• Oil up on tensions in the Middle-East. Brent crude oil price rose to a 29-month high of US$111.83/bbl on 23 Feb as tension in the Middle East and North Africa (MENA) fanned fears of supply disruption in the region. Given that Saudi Arabia, Libya and Iran contribute 19.0% of total global oil production, a major disruption in these countries would have a far-reaching impact on global oil prices. At this juncture, our regional oil analyst’s baseline oil price estimate is US$95/bbl for this year and US$100/bbl for 2012, assuming a limited impact on global supply. In the worst case, the oil price could spike to US$150/bbl or more.
• Negative net effect on global economy. A sustained high oil price would put a damper on economic activity and corporate earnings and fuel inflation. It also has implications for the financial markets, notably equity, exchange rate and the government’s fiscal budget.
1) Growth outlook – The impact may play out over a period of time if the uptrend in oil prices is gradual. Every US$10 rise in the oil price could lop 0.3-1.0% pts off GDP growth for Malaysia, Singapore, Indonesia, Thailand, China and Hong Kong.
2) Inflation – The impact on inflation is more marked given the relatively high composition of fuel (0.7%-11.6%) and related transportation (9.1%-26.8%) in the CPI basket. Given the surging food prices and raw materials, the indirect impact could be even larger. However, some governments may continue to provide subsidies to cool political and social tension. Overall inflation will be 0.2-2.5% pts higher for the economies under review.
3) Interest rate – Policymakers will be caught in a dilemma as the oil supply shock could itself exert a moderating impact on growth and domestic demand. If the policymakers tighten rates further, it could slow down growth.
4) Fiscal imbalances – High oil prices would add pressure on government budgets due to higher subsidies for Indonesia, Malaysia and China.
5) Equity and debt valuations for the oil-importing countries would be revised downwards and vice versa for oil-exporting countries. As for exchange rates, some central banks may tolerate a stronger currency to mitigate imported inflation pressures.
• Ranking of country risk. Our analysis suggests that Indonesia is the most exposed to the risk of a sharp rise in oil price (bloated fuel subsidy, quicker pace of inflation and higher interest rates). Singapore faces more measured risks as it is buffered by its services sector as well as a strong currency. Both Hong Kong and China will not be affected much. Thailand will be more affected. The potential costs are smaller for Malaysia as it is a net exporter of oil.
Oil up on tensions in the Middle-East
From a low of US$41.76/bbl at end-Dec 2008 amidst the US subprime crisis, oil price climbed to an average of US$52.22 in 1H09 and US$71.57 in 2H09. It gained further momentum in 2010, averaging US$77.71 in 1H10 and US$81.67 in 2H10. In recent weeks, oil prices have been creeping up. The price of Brent crude oil rose to a 29- month high of US$111.83/bbl on 23 Feb as tension in the Middle East and North Africa (MENA) fanned fears of supply disruption in the region. Markets will continue to feel the strain of the Middle East uprising despite Saudi Arabia’s assertion that world supply of oil is adequate at the moment. Although supply and demand dynamics should support oil prices at around US$90, unexpected events such as a supply shock could cause prices to skyrocket again.
While it is difficult to predict how the events in the Middle East will pan out, the current price increases and the possibility of more increases have drawn attention yet again to the threat they pose to the global economy. Given that Saudi Arabia, Libya and Iran contribute 19.0% of total global oil production, a major disruption in these countries would have a far-reaching impact on global oil prices. At this juncture, our regional oil analyst’s baseline oil price estimate is US$95/bbl for this year and US$100/bbl for 2012, assuming a limited impact on global supply. In the worst case, oil price could spike to US$150/bbl or more.
The last time oil prices skyrocketed and threatened to derail the global economy was between late Aug 2007 and early Jul 2008. The spot price for West Texas Intermediate (WTI) barrelled from US$58.32/bbl on 3 Jan 2007 to US$145.29/bbl on 3-4 Jul 2008.
Quantifying the impact on Asian economies
The high oil price in 2008, which was compounded by the US subprime crisis, dealt a double whammy to the global economy as it pushed the major advanced economies and most developing Asia economies into a synchronised global recession in 2009. Thanks to the extraordinary monetary stimulus, massive fiscal injection globally as well as financial stabilisation policies, the global economy stabilised and recovered in 2010. But the recovery is still not firmly rooted for the advanced economies due to the multi-year develeraging, high unemployment and struggling recovery of the housing sector. Peripheral euro area economies continue to face sovereign debt problems. Asian economies led the global recovery, powered by China and India.
After a bumper year in 2010, growth in emerging Asia will ease to a more sustainable pace in 2011 due to the ebbing effects of inventory restocking and fiscal pump-priming effects as well as the gradual normalisation of interest rates. Export growth in most Asian economies started to cool off in 4Q10 as external demand eased. Stubbornly high food prices, raw materials and high oil prices are stoking inflation in China, Indonesia, Singapore and Thailand. At this juncture, inflation pressure, though rising in Malaysia, is still manageable compared to its regional peers.
Our review of the key macroeconomic variables for the six economies we cover –
China, Hong Kong, Indonesia, Malaysia, Singapore and Thailand – take into account (i) the still-uneven pace of recovery in the advanced economies, (ii) a US$10/bbl rise in oil price; and (iii) domestic risks.
The impact of high oil prices on these economies depends on the extent of each country’s oil intensity and dependence on oil imports. High oil prices will have a positive impact on net exporting countries though these benefits could be offset by negative effects elsewhere. For net oil importing countries, the impact will depend how much they consume. Oil price effects are transmitted through two main channels (i) On the demand side, higher oil prices reduce households’ real incomes, prompting them to cut back consumption. (ii) On the supply side, an increase in oil prices raises production costs and induces firms to reduce output.
Impact on GDP growth
As most of these economies have recovered strongly in the post global financial crisis period and are fundamentally solid, we expect the lagged impact of high oil prices to be felt more in 2012. The impact may play out over a period of time if the uptrend in oil prices is gradual.
The impact on GDP measures both first-round effects and second-round effects. A negative second-round effect would occur if high oil prices reduced major advanced economies’ incomes and fed through to the consumption of Asian goods and services. Countries with varying degree of fiscal flexibility could implement short-term measures to counteract the impact of high oil prices on domestic demand. These include temporary targeted subsidies or increased aid to protect the lower-income households.
The impact on overall GDP growth is likely to be measured for net oil exporter Malaysia relative to other countries which are net importers of oil. On the demand side, the impact on household incomes will be more significant in Singapore, Thailand, China and Hong Kong due to the complete pass-through of high oil prices at the pumps. Most economies have taken practical measures to cushion the lower-income group from high commodity, food and energy prices. These measures include partial subsidy for food prices, administered price controls on essential food items, increase in minimum wages and financial assistance such as cash payments and rebates for needy citizens. Meanwhile, household incomes in Malaysia, Thailand and Indonesia also benefited from an upswing in commodities and farm prices, which helps to offset the rise in inflation and contributes to domestic demand. However, the rise in production costs from items such as fertiliser and fuel has negated the positive income effect.
In summary, every US$10 rise in the oil price could lop 0.3-1.0% pts off GDP growth for Malaysia, Indonesia, Singapore, Thailand, China and Hong Kong.
Impact on fiscal budget
Rising oil prices undermine fiscal sustainability as outlays on fuel subsidies go up with the rising prices. The upshot is larger fiscal deficits, failing which government spending may have to be cut back. Policymakers in developing Asia implemented gradual fiscal reform of their fuel price policies to ensure a manageable impact on inflation and households’ income. Malaysia started to reduce subsidies on sugar, fuel and liquefied petroleum gas (LPG) in 2010. Higher oil prices’ spillover effects on other industrial inputs will also affect the fiscal budget due to the rising cost of government projects.
Among these six economies, the governments of Indonesia and Malaysia primarily rely on budgetary operations to finance their subsidies. In Indonesia, the projected budget for fuel subsidies is around Rp95.9tr based on an oil price of US$80/bbl. There’s approximately Rp200-300bn additional deficit per US$1/bbl higher oil price. The government has proposed to start limiting subsidised oil for private cars in Jakarta at the end of Mar 2011 before implementing the policy across the nation by 2013 in an effort to reduce the high burden of energy subsidies on the state budget. However, it was recently reported that the government may postpone the implementation of this policy to avoid unrest.
In Thailand, the government will use THB5bn of the THB25bn oil fund to subsidise diesel retail prices over the next three months to prevent a spike in the cost of living and curb inflation. With the general elections expected to take place this year, we think that the government is likely to adopt short-term mitigating measures to ease the burden of households. The cabinet has extended measures to ease the cost of living for low income households until Jun. The measures were due to expire in Feb. In Malaysia, the government initiated a fuel subsidy rationalisation in 2010 in an effort to consolidate the budget deficit. The 2011 Budget earmarked 6.3% of the total operating expenditure (OE) or RM10.3bn in subsidies for LPG, diesel and petroleum based on an average oil price of US$85/bbl. If the oil price rises to US$130-140/bbl, the amount of subsidies could balloon to at least RM18bn-20bn. In 2008, the subsidy on fuel and petroleum-related products amounted to RM17.6bn or 11.4% of OE. The amount of oil revenue is estimated at RM59.4bn or 35.8% of total revenue in 2011. It is estimated that every US$1/bbl rise in crude oil prices would boost the federal government’s revenue by RM400m-450m over two years.
Impact on inflation
There is reason to be nervous about the inflationary pressures that are building up in many developing countries. As food and fuel are core elements in Asian household budgets, sustained price increases not only erode consumers’ real purchasing power but will also spill over to general inflation pressures.
Headline inflation in the six economies has accelerated in recent months, stoked by the continued strength of domestic demand and rising food and fuel prices. Topping the inflation league is Indonesia at 7.0% in Jan 2011, followed by Singapore (5.5%), China (4.9%), Hong Kong (3.9%) and Thailand (3.0% in Dec 2010). Malaysia’s inflation though rising to 2.4% in Jan is benign relative to its regional peers. This was partly due to administrative restraints that hold prices of essential items in check.
Fuel and transport have a 9.1% weight in CPI in Hong Kong, 19.1% in Indonesia, 14.9% in Malaysia, 16.0% in Singapore, 26.8% in Thailand and 9.9% in China. Every US$10/bbl rise in oil price would add 0.2-2.5% pts to CPI growth assuming full-pass through or partial pass-through in the case of Malaysia and Indonesia. For Malaysia, RON97 petrol price follows a “managed float” market pricing while RON95 petrol, which makes up about 88% of total consumption, is still under subsidy. In 2010-early 2011, the government hiked RON97 and RON95 by 45 sen/litre and 10 sen/litre a couple of times to RM2.50/litre and RM1.90/litre, respectively. The current subsidy rate for RON95 is estimated at 40-60 sen/litre based on the current oil price of US$96- 97. Having learned from the bitter lesson in 2008, the government is likely to stick to a small-step reduction in fuel subsidy to avoid a massive fuel price adjustment, which would lead to widespread spillover price increases for other goods and services. In 2008, inflation accelerated to a 28-year high of 8.5% yoy in Jul-Aug 2008 and averaged 5.4% in 2008. In Indonesia, we factor in a 30% hike in fuel prices, and this will push inflation to 9.7% in 2011, up 2.5% pts from our baseline estimate of 7.2%.
Interest rate and currency outlook
Policymakers will be caught in a dilemma in the event of sustained rises in oil price as an oil supply shock could itself exert a moderating impact on growth and domestic demand. If the policymakers tighten interest rates further, it could slow down growth. Faced with moderating growth prospects for this year, the central banks will have to strike a delicate balance between ensuring continued recovery and mitigating the inflation pressures. In 2008, Bank Indonesia and Bank of Thailand raised interest rates to temper the unprecedented rise in inflation but subsequently cut rates to avert an economic downturn sparked by the US subprime crisis. Despite the surge in inflation in 1H08, Malaysia’s central bank refrained from raising interest rates, having assessed that the weakening global growth and cost-driven inflation would moderate domestic economic growth.
Malaysia, Thailand and China started to normalise interest rates in 2010 while Indonesia followed suit in 2011 to combat the accelerating inflation. We see bigger risk for Bank Indonesia to tighten rate more aggressively if inflation accelerates due to rising oil prices. As for currencies, some central banks are willing to tolerate a stronger currency as part of their efforts to bring inflation under control. As international trade in the oil is denominated in the US dollar, the high oil price will increase demand for US dollars. This will weaken the currencies of net importers of oil. The Thai baht will be affected. The impact on the Hong Kong dollar, Malaysian ringgit and Chinese renminbi will be less.
Source/转贴/Extract/: CIMB Research
Publish date:24/02/11