Asia starts to feel oil price shock

SINGAPORE To paraphrase President George W. Bush, the climb in oil prices is the re-run of a bad movie that Asian economic policy makers would rather not watch.

By (Reuters)

Published: Sat 15 Feb 2003, 3:50 AM

Last updated: Wed 1 Apr 2015, 8:24 PM

As was the case during past oil shocks, the price surge induced by the spectre of war against Iraq is taking a toll on growth and trade balances in a region that, except for Indonesia and Malaysia, is a big net importer of oil.

A day after China reported its first monthly trade deficit in six years due to a soaring oil bill, Thailand forecast yesterday an Iraqi war lasting 45-90 days would shave 1.1 points off the country's projected 2003 GDP growth of 3.5-4.5 per cent.

But even if the movie still ends unhappily for Asia, economists see a ray of hope: dearer energy is unlikely to increase inflationary pressures to the point that central banks would feel compelled to react by raising interest rates.

"What central banks don't want to see is the initial rise in headline inflation starting to seep into core inflation later down the track," said Rob Subbaraman of Lehman Brothers in Tokyo.

Because inflation is already very low and fierce competition - especially from China - has sapped the pricing power of producers, Lehman Brothers projects that even if oil averages more than $30 a barrel this year inflation will remain below five per cent except in Indonesia and the Philippines.

Such an outcome would be a replay of the second half of 2000, when a spike in oil prices was largely absorbed by a compression in corporate profit margins.

Still, consumers are unlikely to get off scot-free, even if a number of Asian governments have announced plans for subsidies to curb increases in pump and kerosene prices.

This leads economists such as Andy Xie at Morgan Stanley in Hong Kong to argue that, in the current weak global environment, rising oil prices will intensify deflationary pressures by reducing consumers' disposable incomes.

"Ultimately inflation depends on income, so in the short term you have a cost push and prices might rise some more. But over time a higher oil price is deflationary because people have less to spend," Xie said.

As a result, unless policy makers have their hands tied by wage indexation, a central bank should respond to an oil shock by easing monetary policy, Xie argues.

Even in the case of South Korea, Asia's biggest energy importer, Xie sees a case for the central bank to cut its discount rate by half a percentage point to 3.75 per cent at its next policy-setting meeting on March 6.

Underlying Xie's view are beliefs that the South Korean economy is weakening rapidly as its credit bubble deflates and that oil prices are headed lower, not higher.

US oil prices jumped as much as 34 cents yesterday to $36.70 per barrel, the highest since mid-October 2000, as worries over Middle East oil supplies swelled before chief UN weapons inspector Blix reports to the Security Council at 1515GMT.

But Xie said dear oil was already built into sagging stock prices. "The global trade cycle is heading down and a resolution of the Iraqi conflict is in sight," he said. "So for the market it is time to look beyond today's higher oil prices."

This is far from a universally held view.

David Roche of Independent Strategy agreed high energy prices would act as a tax on consumption and would not become a source of inflation. But in a note to clients he said any relief rally following an expected war against Iraq would be brief.