Iran war's oil crisis looms large over emerging economies

The International Monetary Fund has warned that emerging economies are at a higher risk of financial shocks due to increased reliance on market investors such as hedge funds amidst the escalating conflict in Iran.

Oil prices spiral as global economy teeters

The war has sent oil prices soaring to unprecedented levels, with the IEA warning that the crisis is worse than the combined effects of the 1973, 1979, and 2022 price hikes.

This surge in oil prices, coupled with the shifting global economic landscape, is putting immense pressure on emerging markets. With commodity-intensive economies heavily reliant on imported oil, the rising prices are a major blow to their already fragile financial positions.

According to the IMF, emerging markets received a cumulative $4 trillion in investments last year from outside the formal banking sector, including from hedge funds and investment funds. While these investments can provide benefits, such as easing access to funding for trade and working capital, they are also more likely to be withdrawn suddenly in times of financial stress.

The abrupt retrenchments can intensify external financing pressures, raise borrowing costs, and trigger sharp currency depreciations, ultimately weighing on economic growth. Some countries are already experiencing these challenges, with several emerging markets witnessing a reversal of capital flows from non-resident non-bank investors.

The IMF's analysis also highlights the growing flows of stablecoins, cryptocurrencies pegged to a currency, into emerging economies. These investments are vulnerable to wider fluctuations in cryptocurrency markets, adding another layer of risk for already vulnerable economies.