The low commodity price phase that the world has entered into is not unprecedented, but it can have far-reaching effects for emerging markets and the U.S. firms that invest in, sell to, or are being supplied from developing countries. These effects range from the geopolitical to the financial, and one of the most immediate is the risk of capital controls, which are already appearing or being tightened in some countries. Simply put, when a commodity that a country depends upon declines in price, something has to give: governments can devalue the currency, increase interest rates or freeze capital flows to protect the foreign exchange reserves that help sustain a currency’s value. In an effort to minimize the effect on their own population, many countries try capital controls, causing losses for foreign exporters, investors and lenders. While capital controls are economic policy tools, when many countries enact them at once they become part of the already difficult geopolitical risk picture that firms face today.
One worrisome risk issue with the current commodity price phase is that we may be in a very broad valley. The World Bank recently cut its price forecast for 80% of the world’s commodities based on oversupply and weaker emerging-market growth. After falling by 47% in 2015, oil prices are expected to fall another 27% in 2016. The International Energy Agency predicts oil to be at only $80/bbl by 2020, and their “Low Price Scenario” contemplates $50-$60/bbl “well into the 2020s.” Countries dependent on oil exports and other commodities have to make choices about how to absorb these prolonged effects while minimizing the damage to their economies.
Capital controls themselves are nothing new. China continues their use as they transition toward something closer to a market economy. In a more unconventional approach, Venezuela has long used them to control “speculators” and to try to mitigate the effects of oil price volatility on the economy. Indeed, the International Monetary Fund (IMF) and the Bank of Japan, have condoned the use of capital controls under some conditions.
What is new is that, with this economic policy advice and the commodity price trough, we may see more countries than ever before implementing capital controls. As reported in the Wall Street Journal, oil-dependent Azerbaijan is imposing a 20% tax on any transaction that takes money out of the country; Saudi Arabia disallowed certain shorts against its currency by traders; and Nigeria halted imports of goods, such as some foods and furniture, and imposed spending limits on foreign-currency credit and debit cards. In the credit and political risk insurance marketplace, recently Zurich has even seen some governments and state-owned enterprises delay their own payments to lenders and suppliers because of prolonged low commodity prices.
For U.S. suppliers and lenders, these actions can cause increased costs of doing business, delays or even defaults of payment and potential inability to get dividends out of investments in these countries. In some cases, these are temporary inconveniences. In others, capital controls signal panic, with a corresponding market reaction and knock-on effects that can include shortages of basic goods and civil unrest. With the prolonged commodity price downturn that we seem to be in, U.S. suppliers and lenders to the emerging markets are well advised to hope for the first, but be prepared for the second.
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