the current economic scenario. They began cutting down their budgeted spending and consumption, starting from non-essentials like holidays, out-of-home entertainment, upgrading technology, clothing, telephone expenses, and replacement items and so on. This reduced the demand for product and services in the market, giving rise to recessionary trends in the economy.
Exports of Goods and Services
According to IMF World Economic Outlook for 2009, the US has formally entered into recession, and is expected to see a growth of meager 0.1%. Therefore, the export demand from this country is in for a contraction. The impact of this will vary in magnitude for different countries, depending upon the volume of their exports targeted to the US. The BRIC (Brazil, Russia, India and China) nations have not been severely hit on this count as they have diversified their exposure to other developed and developing nations. Currently, Brazil’s exports to US account for 3% of its GDP. Similarly, for Russia, India and China, this figure stands at 1%, 4% and 8%, respectively. However, overall export volumes across nations have shown a negative trend in 2008.
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Labels: Global Economy, News and Analysis, World