Oil Price Hike: Bad for the Rich, Good for Developing Economies?

By Alan Wheatley

Oil spike to hit West harder than emerging economies

No two oil shocks are alike, but the chances are that emerging economies could suffer a little less than the developed world if the latest price surge to 29-month highs is sustained. Yet this would not be another illustration of how developing countries are decoupling from the West, for slower growth in the rich world would eventually rebound on emerging nations.

Only oil exporters are unambiguous winners — for a while, at least — from the redistribution of income set in motion by a spike in oil like the one this week, which was triggered by fears that unrest in Libya will disrupt supplies.

“Emerging markets will be hit, but they have deep enough pockets to still afford the cushion of subsidies,” said Alicia Garcia-Herrero, chief emerging markets economist for Spanish bank BBVA. That option is not open to most advanced economies, which have started to tighten fiscal policy to reduce budget deficits that ballooned during the worst economic crisis in 80 years.

“The last thing you want now is an oil shock,” Hong Kong-based Garcia-Herrero said. “In the developed world, this additional shock will basically delay the recovery even further.” Among big emerging economies, she said only Mexico, Russia and, to a lesser extent, Brazil, stood to benefit from dearer oil. Latin America would, generally speaking, get off more lightly than Asia, Garcia-Herrero added.

A rise in crude causes a deterioration in an oil-importing country’s terms of trade: it has to pay more for a given amount of imports than it gets for the same volume of exports. This eats into national income and translates into reduced consumption, narrower profit margins and higher inflation.

Central banks in advanced economies typically look past a rise in oil prices when setting monetary policy because, while it brings about a temporary change in the price level, it does not usually trigger an inflationary cycle across the economy.

That’s why G3 central banks — in the United States, the euro zone and Japan — fret more about the impact that a worsening of the terms of trade has on growth than on inflation, said Richard Jerram, chief non-Japan Asia economist at Macquarie.

“But emerging economies tend to be more prone to second-round effects, especially when the domestic economy is pretty tight already and there’s clearly a greater risk of a domestic price effect,” Jerram said. So whereas the Fed would positively welcome a modest inflationary jolt, central bankers in emerging economies already struggling to cap price pressures are in for sleepless nights. “G3 is worried about the hit to growth and emerging Asia is worried about the hit to inflation because it’s recovered already. So you suffer, but you suffer in a different way,” Jerram said.

 FEEDBACK LOOPS

Central banks across Asia were tightening policy too slowly for the taste of many analysts even before turmoil in North Africa sent oil prices through the roof. “This is going to be a further blow because the second-round effects are going to be massive,” Garcia-Herrero said. “I don’t think central banks realise that this might not be just a short-term supply shock, so they should move fast.”

The danger is that without prompt action in Asia to curb booming demand — either by cutting subsidies, loosening price controls or tightening monetary and fiscal policy — oil prices might not quickly reverse, according to economists at HSBC.

That would not only entrench inflation in the region, but, in an illustration of the proliferating feedback loops in the global economy, cause trouble elsewhere, especially in advanced markets. “As Asia fiddles and delays the rise in petroleum costs, it continues to consume oil voraciously, putting further upward pressure on global crude prices. Meanwhile, others take the heat,” HSBC economists Frederic Neumann and Sherman Chan said in a report.

They said there was no need for Asia to panic over this week’s spike in oil because growth in the region was not as sensitive to crude prices as other parts of the world.

But Asia’s exporters would ultimately suffer if dear oil sapped consumer spending in the West. And, echoing the views of others, they said the knock-on effects of higher oil prices was bound to be several times larger in the East than in the West.

“Don’t bet though that central banks will take this as a cue for imminent hikes. The risk, rather, is that they shrug off higher oil prices as self-correcting. That would be a mistake. One, in fact, that was already made in the 1970s. let’s not go back there,” Neumann and Chan wrote.

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NUTSHELL:

Is this really about the divide between rich & poor, developed and developing countries? What about the balance of trade and geology? If you are a developing economy with some level of savings and a higher oil import bill how does that pan out for the economy; and if you are an economy with enormous production levels doe it matter whether your economy is developed or developing? Food for thought.