Global crude oil prices have begun to ease off after the escalation of the Russian-Ukraine conflict drove Brent crude price above $100 per barrel mark on Thursday. But there is still a long way to go before the global economy can heave a sigh of relief on commodity prices.
Economists believe Asian countries that rely heavily on oil imports would be the hardest hit by the latest geopolitical risk. There are three ways that high oil prices could hit these economies. The first is through imported inflation, the second through widening of current account balances and finally even increasing the fiscal deficit. “In such a scenario, India, Thailand and the Philippines are the biggest losers, while Indonesia would be a relative beneficiary,” analysts at Nomura Securities said in a note.
Russian troops invaded eastern Ukraine early on Thursday, setting off panic across global markets and driving up risk premiums on most asset classes. Commodities that both Russia and Ukraine are big exporters of saw prices gallop. Besides being the third largest oil producer, Russia is also a notable exporter of other key commodities. Ukraine is an exporter of agricultural commodities such as wheat and corn.
With the conflict now escalating to a warlike situation, the uncertainty over supply has only exacerbated. This comes close on the heels of the supply disruption that the pandemic triggered over the past several quarters. If Black Sea navigation lines are disrupted, farm supplies from Ukraine would be impacted, according to Soumya Kanti Ghosh, chief economist at State Bank of India (SBI). “The export outlook of services towards Europe will be impacted negatively. Sanctions on Russia may impact regular trade (e.g. tea) between India and Russia,” he wrote in a report.
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But by far the biggest and the most worrisome increase has been that of crude oil prices. As such, oil permeates almost every sector of the global economy. Brent crude slipped marginally but was still above $100 per barrel on Friday. Nomura noted that for most Asian economies food and fuel account for more than half of consumption expenditure. Ergo, the sharp surge in oil prices and the fact that crude may take a long time to cool off has increased the risks for Asian economies.
Who loses, who escapes?
In Asia, some countries such as Indonesia may gain from the movement in commodity prices while most others such as Thailand and Philippines may get hurt. Thailand has been grappling with the impact of the pandemic on its tourism sector, which is one of the biggest contributors of growth. High oil prices may pose an additional challenge to the Thai economy this year. Current account deficits of both Thailand and Philippines are expected to widen considerably given the expansion of the crude bill.
Indonesia is a net oil importer but the country stands to gain from the rise in palm oil and LNG prices, said Nomura analysts. On balance, Indonesia may gain from rising commodity prices. Also, the impact on headline inflation could be limited for the country given that the government may maintain fuel subsidies.
Nomura believes that India would be among the biggest losers among Asian economies in the Russian-Ukraine conflict.
High oil prices hurt the Indian economy in multiple ways. The expansion in the oil bill will widen the current account deficit and imported inflation would drive up domestic consumer prices as fuel has a high weightage in the consumer inflation index.
Analysts at Nomura believe that the elevated crude oil basket price would add about 0.3-0.4 percentage point to headline retail inflation. Retail inflation was above 6 percent in January, beyond the upper limit of the Reserve Bank of India’s (RBI) inflation targeting band of 2-6 percent. Nomura forecasts retail inflation to average 5.8 percent for FY23, higher than the RBI’s projection of 4.5 percent.
Ghosh of SBI noted that the upside risk to the RBI’s projection is about 0.87-1.00 percentage point in the event that crude oil prices average $90 per barrel in FY23.
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Would rising inflation prompt a softer central bank to take a harder stance going forward? So far, the RBI has been growth focused and has refrained from withdrawing liquidity or even hiking policy rates amid rising inflation.
The central bank’s inflation forecast is under threat, as is its policy stance. Analysts believe that the RBI would have to pivot to a harder stance in the coming days. Nomura expects the RBI to raise the repo rate by 100 basis points in calendar 2022. SBI’s Ghosh believes that the retail inflation index needs a revision and that crude oil prices may cool off, making it easier for the central bank going ahead.
“Historical trends (since 2018) indicate that it takes around 18 months for crude prices to crash by as much as 67 percent from the highest level and 30 percent drop from highest level could even come in less than three months. Thus, the decline in crude prices from the current high levels could come even faster going by the recent trends and it augurs positive for overall macro prognosis,” he said.
The upshot is that Asian central banks may begin to forge divergent paths when it comes to monetary policy. Whether the RBI is in the hawkish or dovish camp depends on how fast oil prices are transmitted to domestic pump prices.