THE SELLOFF in the global oil market might bring a sense of relief to Asia’s policy makers: So this isn’t 1973, after all.
Back then, prices almost quadrupled in three months and then just kept rising. This time around, Brent crude zoomed to about $128 a barrel, but fell equally dramatically. Speculative bets on a renewed surge are unwinding — as prices bob around the $100-a-barrel range. Yet, policy makers and investors shouldn’t be too complacent. Even if the benchmark this year doesn’t hit the $200 mark that commodities trader Pierre Andurand sees as possible, oil can be a potent instrument of stagflation.
For starters, as economists at Australia & New Zealand Banking Group Ltd. (ANZ) point out, government budgets in Southeast Asia and India have assumed an average oil price of between $65 to $75 a barrel for the year, a lot lower than where the market is now. Malaysia and Indonesia, which are net energy exporters, will find it relatively easier to subsidize pump prices. Net importers, however, may struggle to be as generous, for they may need to cut back on developmental spending.
It makes sense to protect household consumption because domestic demand is still short of pre-pandemic levels. It is particularly weak in tourism-dependent Thailand. But then, the virus has also pushed up public debt: Consumers can’t be spared entirely. At their recent highs, passing through a $40-a-barrel increase in crude prices to the local economy would have meant a pickup in inflation: from 1.75 percentage points in Thailand to about 1.25 percentage points in the Philippines and India, according to ANZ.
However, somewhat cooler global energy prices may not necessarily take away the inflationary pressure. The reason is China.
Traders are worried about global oil demand because of the recent omicron outbreak in the People’s Republic. But the lockdown in the cities of Shenzhen and Dongguan in Guangdong province, which accounts for a quarter of the country’s outbound trade, could also mean broader supply-side snarls. For Asia, which has a high dependence on Chinese-made parts and components, “Any prolonged or broader lockdowns in China would add further headaches, potentially resulting in reduced production pipeline for factories elsewhere,” says a report by Singapore’s Oversea-Chinese Banking Corp. Thus, instead of containing the inflation threat, oil at $100 might yet end up compounding it.
Then again, oil isn’t the only commodity to worry about; food, too, has a high weight in Asia’s inflation equation. Russia and Ukraine together command a share of 15%-plus of global exports of wheat, corn, fertilizers and seed oil. The longer the war stretches on, the higher the risks of a squeeze. While a food exporter like Thailand might realize some benefit from higher prices, trade deficits across the region may widen because of the combined shock from energy and agricultural commodities.
India appears particularly vulnerable to what Observatory Group analyst Ananth Narayan calls the “policy maker’s nightmare.” If current trends sustain, the current account deficit for the fiscal year that starts in April could exceed 3% of GDP, he says, adding that the Reserve Bank of India may need to sell a record amount of foreign currency to keep the rupee stable.
The saving grace is that at 22% of gross domestic product, India’s foreign-exchange war chest is robust. Still, “consumer-price inflation could exceed 6%, and India’s already weak fiscal balance, growth, and job creation could be hit further,” Narayan says.
At the same time, oil could have an impact on Asia’s growth prospects by crimping demand for the region’s exports. “History suggests that higher oil prices and the associated rise in transportation costs do not bode well for trade flows,” write ANZ economists Sanjay Mathur and Krystal Tan. “A slowdown in global growth will hurt the non-energy exports of Indonesia and Malaysia as well.” The Paris-based Organization for Economic Cooperation and Development expects the war in Ukraine to shave off one percentage point from global growth this year, but because it also anticipates a 2.5 percentage point pickup in inflation, the OECD is advising central banks to focus on fighting price pressures.
In Asia, though, such clear-cut institutional boundaries — governments enabling growth, monetary authorities dealing with inflation — got blurred with the onset of the pandemic; the task of re-establishing them will probably now get postponed until after the end of the war. That means that central banks will prioritize output by keeping interest rates lower, while governments try to manage inflation with energy subsidies. The outcomes could get messy for investors, especially with the US Federal Reserve’s monetary tightening campaign already under way.
The 1970s stagflation in the West coincided with the rise of Asia. With the oil shock worsening their terms of trade, South Korea and Thailand pumped up exports to overcome their handicap. Indonesia took advantage of higher commodity prices. Investment boomed. Tiny Sri Lanka saw an 18 percentage point jump in the ratio of its capital formation to GDP between 1977 and 1982. Conditions are very different now because of, among other things, the scarring from the pandemic. The Thai bond market is getting no love from global investors, while Sri Lanka is seeking a rescue by the International Monetary Fund. Brent crude sustained at $128 a barrel would have dealt a big blow to Asia, but even $100 oil won’t bring it much cheer.