Below is an article appeared in The Edge Financial Daily, February 28, 2011, which I want to keep it for my future reference.
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Title : Global recovery in focus
Written by Chong Jin Hun
Monday, 28 February 2011 12:01
KUALA LUMPUR: As crude oil prices trade to the US$100-level (RM305) once again, not seen since 2008, the spectre of a derailment in the fragile global economic recovery looms just as the world is working its way out of the slump triggered by US subprime crisis in 2008.
Political uncertainties in North Africa and the Middle East, which account for more than a quarter of global crude oil output, have fuelled concerns in oil markets, sending prices of the commodity to fresh highs in recent days.
Economists and analysts said high oil prices will have a negative net effect on the world economy as sustained high commodity prices curb economic activity, hurt corporate earnings and government finances and fuel inflation. The impact on financial markets is also hard to ignore as corporate earnings will be reflected by stock prices, while high inflation influences central banks’ monetary policies.
RHB Research Institute’s head of research Lim Chee Sing said the impact of high oil prices will only be visible if the price level is sustained for six months.
“Higher cost will impact consumption,” Lim told The Edge Financial Daily in a telephone interview.
The impact of costlier oil, according to Lim, will be greater in countries with substantial oil consumption and those whose fuel prices are determined based on market rates, compared to countries where prices are subsidised.
He said sustained high prices of the hydrocarbon commodity could lead to slower consumer demand in the US, the world’s largest economy. When American consumers spend less, US would import less from exporting nations, leading to slower growth for export-dependent economies such as Malaysia and Singapore.
According to estimates by MIDF Research, the medium-term net effect from a US$10 per barrel increase in oil prices would slash Malaysia’s real gross domestic product (GDP) by 0.4%.
The estimates took into account the first and second round effects where the initial impact is expected to raise real GDP by 0.4% as Malaysia is an oil-exporting nation.
However, the subsequent effect is anticipated to cut GDP growth by 0.8% due to a weaker external landscape and domestic demand.
“On the immediate impact towards the Malaysian economy, we are of the view that the higher oil prices will result in the transfer of income from oil-importing countries to oil-exporting countries, thus, raising net income through positive terms-of-trade, thus benefiting the Malaysian economy,” MIDF’s chief economist Anthony Dass said in an email interview.
In a note last Thursday, Citigroup Global Markets said Malaysia stands to benefit in terms of trade as oil prices go higher given that the country is still a net exporter of oil. Meanwhile, Indonesia’s trade balance is almost neutral to rising oil prices, and could be a positive if net coal exports were included, according to the research house.
According to Citigroup, Indonesia and Malaysia had substantial fuel subsidies as a percentage of GDP but both are cushioned by oil revenues where Malaysia’s income from the sale of the hydrocarbon reserve was more than Indonesia’s.
Citigroup said the net fiscal deficit effect from a US$1 increase in oil price is less than 0.01% of GDP for Indonesia and neutral for Malaysia.
“Fiscal risk arising from oil price shocks appears greatest in India and Pakistan where debt and deficits are already very high to begin with and do not have sufficient offsetting oil revenues to provide a cushion,” Citigroup said.
Costlier crude oil, an important input in industrial activities, will inevitably lead to higher costs of doing business, and more expensive consumer products. This means the man on the street will have less disposable income, hence, reducing the propensity to spend.
However, if companies decide to absorb the incremental costs, this will translate into lower profits and margin compression, prompting businessmen to trim capital re-investments and freeze hiring to safeguard earnings.
Rising inflation in Asian economies, meanwhile, has fuelled expectations of further interest rate hikes this year and this has dampened stock market performance.
In February, Indonesia raised its benchmark interest rates for the first time since October 2008 as inflation rose to a 21-month high, with the consumer price index surging 7.02% year-on-year in Jan 2010. Bank Indonesia raised its benchmark reference rate to 6.75% from 6.5%.
Shortly after, China raised its key interest rate for the third time since October in efforts to cool prices. The People’s Bank of China raised the one-year lending rate and the one-year deposit rate by 25 basis points to 6.06% and 3%, respectively, as the country’s consumer price index rose 4.9% in January from a year earlier.
Just last week, Vietnam raised interest rates, the second time in less than a week, as part of moves to tame rising inflation, which hit 12.31% in Feb 2011. The State Bank of Vietnam lifted its seven-day reverse repurchase rate, or what it charges commercial banks in daily open-market operations, to 12% from 11%.
Stock markets in the region have reacted adversely to rate hikes expectations and tensions in the Middle East, exacerbating an outflow of speculative foreign funds that had profited handsomely from both capital and currency gains in the last two years.
The MSCI Asia Pacific ex Japan has declined 4.52% year-to-date.
The FBM KLCI, which ended last Friday at 1,489.3 has lost 2.88% this year. It has fallen below the psychologically important 1,500 level after earlier hitting an all-time high of 1,576.95 in January.
However, rising inflation will also prompt investment demand for crude oil, and commodities in general as a safeguard against rising prices.
In a research note last month, MIDF said the correlation between crude oil prices and stock markets tends to strengthen when oil prices breach US$60 a barrel. However, the correlation is reversed when oil prices hit about US$110 a barrel, according to historical trends.
Last Friday, most of the regional stock markets closed in positive territory following days of sharp losses as crude oil retreated from the US$100 per barrel level.
But the key question on investors minds is — will it last, and how high will oil go?