For a region that is a net oil importer, Asia would seem to be in the firing line of the rapid increase in oil prices. However, the region’s economies have proved surprisingly resilient. Low real interest rates; China’s strong growth, especially its ability to absorb higher input prices; and strong regional economic fundamentals have contributed to Asia’s ability to shrug off higher costs.
Analysts, however, are beginning to take account of the oil-price effect. “People seem to be dismissing the issue,” says Rob Subbaraman of Lehman Brothers in Tokyo. “When oil went from $30 to $40 per barrel people were worried initially. Since then, though, there’s been no apparent effect on Asian economies.”
Shaving forecasts
Subbaraman warns that if prices do not fall soon, he will start downgrading economic forecasts for the region significantly. Some analysts are already shaving their own forecasts for Asian economies, but not as much as might be expected. UBS has reduced its real GDP growth forecasts for Asia to 4.5% from 4.6% in 2005 and to 3.4% from 3.6% in 2006. Part of the reason for restraint in making downgrades, says UBS, is the fortuitous coincidence of higher fiscal spending in the US as a result of Hurricane Katrina and higher capital investment in Japan.
However, while Asia as a whole might escape the economic ravages from costlier oil, some countries are much more exposed than others and economic fissures are starting to appear.
Chief among these is Indonesia, which despite being an Opec member has become a net oil importer by dint of enormous government subsidies on fuel. As energy prices have increased, so has the government’s bill to keep prices low.
This policy will cost the government $14 billion in 2005, a quarter of total government spending, calculates Lehman Brothers. The potentially ruinous implications of this policy dawned on the market when the rupiah hit a four-year low and the central bank was forced to raise interest rates.
Payments reversal
Thailand’s economy has also been hit hard. Higher oil prices coupled with government fuel subsidies turned the balance of payments from a second-quarter 2004 surplus of $0.6 billion into a deficit of $4.7 billion by the second quarter of 2005. Thailand has since scrapped its fuel subsidies, and inflation jumped to 5.6% in August.
Although most other Asian economies do not subsidize fuel directly, some governments tamper with prices in other ways. China keeps retail fuel prices low by forcing refiners to absorb price rises. According to Lehman Brothers, local refiners have hit a ceiling in their ability to absorb higher prices. Fuel shortages have begun to emerge in southern China, as suppliers are reluctant to provide fuel to the domestic market. Korea and Taiwan also hold down retail prices at the expense of refineries.
Even in the Philippines, where the government could not subsidize fuel prices even if it wanted to because it does not have the funds, higher oil prices have had an adverse impact, with a desperately needed expansion of value-added tax stalled because of government concerns about the effects on consumers of higher fuel costs.
Something’s got to give
Regardless of government policies, Asia’s economies will continue to be affected by high oil prices. If governments continue to subsidize fuel costs, budget deficits will rise significantly; if costs are passed on, inflation will rise. Either way, regional currencies will come under pressure, which might explain some of their weakness against the dollar when other fundamentals suggest appreciation is more likely.
One positive effect of Asia’s oil pains is that fuel subsidies are beginning to be withdrawn.
“Asia is a major source of demand for oil,” says Subbaraman, “and they’re not allowing market prices to work properly to curtail demand and force users to be more efficient.”
It is true that despite high energy prices, demand has remained strong in Asia. Governments are finally beginning to realize that the cost of subsidizing this demand outweighs the benefits. While cuts in subsidies will push up inflation in the short term, it will also encourage more efficient use of fuel. And after all, efficiency is something Asians are supposed to understand.
