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Asia faces up to high oil
prices
By Chee Yoke Heong
KUALA LUMPUR - With all the volatility in crude
oil prices recently, there are worries that Asian
countries, many of which are highly dependent on oil
imports, may be subject to shocks that could undermine
the recovery made since the 1997 financial crisis. While
Asia, excluding the Middle East, produces a mere 10% of
the world oil supply, the region consumes nearly a
quarter of that supply.
Even for net oil
exporters such as Malaysia, the strong export prices of
crude oil have posed as a double-edged sword. Malaysia
has reaped huge foreign earnings from oil exports since
the last half of 2003, but it also has been saddled with
huge internal subsidy bills as the prices of refined
products have escalated in world markets. Malaysia
spends about US$2.4 billion in subsidies each year,
which allows the government to keep oil prices at
relatively low levels compared with prices in other
countries in the region. But all that is about to
change, as the government announced last week that it
plans to raise oil prices, the second in a matter of
weeks, by cutting subsidies in order to channel the
funds to finance other development projects.
This will certainly have a spiraling effect on
the economy as inflation, which has remained subdued, is
likely to experience upward pressures. As Malaysia
adjusts to the reality of higher crude oil prices, other
countries in Asia are also expected to feel the pinch in
the next few months and longer if higher oil prices are
sustained for long periods, either by the same intensity
or greater, in which case the effects could be more
severe.
A study conducted by the International
Energy Agency (IEA) in cooperation with the Organization
for Economic Cooperation and Development (OECD) and the
International Monetary Fund (IMF) said that a sustained
$10 per barrel increase in oil prices would have a worse
effect in Asia compared to OECD countries. It would cut
Asian gross domestic product (GDP), within the first
year of the increase, by 0.8 percentage point versus 0.4
for the OECD. Some countries would suffer more than
others: Thailand would lose 1.8% of its GDP, the
Philippines 1.6% and India 1%. China, currently a net
exporter of oil, would see its GDP drop by 0.8% while in
Malaysia, which also exports oil, the impact would be
much less at 0.4%.
Asia would also experience
the largest inflationary increase in the first year,
assuming that the increase in the international oil
price would be quickly passed through into domestic
prices. If so, the inflation rate in China and Thailand
would increase by almost 1 percentage point in 2004.
A country's vulnerability to higher oil prices
varies markedly depending on the degree to which it is a
net oil importer and the oil intensity of its economy,
namely the amount of oil consumed per unit of GDP. The
economies of oil-importing developing countries in Asia
would suffer most from higher oil prices because their
economies are more dependent on imported oil and less
able to weather the financial turmoil wrought by higher
oil-import costs.
It is also because
energy-intensive manufacturing generally accounts for a
larger share of their GDP, and energy in these countries
is used less efficiently. On average, oil-importing
developing countries use more than twice as much oil to
produce one unit of economic output as developed
countries do, says the IEA. India, for instance, uses
more than two and half times as much oil as developed
countries per unit of GDP, while the economies of China
and Thailand are also very oil intensive. It is
estimated that oil imports cost India $15 billion, or 3%
of its GDP in 2003.
According to a study by
Asian Development Bank (ADB) economist Cyn-Young Park,
who looked at the impact a $10 per barrel hike in oil
prices would have on 10 Asian countries, including
Japan, China and India, among the net oil-importing
Asian countries, the Philippines, Singapore and Thailand
would be the most affected.
According to her
report, "Higher Oil Prices: Asian Perspectives and
Implications for 2004-05", the most direct impact would
be felt in trade balances, while the severity of the
deteriorating terms of trade would vary from country to
country depending on various factors such as the share
of oil imports in national income, efficiency of
national energy use and the availability of alternative
fuels. With the exception of Japan, which boasts of
high-energy efficiency and lower oil intensity, net
oil-importing developing Asia experiences considerable
deterioration in its trade balances and subsequently
decreasing real income and outputs.
Should oil
prices remain high at the $40 per barrel mark until the
end of 2005, the effects would be intensified. Inflation
will climb by more than 1% for Asia with the
corresponding loss of real income by 0.8%, or $28.8
billion for Asia, excluding Japan.
While
recognizing the downside, Park believes that despite the
hype, the current price rally is unlikely to match the
ferocity of previous oil shocks in terms of its size and
impact. She thinks that the region is better prepared to
face oil price increases compared to previous oil
shocks, thanks to the depreciated US dollar, higher
international reserves and moderate inflation since the
1997 crisis.
Park points out that the current
price hike features some "benign characteristics" that
will help curb the adverse effect of rising oil prices
in the region. First, the dollar has depreciated against
the currencies of many developing Asian countries over
the past two years, mitigating the impact of rising oil
prices. Second, significantly higher levels of
international reserves and current account surpluses
since the Asian financial crisis provide a cushion
against the short-term deterioration in balance of
payments. Third, despite the pick up in domestic demand
since last year, inflation has stayed relatively low in
many Asian countries, with some economies, such as Hong
Kong, China and Japan, barely escaping from the
deflationary risk.
Still, higher oil prices, if
sustained long enough, could pose risks to recovering
economies. In particular, there is danger of an earlier
and steeper hike in US interest rates due to
inflationary pressures from higher oil prices, which
could lead to a substantial reduction in demand for
Asian goods.
Higher interest rates could also
affect Asian economies through their emerging financial
markets by widening further the risk spreads, which have
already widened due to the higher oil prices, to reflect
higher risk premiums. This could lead to a sudden
withdrawal of portfolio investors particularly with
short-term and speculative funds lured by the increase
in returns on mature market assets, which could result
in higher costs of capital in the region.
But
Park believes the latest oil shock should be seen as an
opportunity to adopt structural reforms to strengthen
the region's resilience to external shocks, which
include efforts to reduce oil dependency and increase
energy efficiency. "The current oil price rally may turn
out a blessing in disguise, if the Asian economies
successfully embrace necessary technological challenges
and find more efficient ways to generate and save
energy," she says.
(Copyright 2004 Asia Times
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