2/25/2011 7:05 PM ET
A spike in oil prices means higher inflation, which makes it much harder for governments to slow growth without tanking their economies.
Related topics: emerging markets, oil, Brazil, investing strategy, Jim Jubak
Is the violence in Libya the last straw for the world's emerging economies? Or at least for investors in those markets?
I think the big stock drops of developing nations are leading some investors to abandon markets they never felt all that comfortable with in the first place.
For those of us who believe in the long-term emerging markets story (and I do mean us -- I wouldn't have started a global mutual fund if I didn't), it is important to acknowledge that risk associated with the Libya crisis has increased sharply. What initially looked like a short-term crisis has now widened to the medium term -- say the next six to nine months.
Libya news
That in turn makes higher oil prices the big problem.
Yes, I know that Saudi Arabia has lots of excess oil capacity and has pledged to pump more petroleum to meet any losses from Libya. It's likely that once the Libya crisis is over, oil prices will retreat from current levels. The world is probably not looking at $110 a barrel as the new base price for oil. (I argued this in a Feb. 23 post on my blog.)
Jim Jubak
I also know that the worries of the moment are concentrated in the world's developed economies, especially Europe, which is highly dependent on oil and gas supplies from Libya. Many fret that higher oil prices -- Brent crude for April traded as high as $120 a barrel on Feb. 24 -- could stall the weakest economies in the European Union.
Higher oil prices, even modestly higher oil prices, couldn't come at a much worse time for many emerging nations, where governments are waging a tough battle to control inflation without tipping their economies into a slowdown.
That balancing act, already difficult, got much, much harder with Libya's unrest. The danger of a policy mistake -- too much inflation fighting leading to too little growth or too little inflation fighting leading to too much inflation -- has gone way up. This remains true, even if the price of oil comes back down to $95 or so.
To understand the risks, play central banker with me for a moment. Pretend that you're the head of the People's Bank of China, the Reserve Bank of India, or Banco Central do Brasil. You're engaged in a tough battle to control inflation while preserving as much economic growth as possible./*
In Brazil, for example, inflation roared ahead to a 5.99% annual rate in January and then climbed further, to 6.05%, in February. (Brazil measures inflation from mid-month to mid-month.) That increase came despite an interest rate hike from the central bank to 11.25% in January. Banco Central is expected to raise its Selic benchmark interest rate again when it meets again in early March.
Economists don't think that March increase will be the last. The consensus is that the Selic rate will hit 12.5% by the end of 2011 before falling back to 11.25%, the current rate, by the end of 2012. Even with those increases, economists are expecting inflation to be a still-high 5.75% by the end of 2011.
To reduce inflation in 2012, Brazil has to slow its economy, which appears to be happening. Economists now project the economy to grow by 4.5% in 2011. That's down from an earlier projection of 4.6% growth and well off 2010 growth of 7.8%. It's also below the government's official projection of 5% growth.
Threading this policy needle already looked tough enough. Thanks to that 7.8% growth rate (gross domestic product growth averaged a much lower 3.24% from 1991 to 2010), unemployment in Brazil hit a record low of 5.3% in 2010. Unemployment averaged 9.95% from 2001 to 2010. A slowdown to 4.5% growth won't increase unemployment, but it is sure going to stir anxiety in a country coming off annual growth of 7.8%.
Into this tricky growth/inflation mix, we now add rising commodity prices. Higher commodity prices are good news for growth in an economy that exports commodities, such as Brazil, but such a trend is still bad news for inflation. If iron ore, sugar and coffee prices all go up -- and prices for Arabica coffee beans are up more than 100% since June 2010 to a 30-year high -- that means good times for Brazilian companies such as Vale (VALE, news) and Cosan (CZZ, news). But it also means higher consumer prices for everything from cars to soda and coffee -- and bigger inflation worries for the Banco Central do Brasil.
Of course, we now also have spiking oil prices, thanks to the turmoil in Libya. Brazil is an oil exporter -- an estimated 570,000 barrels a day in 2010 -- which is good for Brazilian oil companies and their partners. But an increase in global oil prices still means an increase in the price that Brazilian companies have to pay for fuel and the petroleum feedstock used to make everything from plastic gadgets to hand lotion. Brazilian airline Gol Linhas Aéreas Inteligentes (GOL, news), for example, modeled its 2011 guidance for investment analysts in early January using a range of $82 to $93 a barrel for oil (West Texas Intermediate). That benchmark closed at $99 a barrel on Feb. 23, substantially above Gol's worst-case scenario.
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Unfortunately, the unforeseen consequences are they the price of all commodities (energy, food, metals, etc.) is going to exceed our ability to maintain our standard of living as enterprises and jobs more offshore. Same thing that happened to Europe during the Industrial Revolution is now happening to the USA during the Technology Revolution. Apple Asia, Intel Asia and Microsoft Asia will grow but the jobs and the wealth will accrue to Asia and the Middle East do to the trade imbalance in energy and manufactured goods. A person can survive by investing in these enterprises but those that don't have capital to invest are going to suffer. 1 0ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. 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Economists don't think that March increase will be the last. The consensus is that the Selic rate will hit 12.5% by the end of 2011 before falling back to 11.25%, the current rate, by the end of 2012. Even with those increases, economists are expecting inflation to be a still-high 5.75% by the end of 2011.
To reduce inflation in 2012, Brazil has to slow its economy, which appears to be happening. Economists now project the economy to grow by 4.5% in 2011. That's down from an earlier projection of 4.6% growth and well off 2010 growth of 7.8%. It's also below the government's official projection of 5% growth.
Threading this policy needle already looked tough enough. Thanks to that 7.8% growth rate (gross domestic product growth averaged a much lower 3.24% from 1991 to 2010), unemployment in Brazil hit a record low of 5.3% in 2010. Unemployment averaged 9.95% from 2001 to 2010. A slowdown to 4.5% growth won't increase unemployment, but it is sure going to stir anxiety in a country coming off annual growth of 7.8%.
Into this tricky growth/inflation mix, we now add rising commodity prices. Higher commodity prices are good news for growth in an economy that exports commodities, such as Brazil, but such a trend is still bad news for inflation. If iron ore, sugar and coffee prices all go up -- and prices for Arabica coffee beans are up more than 100% since June 2010 to a 30-year high -- that means good times for Brazilian companies such as Vale (VALE, news) and Cosan (CZZ, news). But it also means higher consumer prices for everything from cars to soda and coffee -- and bigger inflation worries for the Banco Central do Brasil.
Of course, we now also have spiking oil prices, thanks to the turmoil in Libya. Brazil is an oil exporter -- an estimated 570,000 barrels a day in 2010 -- which is good for Brazilian oil companies and their partners. But an increase in global oil prices still means an increase in the price that Brazilian companies have to pay for fuel and the petroleum feedstock used to make everything from plastic gadgets to hand lotion. Brazilian airline Gol Linhas Aéreas Inteligentes (GOL, news), for example, modeled its 2011 guidance for investment analysts in early January using a range of $82 to $93 a barrel for oil (West Texas Intermediate). That benchmark closed at $99 a barrel on Feb. 23, substantially above Gol's worst-case scenario.
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