China’s economic slowdown could roil emerging markets, creating a high-risk scenario that would have a “very high impact” on global markets, the report said.
Further deterioration in China, such as a strong market correction or real estate developer defaults, would likely cause capital to flee emerging markets.
Other macro factors support a negative scenario. Plunging oil prices are hurting EM oil producing economies and the expected US interest rate hike will put strong pressure on EM corporates that borrowed in US dollars, the report said.
“A default by a major emerging-market corporate or sovereign, even if it were relatively isolated from the rest of the global economy, could trigger a sell-off across emerging-market assets.
“Given the growing dependence of Western manufacturers and retailers on demand in the developing world, a prolonged deceleration in emerging markets would have a severe knock-on effect across the EU and the US—far more than would have been the case in earlier decades.”
The US interest rate hike, expected sometime this year, will negatively impact some emerging markets.
Turkey, South Africa, Russia and Venezuela are “especially vulnerable” and these economies are likely to have further capital outflows “as investors leave riskier markets in search of rising returns in the US.
“Although the speed of US monetary tightening is unlikely to match previous cycles, the [rate hike] will still have a knock-on effect on international rates. More than 25 central banks around the world cut interest rates in the first quarter of this year, but there will be a significant turnaround in the wake of Fed tightening and as the oil price slump falls out of consumer price calculations.”
Outside of Asia, the report cited other high risks that could upset global markets. Greece exiting the Eurozone is at the top. Despite making compromises with creditors and adopting austerity measures, Greece remains high risk until 2016. Difficulties in complying with the conditions of the agreement are likely, the EIU said.
In Russia, the conflict with Ukraine is another red flag. The EU renewed its sanctions last month, and Russia's oil-based economy is hurting from low oil prices. “[W]eakening trade ties will continue to damage Russia’s economy badly, and also contribute to sinking industrial output in central and eastern Europe”.
Each month, the EIU measures risk intensity as “a product of probability and impact” on a 25-point scale.
The risk scenarios are “potential developments that might substantially change the business operating environment over the coming two years”.