As emerging markets (EMs) continue to recover from the pandemic, they now face the possibility of international energy prices remaining elevated, or even climbing higher, for longer. Oil prices hit seven-year highs in February, spurred by a recovery in mobility, worries over spare capacity among key producing nations, historically low inventory, slow progress in getting Iran's sanctions lifted, and now, conflict in Ukraine. Russia's pivotal role in the global energy supply means the conflict will pressure energy prices.

Given the circumstances, we explore which net energy importers among key emerging markets (10 in our sample of 16) are more vulnerable to rising energy prices. S&P Global Ratings' baseline assumption is for Brent oil prices to average $85/barrel for the remainder of the year. A growing risk of oil prices staying elevated for longer made us consider what a Brent price of $100/barrel for the rest of the year, or a 40% increase from last year's average, may mean for EMs. For simplification, and partly for data availability reasons, we assume a 40% rise across overall energy prices.

While net energy importers all stand to lose from higher energy prices, drivers of vulnerability vary across our sample of EMs. Some are exposed because of higher energy intensity, while others are vulnerable because of their high dependency on imports to cover domestic energy needs. Overall, structural vulnerability metrics point to Thailand, Turkey, Chile, the Philippines, India, and Poland as the EM economies among key energy-importing EMs most at risk to a negative energy price shock. In fact, the magnitude of potential GDP loss from energy prices averaging 40% higher in 2022, than in our November base case, could lead to more than one percentage point shaved off their GDP growth, all else equal.

Fortunately, external accounts in energy-importing emerging markets are generally in decent shape, helped by robust exports and in some cases still subdued non-energy imports in the aftermath of the COVID-19 pandemic. This should help withstand higher energy prices today. However, the longer energy prices remain elevated, the more vulnerable these emerging markets become.

Of particular concern is the impact of rising energy prices on the inflation outlook in EMs. Many emerging economies have already keenly felt the effect of soaring international energy prices on domestic consumer and producer prices. In many cases, further energy price increases will complicate disinflation and pose challenges the central banks. If Brent oil prices remained elevated at $100 for the rest of the year, energy's contribution to headline year-over-year CPI inflation for a median emerging market economy--in the sample of 16 major EMs--would be one standard deviation above the 2007-2019 average contribution. This is a stark contrast to what we assumed in our November baseline assumption, when we anticipated energy prices having a negative contribution to headline inflation in 2022.

However, many factors can offset or amplify the energy price shock, like the strength of external demand and, crucially, the policy response of governments and central banks at home and abroad. (1) Overall, fiscal policy space in EMs is more limited after two years of pandemic-related budgetary support. Monetary policy has been tightening in many EMs, but because of worsening terms of trade, most EM currencies are still facing broad depreciatory pressure against the U.S. dollar, which is amplified by the anticipated normalization of U.S. monetary policy.

This is in contrast with another period in which oil prices rose rapidly and stayed above $100/barrel for some time, in 2010-2011. During that period, the Fed was implementing quantitative easing (QE), which boosted capital flows to EMs, driving appreciation in their currencies against the U.S. dollar. In this year's episode of high oil prices, the reactions of central banks will vary across EMs--it is likely to be more acute in Latin America and EM-EMEA than in EM-Asia, and part of it will depend on changes to expectations for global demand and U.S. interest rates normalization.

Just When You Think Oil Prices May Have Peaked

In the last 12 months, oil prices surprised by moving up another leg (see chart 1). Despite a planned increase in production by the member countries of OPEC+, global oil output rebounded more slowly than expected owing to supply outages and production constraints, in addition to a muted response to higher prices by U.S. shale oil production. The recent rise in prices to more than one standard deviation above 2000-2021 is from a combination of supply and demand shocks, weighted more on the supply side (actual and expected), also reflective of geopolitical risk premium. Natural gas prices have also risen sharply with emerging economies in emerging Europe increasingly exposed.

Chart 1

Net Importers Of Energy Are Vulnerable To A Supply Shock

The impact of higher energy prices on net energy-importing countries can be felt through several channels, including depreciating exchange rates and higher inflation. Ultimately, worsening terms of trade (the ratio of export prices to import prices) could lead to lower real income and demand, all other things equal.

That said, historically, the effects of substantial changes in energy prices on an economy have depended on the underlying sources of the shock. When it is a negative supply shock leading to a spike in prices, it leads to the transfer of income from net importers to exporters. On the other hand, energy prices rising due to positive global demand shocks tends to lead to weaker and, in some cases, insignificant effects on energy net importers since oil demand shocks would be the outcome of changing real activity, and the non-energy component of trade could offset the drag.

At the beginning of the year, an increase in oil prices reflected both stronger global demand (which is generally good for EMs) and supply concerns. But with the Russia-Ukraine conflict, more recent oil price moves are likely reflecting concerns about Russian crude supply, as there continues to be risk of more sanctions that could indirectly or directly impact oil purchases or supplies. According to S&P Global Commodity Insights, potential sources of incremental supply in coming months are not enough to offset a prolonged substantial loss of Russian oil exports. For now, the duration and magnitude of impact on Russian oil supply remain unpredictable, but it is clear that net energy importers are set to lose from oil prices moving higher due to the expected supply shock.

Out of 16 key emerging markets we cover, 10 are net energy importers (see chart 2). Of these 10 net energy importers, energy trade balance as a share of GDP moves closely with the price of oil (see chart 3). Still, some of them are more vulnerable than others.

Chart 2

Chart 3

Structural Vulnerability

We start by assessing how vulnerable key energy-importing EMs are to rising prices for imported energy. We call these factors structural because they are not related to a business cycle and change slowly.

There are two sources of structural vulnerability on energy importers to energy price shocks:

• Energy intensity--meaning how much energy an EM uses to produce one unit of output (measured as metric tons of oil equivalent to GDP based on purchasing power parity); and
• Energy import dependency--meaning the extent an economy relies on imports to meet its energy needs.

There is a wide variation across key EMs on these metrics (see chart 4).

South Africa's economy is the most energy-intensive among key net energy-importing EMs, followed by China. At the same time, both countries depend less on imported energy than other EMs. In both economies, coal dominates their energy mix (see table 4 in the Appendix). Close to 80% of China's energy supply is produced domestically. And South Africa's sizable coal exports make it a net exporter of energy in real terms measured in Terajoules. (However, because of higher prices for South Africa energy imports of oil and oil products, compared to coal exports, in U.S. dollar terms, South Africa is a net importer of energy.) On the other end of the spectrum, Turkey is the least energy-intensive, but it depends more on imported energy than any of the other 16 EMs, with more than 70% of its energy supply coming from abroad. Poland's dependency on energy imports has risen over the last two decades, with imports now covering almost half of the country's energy needs.

In emerging Asia, Thailand is a relatively energy-intensive economy. The country imports more than half of its energy needs, which makes it more vulnerable to energy price shocks. Among Latin American economies, Chile stands out as being most dependent on energy imports. Mexico turned to a net energy importer in 2015, as its fuel imports (mostly gas and gasoline) exceeds the country's oil exports. Brazil, on the other hand, became a net energy exporter a few years ago.

In the medium term, the use of more energy-efficient technologies, coupled with changes in economic structures like the rising share of services, can reduce energy intensity. The growing share of renewable energy sources can reduce dependence on imported energy. In the short term, however, structural dependency on energy imports is relatively fixed.

Chart 4

External Vulnerability

Structural vulnerabilities aside, most energy-importing emerging markets are facing current higher energy prices with relatively strong external accounts, suggesting they can absorb part of the price shock. In many EMs, imports declined sharply as economic activity was severed by the pandemic, while exports recovered swiftly thanks to strong demand for manufactured goods and (non-energy) commodities. These trends continued into 2021, with strong exports and in some cases still subdued imports underpinning current account surpluses (or modes deficits) in many EMs (see table 1).

The continuing recovery in demand should boost non-energy imports in emerging markets. Exports resilience is therefore key to help the economies partly absorb the energy price shock. Economies with exports exposure to energy producers tend to benefit from stronger demand in these economies, underpinned by higher energy prices. For example, Turkey's higher energy bill is likely to be partially offset by rising exports to the Gulf countries. If non-energy commodity prices, like industrial metals, or food, also rise, this would boost exports for some EMs, including Chile (copper), South Africa (iron ore), and Thailand (food), mitigating the effect of higher energy prices on external positions and growth.

Thailand's energy imports bill is the largest among key EMs at an estimated 6% of GDP in 2021, and rising energy prices are weighing on on the trade account. Thailand already experienced the largest deterioration in its current account balance among major EMs chiefly because of the collapse in tourism, and it registered its first current account deficit since 2013 last year. Rising energy prices, together with ongoing negative pandemic developments that could keep Thailand tourism receipts weak for some time, may keep its current account in deficit. Thailand is a significant food exporter, and rising food prices can mitigate the impact. A silver lining, in any case, is that its central bank reserve adequacy remains one of the healthiest among EMs.

Turkey's energy imports is also significant at 5.3% of GDP in 2021, and the economy is one of the most vulnerable on the external side, given that its external financing needs remain significant, while international reserves are low. The worsening of the trade account because of the higher energy bill may be mitigated by the increased exports to the Gulf.

In Latin America, Chile is the largest net importer of energy goods in the region (roughly 4% of GDP). The country is running one of its largest current account deficits in recent history, estimated at close to 5% of GDP in 2021. The current account shortfall has partly been driven by strong fiscal stimulus, which contributed to a surge in imports last year, and the recent increase in energy import costs could keep the deficit relatively high this year.

Table 1

Thought Experiment: Oil Price At $100 Through 2022

In our thought experiment, the price of Brent crude oil stays at $100 through 2022, before gradually dropping to $80 by year-end 2023, the average price of 2010-2019. In 2020, Brent crude prices averaged less than $42 a barrel--extraordinarily low--and in 2021, they averaged just under $71. The oil price at $100 is a 40% rise from last year. For the purposes of this exercise, we extend the percentage change assumption to all energy prices.

The scenario ignores the "demand destruction" (decline in demand) expected at higher oil prices, as well as potential supply responses from OPEC+ or other producers. It assumes that the global oil supply will remain constrained. This makes it of particular interest for assessing the impact on inflation and to illustrate which countries in our sample of 16 major emerging market economies are vulnerable to an extended period of high oil/energy prices.

GDP at risk using net imports framework

For illustration, we estimate the magnitude of potential GDP loss from the energy price shock using the energy vulnerability derived from structural components of the economy, multiplied by the price change. The product of energy intensity of the economy and import dependency of energy is simply net energy imports as a share of GDP:

Based on this framework, potential GDP losses from higher energy prices could be around 0.4-1.2 percentage points (ppt) with the assumption that energy prices are up 20% in 2022 from 2021 (consistent with Brent $85/barrel in 2022). In a scenario where energy prices move up to a higher 40% (oil prices averaging $100/barrel this year), potential GDP losses could amount to 0.8-2.4 ppt (see table 2) compared with a no change from last year. And if oil prices stay at the level of around $115/barrel, which would imply that the average oil price in 2022 would be 60% higher than in 2021, the impact could reach 1.3-3.6 ppt.

Table 2

Impact on inflation

If the Brent oil price remained elevated at $100/barrel the rest of the year (see chart 5), oil price inflation would average close to 40% this year, more than twice the average oil price inflation based on $85/barrel. This is in stark contrast to the deflation (-8%) assumed in our (and consensus) November baseline macroeconomic forecasts of $65/barrel average in 2022. Although the price remains elevated in 2022, its rate of growth returns to zero rather quickly on a quarter-over-quarter basis in 2022.

Year over year, the base effect declines from 55% in the first quarter to 25% in the fourth quarter, before turning deflationary in 2023 (-11% on average). Energy's contribution to headline inflation of a median emerging market economy in our sample (excluding Argentina) would stay positive, versus a negative contribution based on November baseline assumption for oil prices (see chart 6). It is a 1 percentage point swing from negative to positive in the first half of 2022, and another half a percentage point swing positive contribution in the second half, compared with our November baseline path. (2)

Chart 5

Chart 6

This doesn't consider the energy price pass-through to food production and other core prices. Unlike in advanced economies, food consumption weight accounts for a huge percentage (about 25% median EM) of their CPI baskets. What's more, given Russia and Ukraine are important for the global grains market, any hit to crops or exports could be at least partially reflected in higher prices for many EM countries. Russia is also a key global producer of some commodities (such as palladium and nickel) (see chart 7), and that could hit industrial production supply chains and producer prices in EMs.

Chart 7

However, historically, the relationship between global food price indices and EM food CPI inflation has been weak, partly because these indices are composed of multiple products that move in different directions (wheat prices have risen recently while rice prices have fallen). But more importantly, EM food inflation tends to be driven by domestic factors, like adverse weather or diseases. Food price inflation has been elevated in EMs in Latin America and EMEA throughout 2021 while it remains low in EMs in Asia.

Although the relationship between oil prices and headline consumer prices may be weaker than anticipated, there is a strong relationship between oil prices and producer price index (PPI) inflation (see chart 8). The strong link likely comes from the importance of oil as input in the production of goods. In the absence of the ability to pass through to consumers, who would already be experiencing a drag in real income, producer profits would be at risk.

Chart 8

EM governments may choose to cushion the blow for consumers and domestic producers through social spending, reduced energy taxes, or energy subsidies. In Brazil and Mexico, energy prices (especially gasoline) have a large tax component, and in both cases, there are discussions to lessen the tax burden on energy consumption. While mitigating the impact of the price increases on inflation, income, and growth, that would likely result in deteriorating fiscal dynamics. Overall, fiscal policy space in many EM economies is more limited after two years of COVID-19-related budgetary support.

Monetary Policy: Will Central Banks Look Through Current Inflation Threat?

Russia-Ukraine developments threaten to keep energy prices high, reinforcing price pressures from food, logistic charges, and persistent supply disruptions. Given mounting upside risk to our inflation forecasts for major inflation-targeting central banks in the emerging markets in Latin America and EMEA, it is looking more likely now that it may lead them to miss their targets in most of 2022 (for a second consecutive year in Latin America). And, for another year, inflation is likely to end the year above the upper bound of their respective tolerance margins too.

Monetary policy in emerging markets tends to be more sensitive to short-term inflation movements than in developed markets, given that inflation expectations are generally less well anchored. And exchange rate movements can have a large influence on monetary policy in some EMs when its pass-through to domestic prices is high. Higher foreign exchange reserves and real interest rates step in to provide relative protection against any negative spillover from higher commodity prices into foreign exchange depreciation and inflation.

In the current monetary cycle, many EM central banks have already been tightening policy aggressively to check inflation expectations and weakening currencies (see table 3). Reserve buffers and policy adjustments already made EMs less vulnerable this time around. But that's not to say that above-target inflation for longer, combined with a sustained risk-off backdrop amid major global conflict won't put pressure on the EM central banks to raise rates further than what was expected only just a month ago. This is in contrast with 2010-2011, when oil prices were also rising fast, but the Fed was doing QE then, and capital flows to EMs were strong, so many EM currencies were appreciating.

Table 3

That brings us to how the current episode of high energy prices and the Russia-Ukraine conflict impact global demand expectations, and how U.S. monetary policy responds to that scenario also matters. If the U.S. Federal Reserve puts the breaks on the rate hiking cycle that is expected to begin this month, or expectations of it slow significantly in response to concerns of a deterioration in economic growth or financial conditions, EMs central bank would face less pressure to increase interest rates as lower U.S. interest rates expectations would exert less pressure on the currency and capital outflows from EM assets, all else equal.

What we know so far from financial market pricing is that the initial reaction to the increase in energy prices stemming from developments in the Russia-Ukraine, and their impact on energy prices, has varied across EMs. Broadly speaking there has been only modest upward pressure on interest rates across Latin America and EM-EMEA, but not really in EM-Asia. Furthermore, expectations for faster Fed tightening have not increased from higher energy price expectations. If anything, the market in recent weeks is pricing a marginally less aggressive Fed monetary policy tightening.

The bottom line is that the reactions of central banks in EMs to higher oil prices for longer will vary across EMs. They will likely be more acute in Latin America and EM-EMEA (where inflation is likely to be running near upper bound of their target range for a second year in a row) than in EM-Asia, and partly will depend on expectations for global demand and U.S. interest rates.

Endnotes

(1) The risk of a price spike is capturing attention right now, but there is also the possibility that oil prices might plummet. Negotiations are underway to revive the 2015 Iran nuclear deal. If successful, a lot of Iranian oil would be heading to global markets. There's also another wild card in the wings: A new coronavirus variant could lower oil prices by reviving the prospect of new lockdowns or travel restrictions, which would likely push oil demand down.

(2) We estimate energy component's contribution to headline CPI growth by taking the median weight of energy in the CPI basket in our sample of emerging market economies (10%) and multiplying by pass-through of Brent to CPI-energy estimated using a fixed effects panel regression of 15 emerging countries (excluding Argentina) over 2007-2021 (14%) and by year-over-year percentage rise in Brent in the quarter. This assumes the same price effect from other forms of energy since the 10% energy weight in CPI is based on all forms of energy usage by the consumer.

Appendix

Table 4

Acronyms for the countries in chart 2, chart 4, and table 2:

• THA: Thailand
• IND: India
• TUR: Turkey
• CHL: Chile
• PHL: The Philippines
• POL: Poland
• CHN: China
• ZAF: South Africa
• MEX: Mexico
• ARG: Argentina
• BRA: Brazil
• IDN: Indonesia
• MYS: Malaysia
• COL: Columbia
• RUS: Russia
• SAU: Saudi Arabia