El Nino: Is Another Storm Brewing for Emerging Markets?

The potential risks that come with the occurrence of El Niño demonstrate the importance that investors understand the intricate links between climate, the environment, and investing. If active investment managers want to incorporate environmental, social, and governance (ESG) considerations into global investing, attention to climate related-risks matter. History can be a valuable guide for the future; both the Latin American debt crisis (1982-83) and East Asian financial crisis (1997-98) coincided with some of the strongest El Niños in recorded history.³ El Niños can vary with different intensities, as shown in the “Oceanic Niño Index (ONI) 1900-Present” graphic.

The 2024 El Niño is extremely untimely, given the ongoing imbalances in the supply of food and fertilizer caused by the Russian-Ukrainian war. Several nations implemented limitations on food exports to maintain national food security. In summer 2023, India declared that non-basmati white rice would no longer be allowed for export. This was meant to assure rice availability and decrease costs. The ban, following other restrictions, “has sent the Asian market into a panic,” said Tanner Ehmke, lead economist for grains and oilseeds at CoBank. “Now there’s concern about food inflation, especially across Asia.” India supplies roughly 40% of the global rice trade, while the banned non-basmati white rice represents about 15%.⁴ By month-end August 2023, rice prices in key exporting countries, including Thailand and Vietnam, rose around 20% since India’s ban, which tightened global supplies.⁵

El Niño: The “Skinny” on Warming Implications

The NOAA's Ocean Niño Index (ONI) uses the temperature of the sea surface to gauge the strength of El Niño episodes.⁶ The National Weather Service will officially declare an El Niño to be in effect when water temperatures are at least 0.5 ˚Celsius, approximately a 0.9 ˚Fahrenheit, above average over a three-month period. This slight rise in temperature is considered a “weak” El Niño. When sea temperatures rise by more than 1.5 ˚C / (~2.7 ˚F), it’s considered a “strong” El Niño, which can boost global temperatures by as much as 0.4 ˚C / (~0.7 ˚F).⁷ In September 2023, the NOAA forecasted a more than 70% chance of a strong El Niño at over 1.5 ˚C / (~2.7 ˚F) above average temperatures. There is even a 30% chance that the 2024 El Niño will exceed 2.0 ˚C / (~3.6 ˚F), which would put ocean temperatures in a tier with some of the strongest El Niños since 1950.⁸

The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) forecasted that the country's winter wheat crop production would decrease by 34% in 2023–24, after three consecutive years of record production. This indicates that Australia’s current outlook is already bleak. According to the Bureau, the reduced projections are due to the expected emergence of an El Niño weather pattern.⁹

Projections for Malaysia suggest a mild El Niño could reduce the country’s palm oil production by 10%, while a severe one could reduce crop yield by as much as 20%. Malaysia’s palm oil production declined -20% during the 2015-16 El Niño.¹⁰

In February 2022, the Central Bank of Egypt’s interest rate was 8.25%. In August 2023, the interest rate reached 19.25%, an increase of 11% in less than two years to arrest inflationary pressures. If El Niño increases in severity in 2024, the additional price pressures may cause the Central Bank of Egypt to tighten even further. Such a scenario would be devastating, as Egypt already faces sovereign debt sustainability concerns.

Egypt’s 2024 budget, which was published in June 2023, estimated that the average interest on government debt instruments would approach 18.5%, aggravating the government’s ability to issue additional debt.¹⁴ Over half of Egypt’s gross government revenue is projected to be used to pay interest on outstanding debt in 2024. Egypt’s outsized interest payments look even more problematic when compared to Turkey and Ghana, which also have high inflation rates. Egypt’s total gross financing needs are expected to rise from 15% of GDP in 2023 to over 35% of GDP in 2024.¹⁵

During the 2015-2016 El Niño, Egypt's gross public debt increased by 7.8% as a percentage of GDP. Meanwhile, the budget deficit increased by over 14%, or 1.4% of GDP. If past events are any indication, Egypt faces significant challenges in 2024. Agriculture, forestry, and fishing make up about 11% of Egypt’s GDP, and all three industries are especially susceptible to El Niños. If the GDP does not reach target estimates, government income will likely decrease, which would increase the burden of interest payments on the government budget. El Niño may have devastating effects on Egypt’s economy due to the combination of rising food costs, declining GDP, low interest rates, and preexisting sovereign vulnerability.

Conclusion

On December 18, 2023, Abdel Fattah el-Sissi was re-elected to a third term as the president of Egypt. President el-Sissi formulated an ambitious eight-point economic agenda for his sixyear term spanning 2024 through 2030. One of the agenda’s directives aims to lower Egypt’s debt-to-GDP from 96% (FY2022-23) to 75% by fiscal year 2029–30. The agenda also includes attaining pricing stability and decreasing inflation to single digits by the end of 2025. The sixth directive of the economic plan, “improving quality of life,” increases fiscal spending on social programs from 18% to 23%.¹⁶ Egypt’s ambitious economic strategy and dire financial situation offers a crucial case study on how the risks of climate change can impact the well-being and daily lives of citizens.

As active global fixed income managers that integrate ESG factors into the investment process, we find that accounting for climate-related risk adds a crucial lens for holistically evaluating a nation's prospects and risks— a factor that conventional financial analysis may miss.