Emerging markets: Resilience and divergence in the face of the latest oil shock

We have some recent history of EM resilience to shocks to draw on, including the effects of the COVID-19 pandemic in 2020, the Russia-Ukraine war, which began in early 2022, and the US Federal Reserve’s interest-rate hiking cycle in 2022‒2023. In general, EMs withstood these shocks well, and where there were issues, there was no “contagion” such as we might have seen in decades past. While we can use these more recent prior experiences as a guide, shocks are never identical, and initial conditions change, so investors should take care when assessing possible outcomes.

The current oil shock is both a price and supply shock. There are a number of layers involved in analyzing effects on particular economies. At a high level, we differentiate between oil importers and oil exporters, where the oil shock would likely hurt importers more and the latter would possibly even see some benefits accruing. Drilling down further, however, there is much that differentiates countries even within each of these two groupings, underlining that assessment needs to take place on a country-by-country basis. Some of the factors that are important to consider here include:

• The energy intensity of production within a country: Countries that use more energy per unit of production than others are more vulnerable to higher oil prices. In general, global energy intensity has been declining over the past few decades; the mix of energy used has also been changing as a number of countries have shifted toward an increased share of renewable energy.
• Initial macroeconomic conditions: As a result of some years of better policy, many EMs have built up comfortable buffers from both a balance of payments perspective (foreign reserves) and a fiscal perspective. Some of these buffers had been used to help compensate for the prior shocks mentioned above, so they may be somewhat more vulnerable now than they had been then. That said, many remain in a fairly comfortable position.
• Countries may enter this shock with different macro starting points compared to the prior shocks. Continued reforms continue to provide comfort. There are some countries where reform progress has accelerated in the past few years (often linked to International Monetary Fund programs), putting them in a better space to face a shock now than they were a few years ago. Domestic political shifts in some countries have also driven broad macro-policy changes—some for the better and some for the worse—which also affect how they may be able to respond to current conditions.
• Transmission channels vary between countries. For some countries, oil’s direct impact may dominate, whereas other countries may also be exposed to additional effects in the current environment. Examples of these include the spillover effects on fertilizer trade and prices (which tend to move similarly to energy prices), shipping disruptions affecting other imports or exports, and tourism effects (whether from geographical proximity to the conflict or the effect of the shock on consumer spending in their source markets).
• Policy responses matter and have different implications for macroeconomic fundamentals. For example, some countries might subsidize the cost of fuel to minimize disruptions to consumer spending and inflation, but this will come at a cost to fiscal accounts. We highlight that this outcome also applies to oil exporters, a number of whom routinely subsidize domestic energy costs. Others might allow full passthrough of fuel prices and help protect their fiscal positions, but at the expense of lower growth and higher inflation. Some EMs may allow flexibility in their foreign exchange rates to absorb some of the shock. Some governments may use other fiscal measures (such as tax relief) to try to cushion the shock for consumers. Central bank responses may differ according to their perception of the growth/inflation trade-off, which may have implications (positive or negative) for the perceived credibility of monetary policy.