Emerging Markets Walk A Fine Line

  • We don’t expect the West to impose widespread sanctions in the event Russia invades Ukraine.
  • Emerging market central banks — taking their cue from the Fed — will likely remain hawkish.
  • A stable or depreciating U.S. dollar will be supportive of currencies and local markets in developing countries.

The global backdrop has been challenging for emerging market (EM) economies. Tensions between Russia and Ukraine, rising interest rates, and high Omicron variant infection rates have created headwinds. Still, emerging market assets — especially currencies and bonds — have proved to be resilient.

The Russian impasse

The outcome of the Russia–Ukraine conflict will depend on President Vladimir Putin, although there has been an urgent diplomatic push to defuse the crisis in recent days. U.S. President Joseph Biden and Germany’s Chancellor Olaf Scholz have been committed to diplomacy to end the standoff, and Biden warned of “severe costs.” The United States and Europe have threatened sanctions should Russia invade Ukraine.

Even though a military invasion or severe sanctions are not our base scenario, we must consider those possibilities. Russia’s annexation of Crimea in 2014 led to a set of sanctions, including the ban on technology for oil and gas exploration, travel restrictions on influential Russians linked to Putin and his inner circle, and the ban on provisions of credit to Russia, state banks, and energy companies. Currently, U.S. investors are banned from buying new Russian sovereign debt. The West could further tighten existing sanctions. Additional restrictions on buying Russian government and bank debt will affect international investors.

Widespread sanctions would push energy prices higher temporarily as Russia would be able to find new export channels. As in previous supply-driven oil shocks, EM energy exporters would benefit, and energy importers would be hurt. There would also be direct fiscal consequences. Many EM countries use subsidies and other tools to control domestic energy prices. An oil supply shock would affect those countries. But we believe any spillover to EM countries would be limited.