Oil Crisis - Winners & Losers in Asia

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Ng Jun Jie, Shawn's picture

The crashing of oil prices will benefit some countries but bring problems to others. From around US$115 per barrel, Brent crude oil has lost around a third of its price and financial analysts expect it to average around US$70 per barrel in 2015 following a recent announcement by the Organization of the Petroleum Exporting Countries (OPEC) that it would maintain production at 30 million barrels per day.

The metrics to determine which country stands to gain or lose the most is measured based on its impacts on macroeconomic health of the country. The impacts of the decline in oil prices vary across countries due to differing current economic states, their dependence on oil imports and their energy usage. The big winners from the decline in oil prices will be emerging Asian economies that depend heavily on oil imports to service their energy requirements. Furthermore, emerging economies are often faced with high inflation and large oil subsidy financing. Thus, the fall in oil prices enables them to abandon oil subsidies and subsequently relieve pressure from their public finances. As most advanced Asian economies are less dependent on oil for economic growth, the gains from the crisis are rather limited. On a contrary, the biggest losers will be countries that are depend on oil exports for economic growth. The decline in oil prices will contribute to a decline in export revenue, thus limiting the engine of growth. Based on these objective criteria, we will next proceed to examine why India benefits greatly while Malaysia suffers in the short-term from the decline in oil prices.

Asia’s Greatest Winner – India:

India has the most to gain from the decline in oil prices in Asia. This is because India is the 4th largest net oil importer in the world. Oil constitutes 37% of India's total imports while its exports are varied ranging from agricultural products to information services. The decline in oil prices will thus lead to a more than proportionate fall in costs of imports, thereby reducing India’s trade deficit. For instance, it was estimated that the cost of oil imports had decreased from US$169bn to US$164bn (year-on-year). Although this is similarly expected in every other country that imports oil, the greatest advantage will be experienced by India. This is because oil imports constitute approximately 67% of India’s trade deficit and it would reduce its trade deficit by approximately 25% if oil prices continue to remain at low levels. Thus, the oil price decline allows India to significantly reduce its trade deficit.

Moreover, the oil price decline has also led to a reduction in India’s inflation, decreasing from 10% in 2013 to a current 6.5%. India stands to benefit the greatest from the reduction in inflation, as it is highly dependent on the agricultural sector for Gross Domestic Product (GDP) growth. For instance, India’s agricultural sector is the single largest economic sector, accounting for 22% of its GDP and provides employment to 60% of its population. Also, agriculture by nature consumes more energy than manufacturing and is dependent on fertilizers as its main source of energy. The World Bank estimates that a unit of agricultural output requires approximately five times more energy to produce a unit of manufactured goods. This decline in oil prices thus creates a knockdown effect on the price of fertilizers, which in turn boosts food production and reduces the rate of increase of food prices. Thus, this will allow businesses in India to enjoy significant cost savings and lower operation costs. This will correspondingly stimulate the Indian economy as they have greater capacity to expand their production.

Furthermore, based on Irving Fisher’s effect, this lower expected inflation within India will correspondingly lead to lower interest rates. Subsequently, the low interest rates will reduce borrowing costs and increases the expected rate of return of investment (ROI), thus improving business expectations and attracting more investments. The lower inflation rate will also attract more Foreign Direct Investments (FDIs) into India due to greater investors’ confidence and a positive outlook of economy. Thus, this influx of FDIs and improvement in business expectations will spur long-term economic growth for India.

 

 

 

 

Finally, the decline in oil prices provides India with a valuable opportunity to abandon their fuel, fertilizer and food subsidies. India has been experiencing significant budget deficit over previous years, with current estimates constituting 4.5% of its GDP. This deficit is partly driven by India’s food subsidies financing which totaled US$41 billion in the year ending March 2014. As previously seen, the decline in oil prices leads to the decline in food prices, thus reducing the need for food subsidies, as more people are now able to afford the purchase of food. Such fiscal reforms has come timely for the newly elected leader of India, Narendra Modi who can use this opportunity to deregulate the fuel industry and raise fuel taxes without fear of consumer backlash. Thus, the oil price decline has opened a new door for India to reduce its trade deficit, reduce its high inflation rate and undergo fiscal reforms to relieve pressure from their public finances.

Asia’s Greatest Loser - Malaysia:

On the contrary, Malaysia has the most to lose from the oil prices decline in Asia. This is because 30% of Malaysia government’s revenue is derived from oil. The decline in oil prices will lead to a corresponding reduction in oil-related revenue, thus worsening the government’s budget deficit. The recent decision to abandon fuel subsidies may not come timely and could exacerbate the problem. Although the removal of subsidies will reduce its budget expenditure, the recent decline in oil prices had been so significant that the subsidized price was higher than the prevailing market price. This suggests that the removal of subsidies will worsen the budget deficit in the short-run. Previously, the government will use subsidies as a way to mitigate the high cost and ensure oil remains affordable. With these new fiscal reforms, the more oil prices fell, the larger Malaysia’s budget deficit. Moreover, Malaysia is one of Asia’s remaining net oil exporters. The fall in oil prices will lead to a decrease in export revenue, thereby reducing the current account surplus. For instance, a study done by Credit Suisse showed that a 10% decline in oil prices would reduce Malaysia's GDP growth rate by 0.2% points. Therefore, the decline in oil prices will lead to a negative impact on the Malaysian economy as evident from the reduction in oil-related income, declining current account surplus and GDP.

Unlike other Asian economies, the main reason why Malaysia will be most severely impacted is due to its heavy reliance on state-owned oil company, Petronas for tax, royalties and dividends. With domestic production in Malaysia on a decline, Petronas had recently decided to cut 15-20% of its capital expenditure budget and this will lead to a reduction in dividends payment to the Malaysian government. For instance, Petronas expects to pay around US$12 billion to the government next year, lower from the proposed 2015 budget expenditure of US$80 billion. This will affect the ability for the Malaysian government to reduce its budget deficit and finance the loan obligations of Malaysian bonds. Currently, Malaysian bonds are given an “AAA” rating as such obligations are guaranteed by oil funding. The inability to finance these loan obligations will therefore increase the default risks of Malaysian bonds, which in turn increasing its vulnerability to financial shocks. Foreign investors will start to offload Malaysian bonds, thereby hurting government efforts to reduce its budget deficit.

Finally, in anticipation of the US Federal Reserve (Fed) to raise interest rates in the near future, it will strengthen the US dollar, leading to the depreciation of Ringgit. As seen previously, declining oil prices will reduce Malaysia’s current account surplus, and therefore creates a smaller buffer to counter capital outflows particularly if the Fed moves earlier than anticipated, thus leading to the depreciation of Ringgit. A weaker Ringgit will increase the prices of import prices just as Malaysia prepares to introduce a 6% goods and services tax (GST) in April. This may correspondingly raise inflation within Malaysia and may lead to outflow of foreign investments due to higher operation costs.

In conclusion, the decline in oil prices has enabled India to reduce its budget deficit through cutting back on fuel subsidies and raising petrol taxes. Being heavily dependent on oil imports and agricultural sector, India will be able to reap significant cost savings in the near term. However, Malaysia will be negatively impacted by the oil price decline as it is still a net exporter of oil and the government requires oil-related income in order to reduce its budget deficit. This could mean that the government will fall short of their fiscal targets and there are concerns that it will have to cut back on expenditure, which could lead to further financial distress. Finally, it is necessary to analyze the impacts over a period of time to be able to examine the full effects of the decline in oil prices.

References: 

A. Gary Shilling (December 2014). Who Gets Hurt When Oil Falls

Gawdat Bahgat (November 2014). The Drop in Oil Prices: Economic and Strategic Implications

Robert Klemkosky (December 2014). The Real Cause and Impact of Falling Oil Prices

Associated Press (November 2014). Winners and losers of the great oil price plunge

A Cushman & Wakefield Research Publication (November 2014). The Economic Benefits of Lower Oil Prices

Paul Ebeling (October 2014). Impact Of Crude Oil Price Fall On Asian Economies

Business Insider Singapore (November 2014). Here’s How The Oil Crash Is Affecting Asian Countries