How will Asia cope with $100 oil?

Transcription

1 Economics & Strategy Weekly How will Asia cope with $100 oil? DBS Group Research 5 October 2018 Taimur Baig Chief Economist taimurbaig@dbs.com Ma Tieying Economist matieying@dbs.com Please direct distribution queries to Violet Lee violetleeyh@dbs.com Geopolitical risks around the supply of oil are rising as US ratchets up sanctions on Iran. We consider a tail risk scenario for, under which crude oil averages USD100 for the year, a 35%yoy shock to oil importers. The key stress points in Asia around much higher oil prices will be India and Indonesia, as it has been the case this year already. Beyond India and Indonesia, sharply higher oil prices will pose macro challenges across the board. Inflation will become a problem everywhere, either in actual manifestation as the higher import cost is passed through to the consumer (Philippines) or suppressed through fiscal subsidies (China). Malaysia will be one unambiguous winner in the bullish commodity price environment. If high fuel prices persist, inflation will spill over from headline to core, forcing many central banks in Asia to follow the Fed in. Looming Iran sanctions will make a challenging environment worse Geopolitical risks around the supply of oil are rising as US ratchets up sanctions on Iran. With continued belowtrend production by Libya and Venezuela, and no major pick-up in Russia or Saudi Arabia so far, chances are as Iran s supply dwindles, the near-term impact would be further rise in crude oil prices. Beyond the issue of supply-demand imbalance, the risk of a military confrontation between Iran and the US (and the countries allies) in the Persian Gulf could rise as well, fuelling further upside to oil. Most critically, we see no clear path to resolution in this brewing Iran-US conflict; we think that the risk of matters worsening is far higher than some sort of mitigation in the near term. Against this background, we devote this Weekly to a scenario under which oil averages USD100 in. This would constitute a 35%yoy price shock to oil importers, a dramatic development, give that it would build on top of a 30%yoy jump in In the following sections we look at country-by-country analyses (implications for growth, inflation, fiscal, current account, and FX), followed by notes from our macro strategists on the impact on various asset classes. The key stress points in Asia around much higher oil prices will be India and Indonesia, as it already has been the case this year. But inflation will become a problem everywhere, either in actual manifestation as the higher import cost is passed through to the consumer (Philippines) or suppressed through fiscal subsidies (China). While fuel is excluded from core inflation calculations, we have seen a strong pattern in the past (both in developed and emerging economies) that if high headline inflation persists for a couple of quarters, it tends to pull up core inflation as well. Monetary authorities will have to be cognizant of this eventuality. Taimur Baig Refer to important disclosures at the end of the report

2 China Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) Domestic fuel prices are heavily regulated by the Chinese authorities. The following chart shows the divergent trend of PPI and CPI despite surging Brent prices, as producers are not allowed to pass cost increments onto consumers easily. Hong Kong Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Exchange rate (eop, per USD) Surging oil prices has negligible impact on the servicesbased Hong Kong economy because oil accounts for 1.7% of total imports. Potential repercussions on the current account is mild. The risk of cost-push inflation is also low. In fact, motor fuel, liquefied petroleum gas and other fuel only account for 0.77% of the whole consumer price basket. Source: CEIC, DBS Upstream industries will be hit much harder than the consumers. Should oil prices hit $100 at some point, the state will have to vent the upward pressure somehow onto the consumer. Yet, the magnitude is likely to be very mild. Policymakers will unlikely withstand rising costpush inflation on the back of weakening domestic demand and a worsening trade war with the US. Source: CEIC, DBS Samuel Tse Chris Leung The impact of high oil prices will be reflected in larger import bills. Given that oil accounts for 10% of China s total imports, the surge in oil prices (up 50% YoY) has been the prime driver of import growth (21% YTD YoY) in The current account balance as a share of GDP currently standing at 0.5% of GDP will likely dive into the negative territory in. As a result, growth of foreign reserve will likely shrink, exerting downward pressure on the CNY exchange rate. Page 2

3 India * Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) *Year ending March 2020 High oil prices are a key Achilles heel for the Indian economy, complicating the inflation, current account, fiscal balance and currency outlook. This vulnerability stems from India s rising reliance on imported crude, to meet 83% of its domestic oil demand (vs 78% in past three years), amplified by a weakening exchange rate. The outlook for external balances, particularly the current account, is negative. With every USD1pb move in the Brent prices adding ~USD2bn to India s oil imports bill, high oil prices risk widening the net oil deficit as well as the current account gap. We estimate that a 10% rise in crude prices, widens the current account deficit (CAD) by % of GDP. Factoring in the tail risks on oil, the CAD could widen past 3.5% of GDP next year. Higher foreign capital will be required to finance this gap, as the balance of payments risks falling deeper into red. For CPI inflation, the direct impact of higher crude prices might be modest given the configuration of the price basket, but despite this a 10% rise in global crude prices stands to potentially lift headline CPI inflation by ppt, assuming a complete pass-through. The impact will be higher if we include the second-order pass-through of high transport costs feeding into manufacturing/ food costs. On the fiscal end, the government has prudently held back from either reinstating subsidies or cut taxes to lower record high domestic fuel prices. Approaching elections and relative inelasticity of domestic energy demand, however, suggests the fiscal and external balances will continue to be tested. Radhika Rao Indonesia Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) Currently, Indonesia s domestic inflation has been protected from increasing oil prices due to the implicit below-the-line subsidy. However, if oil prices reach $100 in, the government will finally adjust domestic fuel prices, at least partially. A full-fledged adjustment of domestic oil prices will boost inflation by 1ppt, yet we think that the increase will be implemented gradually after the election. We pencil in an additional 0.3ppt to our headline inflation baseline, reaching average inflation of 4.3%. The higher inflation will erode consumption that barely reached 5% in the last year. In addition to the inflation impact, oil trade deficit will continue to widen. We estimate that the impact will be close to 0.5% of GDP, resulting in a CAD number that exceeds the comfortable level of 3% especially given the tightening outlook on the financial side. Widening trade deficit that could also induce more outflows can pressure Rupiah closer to /USD. We believe that Bank Indonesia will raise policy rate several times to be ahead of the curve, facing more pressure to Rupiah due to the widening CAD and inflation that is close to BI s upper limit of 4.5% in our scenario. On another account, the impact on fiscal balance is a net positive 0.5% of GDP as the impact of additional nontax revenues is bigger than possible increase of diesel subsidy. A $1/bbl increase in oil prices is associated with increase in government revenues by IDR3tn. As the budget assumption of oil prices is $70, the additional non-tax revenues will be around IDR90tn. The impact of price increase is bigger for diesel compare to gasoline, as diesel price will feed into logistics costs. We assume another adjustment of IDR1,500 to diesel subsidy like this year. All in, under this scenario, GDP growth will slip below 5%. Masyita Crystallin Page 3

4 Malaysia Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) Higher oil prices are in general positive for Malaysia given that it is a net oil exporter. Net oil exports (excluding LNG) registered MYR8.7bn (0.6% of nominal GDP) in Higher oil prices should reasonably bring about higher production output from the mining industry and contribute directly to overall GDP growth. We expect better outcome from the external balance as well. When oil last rose above USD100/bbl in 2010/11, Malaysia s current account to GDP ratio registered about 11%, albeit the upside could be limited by correspondingly higher imports on refined petroleum products. Moreover, the removal of the fuel subsidy in Dec14 also means that high oil prices will be positive for the fiscal balance. Petroleum related tax revenue accounts for about 9% of overall tax revenue. This will help narrow the fiscal gap arising from GST removal. But as fuel subsidy has been removed, the inflationary impact of high oil prices will be more direct. A 10% rise in oil prices is expected to lift inflation by 0.2ppt. We expect Bank Negara to adopt a slightly tighter monetary policy stance to anchor inflation expectation. Expect another 25bps hikes in the OPR to 3.50% by end when inflation rise above 3%. Philippines Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) Oil price scenario of $100 can boost inflation by 0.4ppt, reaching a number of 5.9%, above the BSP s upper limit. Inflation has been high in recent years due to higher commodity prices way exceeding the BSP upper limit of 4%. Oil imports account for more than 10% of total imports, hence have a big impact on trade. This year alone (until July), there was an additional USD14bn of imports which were mostly due to oil price increases. Current account deficit is likely to reach 3% - already considering the weaker remittances which was the case in recent years. Given that the Philippines economy is currently overheating, BSP will likely raise rate further by at least another 75bps to contain inflation in our baseline scenario. If oil goes to $100, there could be another 5-bps upside to the policy cycle. Widening trade deficit and possibly weaker consumption due to lower purchasing power, will adversely impact growth. Under this scenario, GDP growth in will only reach 6% compared to 6.7% in our baseline. Masyita Crystallin Irvin Seah Page 4

5 Singapore Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Exchange rate (eop, per USD) Although Singapore is a net oil importer, with a deficit of SGD9.7bn (2.1% of nominal GDP), its oil and gas sector (accounting for 5-6% of GDP), together with other supporting services, are expected to benefit from the higher oil price. Though oil imports may affect the external balance, Singapore has one of the highest current account position in the region (+18.8% of GDP) and the impact will also be offset by increase in refined petroleum exports. Impact on the economy will be mostly felt in terms of inflation. Every 10% increase in oil prices will likely add about 0.3ppt to the headline CPI inflation. And there is marginal upside risk considering the upward adjustments made in utility tariffs in recent years. However, with a record budget surplus of SGD9.6bn in FY17, the government is in a strong fiscal position to introduce offset measures to curb against the price impact on consumer spending via a small deficit. From monetary policy perspective, the MAS will likely continue to maintain an exchange rate policy stance of a gradual appreciation of SGD NEER to mitigate against the inflation risk. This should likely help to keep the SGD resilient against the USD. Irvin Seah South Korea Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) Higher oil prices will boost inflation, erode real incomes and cut GDP growth for South Korea. The impact will be significant and immediate, given the country s heavy reliance on energy imports and adoption of a floating fuel pricing mechanism. We estimate that a 10% rise in crude oil prices (in KRW terms) will boost headline CPI by 0.3%. Inflation would easily exceed the Bank of Korea s 2% target next year, should oil prices rise to USD100/bbl. A surge in oil prices will likely strengthen the case of BOK rate hikes. Following an explicit inflation targeting framework, the BOK raised the benchmark rate by 25bps and 75bps respectively during the oil price rally in 2008 and Nonetheless, policy response would be more prudent this time. The output gap, domestic demand and labour market conditions are relatively weak during the current cycle, which should help to contain the secondround inflation effect of oil price increase. The stress on external balance will be manageable. The current account is expected to decline by USD7.2bn on the annual basis (0.4% of GDP), for every USD10/bbl rise in crude oil prices. A swing into deficit is very unlikely even if oil prices shoot up to USD100/bbl. A small decline in current account surplus, coupled with a rise in portfolio investment outflows (due to deterioration in growthinflation dynamics), would mean moderate deprecation pressure on the KRW. Ma Tieying Page 5

6 Taiwan Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Fuel prices are floating in Taiwan, despite the partial subsidies provided by the state-owned Chinese Petroleum Corporation (CPC). The CPC adjusts domestic retail fuel prices by 80% of the changes in wholesale prices, which are calculated based on the weighted average of Brent and Dubai oil prices (in TWD terms). Normally, a 10% rise in global oil prices will push up Taiwan s CPI inflation by 0.2ppt. Thanks to a high comparison base, we estimate that inflation will rise but remain below the 2% mark in under the scenario of oil price spike to USD100/bbl. A surge in oil prices will also depress Taiwan s GDP growth. The business sector will face a profit squeeze due to higher upstream costs. The household sector could withstand higher inflation in the near term thanks to the pickup in wage growth this year (about 2.5% YoY). But the support from the labour market would start to fade if corporate profits were to remain weak for several quarters. We reckon that GDP growth may fall below 2% in if oil prices stay at USD100/bbl. Taiwan s central bank (CBC) will face a dilemma on monetary policy. The CBC raised rates by 25bps during the global oil price rally in both 2008 and Back then, GDP growth was running above potential and the output gap was positive. During the domestic fuel price hike in 2012, the CBC refrained from monetary tightening as higher inflation (together with weaker global demand) triggered a significant growth slowdown. We think the CBC is more likely to follow the 2012 path and opt for a neutral policy this time. Ma Tieying Thailand Growth (real GDP, % YoY) Inflation (average, % YoY) Fiscal balance (% of GDP) Current account (% of GDP) Policy rate (eop, %) Exchange rate (eop, per USD) The Thai economy is dependent on the global crude supply, with its own domestic crude production sufficient to only meet about a quarter of its total demand. The net oil deficit has narrowed in the past three years as global prices fell, but the current account math is unlikely to turn dire as the economy continues to enjoy strong trade surpluses (~10% of GDP), led by higher non-oil export shipments and tourism receipts. Rising oil prices has prompted the government to partially reinstate the diesel subsidy scheme this year, tapping the support of its national oil fund. This has happened in the past (2008, 2011 etc.) to alleviate the impact of a surge in prices on consumers and manufacturers. Under the present arrangement, retail diesel prices will be subsidised to keep prices below THB30/litre, as the oil fund set aside THB6bn for this measure. This arrangement is likely to remain in place until late 2018, if crude prices (Dubai crude is used as the official benchmark) hold below USD85/bbl. Official remarks, however, suggested that if the tail risk of oil prices surging towards USD100/bbl materialises the government might allow a bigger pass-through into retail prices, in light of rising burden on the oil fund as well and as fiscal balances. Rationalisation of these subsidies will be negative for inflation and growth prospects. The Thai baht s outperformance this year has been laudable, but we don t see it bucking global USD trends into. Given the lingering risk from China-US trade wars and the Fed Funds Rate, in addition to a surge in oi prices, that continues to rise above the BOT policy rate, the baht is likely join rest of the region in ending the year weaker. Rising inflationary risks might also prompt measured rate hikes by the Thai central bank next year. Radhika Rao Page 6

7 Strategy Rising oil & interest rates With oil prices pushing higher, the impact on USD rates has to be considered. We look briefly at two periods (1Y ending mid-2008 where oil prices pushed sharply higher and the past 5 years) to see how rates and oil interact. The intuition is that higher oil prices should translate into elevated inflation expectations, thereby pushing US yields up. However, the reality is not quite so simple. Correlation does not imply causation and there are many other factors to consider even as we try to isolate the impact of oil on rates. It is true that the WTI s correlation with inflation expectation (5Y breakeven) is high (0.6 for one-year ending mid-2008, 0.9 since 2014). However, the correlation between 10Y US yields and WTI did not hold as well. To be sure, this figure is positive in recent years. However, the period in 2007/08 saw 10Y yields fall even as oil prices push to a record USD145/bbl in mid The negative correlation between yields and oil prices in 2007/2008 is largely due to the Fed cutting rates even as oil prices were climbing relentlessly. This lead to downward pressure on yields across all tenors, more than offsetting the rise in inflation expectations caused by high oil prices. In the coming quarters, it makes more sense for us to assume that the US economy continues to hold up well and that the Fed will deliver on rate hikes as forecasted. At the very least, even if there is no passthrough from short-term USD rates to longer-term ones, the level of the UST curve should not be heading lower. Therefore, we should be reasonably confident that higher oil prices should translate into higher inflation expectations and higher UST yields. Taking a correlation of 0.6, a 33% jump in WTI price to USD100/bbl could push inflation expectations (5Y breakeven) and 10Y yields up by approximately 30bps. In Asia, inflation expectations are much more difficult to quantify (inflation-linked bonds are not common). We have calculated the 10Y local currency yield-wti correlations in the table above. The figures for 2007/08 are probably distorted by market turmoil in the leadup to the global financial crisis. Falling US yields also provided some measure of support. The correlation figures over the past five years may be more instructive. Correlations are positive (with the exception of China). However, we suspect that the nuances of each economy may not be adequately reflected in the figures. Correlations in net oil importers (Indonesia, India) are high as expected. It probably does not help that the market is concerned about current account deficits amidst a strong USD environment. Developed economies with sizable surpluses should have low correlation (Korea, Taiwan). We would argue that the figures are probably too high for Malaysia (oil exporter) and Thailand (sizable current account surplus). Eugene Leow Page 7

8 Impact of higher oil prices on Asia equities The market cap composition of Asia suggests that about 14% of the region s market cap is exposed to the energy and materials sector which should benefit from rising oil prices. Cyclical sectors make up 39% of the total market cap which means they are likely to be negatively affected by rising oil prices. For industrial cyclical sectors, the sensitivity on earnings is related to higher input costs and material costs, thereby affecting margins, while top-line revenue growth for consumer cyclical sectors could be impacted by squeeze in purchasing power. Interest-ratesensitive sectors account for 30% of market cap. The likely threat of central banks having to raise rates due to inflationary pressure should raise concerns on the financial sector. That said, the balance of both positive and negative exposure should mean Asia countries will likely suffer from higher oil prices when looking at sector exposure by market cap. Among Asia countries. Thailand has the highest exposure benefiting from higher oil prices, while Singapore, Philippines, Hong Kong and China have the lowest exposure. Market weights by economic-sensitive sectors Macro headwinds will affect Indonesia, Philippines and India the most. While market exposure is part of the analysis, the macro headwinds of rising current account deficit (rising import bills) and high inflation as a result of higher oil price will likely pressure markets on a broad macro basis, leading to weakened currencies, risk aversion and fund outflows. This is especially applicable for Indonesia, Philippines and India. Oil & gas-related stocks are prime beneficiaries, airlines are losers. E&P (exploration and production) players which have greater sensitivity to oil prices remain the preferred proxies to ride the upward trend of oil prices. In our earnings models, we have assumed Brent oil to average US$70-75/bbl in 2018 and US$75-80/bbl in. Our forecast earnings will have to be raised if high oil prices are sustained above US$85/bbl. We estimate that every US$1/bbl increase in crude oil price could lift earnings by about 2-3% for some of the companies in our coverage. Sustained high oil prices will also lead to capex expansion in and beyond, and filter through the value chain. The spotlight shall then turn to Oilfield Service Providers. Interest rates Global price sensitive Cyclicals Defensive sensitive Singapore 47% 32% 18% 3% Malaysia 32% 15% 40% 13% Indonesia 35% 14% 38% 14% Thailand 23% 26% 19% 32% Philippines 34% 29% 32% 5% Hong Kong 35% 34% 24% 7% China 39% 51% 3% 7% Korea 12% 59% 15% 13% Taiwan 18% 53% 12% 18% India 25% 27% 23% 25% Asia exj 30% 39% 20% 14% Source: Thomson Reuters, DBS The sharp increase in oil price is negative for airlines, as jet fuel costs account for 25-45% of operating costs (more so for low cost carriers), though the impact on individual airlines would depend on how well and far they have hedged. Yield-to-fare pass on typically requires time lag. Meanwhile, the Chinese carriers do not hedge any of their fuel requirements, but they do have significant pricing power on their domestic routes to offset some of the higher fuel costs. Joanne Goh Page 8

9 Highlights of the week: Singapore: Opportunity from the trade war India: Tide to turn in favour of banks vs non-banks Taiwan chart book: policy remains neutral Page 9

10 Key Forecasts GDP growth, % YoY CPI inflation, % YoY, ave f f f f China Hong Kong India* Indonesia Malaysia Philippines** Singapore South Korea Taiwan Thailand Vietnam Eurozone Japan United States*** * refers to year ending March ** new CPI series *** eop for CPI inflation Policy interest rates, eop 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 China* India Indonesia Malaysia Philippines Singapore** South Korea Taiwan Thailand Vietnam*** Eurozone Japan United States * 1-yr lending rate; ** 3M SOR ; *** prime rate Q1 18 Q2 18 Q3 18 Q4 18 Q1 19 Q2 19 Q3 19 Q4 19 China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Thailand Vietnam Australia Eurozone Japan United Kingdom Australia, Eurozone and United Kingdom are direct quotes Exchange rates, eop Page 10

11 Group Research Economics & Strategy Taimur Baig, Ph.D. Chief Economist - G3 & Asia taimurbaig@dbs.com Nathan Chow Strategist - China & Hong Kong nathanchow@dbs.com Ma Tieying Economist - Japan, South Korea, & Taiwan matieying@dbs.com Masyita Crystallin Economist Indonesia & Philippines masyita@dbs.com Radhika Rao Economist - Eurozone & India radhikarao@dbs.com Joanne Goh Regional equity strategist joannegohsc@dbs.com Irvin Seah Economist - Singapore, Malaysia, & Vietnam irvinseah@dbs.com Neel Gopalakrishnan Credit Strategist neelg@dbs.com Samuel Tse Economist - China & Hong Kong samueltse@dbs.com Eugene Leow Rates Strategist - G3 & Asia eugeneleow@dbs.com Duncan Tan FX and Rates Strategist - Asean duncantan@dbs.com Chris Leung Economist - China & Hong Kong chrisleung@dbs.com Philip Wee FX Strategist - G3 & Asia philipwee@dbs.com Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations). Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore Tel: Company Registration No E. Page 11