Saudi Arabia faces a crisis in the next three to five years if oil prices remain low, and the country still has big budget deficits, and a rigid, pegged currency, participants in the Reuters Global Investment Outlook Summit said on Tuesday.
During a panel discussion about emerging markets and China, investors also predicted a broadly stronger dollar in 2016, but they also doubted a systemic corporate debt crisis would develop in the developing world next year.
That was especially the case with China, where three of the four participants saw annual growth averaging 6.5 percent, with the authorities fully capable of dealing with market wobbles and capital flight by "zombifying" - effectively freezing - the financial system.
But its slowdown, with the knock-on effect for oil and commodities, is raising red flags elsewhere, investors reckon. Countries such as Brazil and Russia have let their currencies fall 20 to 30 percent against the dollar this year, but the risk lies in place where no such adjustment is occurring, they say.
"If Saudi Arabia buckles, we have a huge problem, on a scale that is not comparable to what we are contemplating at this point," Stephen Jen, Founder of Macro Hedge Fund SLJ Partners, told the summit.
"For Russia, in the short term the most efficient way (to adjust) was to devalue the rouble. Go to Saudi Arabia, same shock but with a pegged currency, it can't devalue."
The Saudi riyal is pegged to the rising dollar around 3.75 SAR, denying the economy the lift from a cheaper currency.
In addition, its budget deficit will top $100 billion this year, according to the International Monetary Fund, which has warned that without serious spending cuts, Riyadh will run out of cash reserves in less than five years.
"Saudi can be a problem in three to five years if they run a deficit of 20 percent-plus," said penalist Mauro Ratto, Head of Emerging Markets at Pioneer Investments, said.
Investors at the 2016 summit note oil futures currently contain very little premium to account for geopolitical risk.
Last week's attacks in Paris, if replicated in Gulf oil installations, could cause crude prices to surge. That would help countries such as Saudi Arabia, bit it would also wreck funds' baseline calculations for 2016 investments.
"That's where the geopolitical premium will come in, and it's not currently in the price," Salman Ahmed, Chief Global Strategist at Lombard Odier told the panel.
Anne Richards, Chief Investment Officer at Aberdeen Asset Management, also broached the issue earlier in the day.
"No one is looking at what the effect would be of a higher oil price in 2016," she told the summit. "Oil went from $100 to $50. Could it go into the other direction? I can't see why not."
CHINA AND EMERGING MARKETS
Emerging market assets have suffered from a strong dollar and a looming US rate increase since 2013 and are expected to see net capital outflows in 2015 for the first time since 1988. But Ratto predicted emerging market dollar debt would return 3-4 percent in 2016 and local currency bonds might perform better.
He expects corporate default rates to rise to 4 percent in 2016 but says most risks are already priced in.
"Our opinion is that next year will not be as bad as 2015 for countries such as Brazil, which have huge capacity to cut rates ... real interest rates are around 300 basis points," he said.
But fellow penalist John-Paul Smith, Founder of investment consultancy Ecstrat, predicted emerging market equities would continue to underperform developed peers.
Known for predicting the 1998 Russian crisis and correctly calling the underperformance of emerging market stocks from the end of 2010, Smith says poor EM fundamentals and lack of reform will prevent a recovery next year.
Smith was also the only panelist bearish on China. He said the country's real economic growth is zero, taking into account debt and overcapacity in manufacturing, which would eventually hit the consumer and get reflected in markets.
"If you want an analogy for what's happening in China, you should look at Russia in 1998. Financial markets will seek out the point of vulnerability in an economy," Smith said, seeing a Yuan devaluation as inevitable.
Others are more confident.
Lombard Odier's Ahmed reckons China's $3.5 trillion of reserves is ammunition enough to ward off any crisis and prevent outside spill over. One strategy, employed during this summer's equity rout, was to freeze markets by stopping trade or sucking up liquidity.
Those reserves are "a lot of dry powder to zombify the situation. If you create a wedge between the market and pricing, you can easily zombify the situation ... even though there is a solvency issue, there is excess capacity and some of these companies should not exist," Ahmed said.