Impact of Oil Price Increase in Vietnam and Policy Response. Seminar at the Institute for Price and Market Research October 21, 2005

Transcription

1 Impact of Oil Price Increase in Vietnam and Policy Response Seminar at the Institute for Price and Market Research October 21,

2 Outline Key stylist facts (Price developments) Net impact on the economy to date Outlook and assumptions for 2006 Possible outcomes and Policy options 2

3 Crude oil price has been rising for the last several years. But domestic price is adjusting with a lag Crude oil USD/barrel (RHS) Crude oil (% change) Domestic price (% change)

4 Domestic petrol price adjustment has been largest, with other products only catching up in Period average - Unleaded petrol RON Unleaded petrol RON Unleaded petrol RON Diesel 0,5%S Kerosene Fuel Oil (FO N 2B) Simple average End period - Unleaded petrol RON Unleaded petrol RON Unleaded petrol RON Diesel 0,5%S Kerosene Fuel Oil (FO N 2B) Simple average

5 The world s experience: pass through for oil products Domestic gasoline prices in a majority of countries have increased in absolute terms by more than in the United States, where adjustment is generally regarded as complete. Nevertheless, in a number of countries the absolute price increase has been significantly smaller than in the United States, suggesting the pass thought may have been incomplete in those countries. The incomplete pass through is significant in most oil-exporting countries. 5

6 Domestic Retail Fuel Price in Vietnam and in the world Price level in U.S. cents per liter Price level relative to U.S End 2002 End 2004 Mid 2005 End 2002 End 2004 Mid 2005 World Crude oil Exporters Crude oil Importers Vietnam

7 Crude oil export volume peaked in 2004; surprisingly import volume increase has been remarkably low relative to real GDP growth Crude oil exports (US$ mn) Petroleum imports (US$ mn) Exports ('000 metric tons) (RHS) Imports ('000 metric tons) (RHS) 7

8 Oil revenue has been rising steadily, but not as fast as nominal GDP. Crude oil export revenue is by far the single largest revenue source Oil export revenue (VND bn) VAT and excise (VND bn) Duties on imports (VND bn) In percent of GDP 8

9 Contribution to inflation from higher oil prices has been modest partly because of the low weights in the CPI basket, and slow adjustment in administered prices Direct Fuel for cooking Fuel and lubricants Implied inflation (weight 3.3%) Indirect Electricity Public transportation Total Implied inflation (weight 5.9%)

10 Net impact of the oil sector on the economy (In percent of GDP) Overall economy Net oil impact on the trade balance Net profit remittances by FIEs (estimates) Government From crude oil From petroleum imports Private sector Imports of petroleum product Government subsidy Memorandum items: Exports of crude oil Net external balance from oil trade

11 Looking ahead Basic assumptions on outlook Case 1 Case 2 Crude oil (US$/barrel) GDP (USD bn) Percent change Crude oil export volume (% change) Petroleum import volume (% change)

12 Understanding the flow of funds of oil exports and imports key role played by the government State asset Government Crude oil revenue Crude oil exports Spending Subsidy Taxes Petroleum products imports Natural (oil) resources Private sector 12

13 What should the government do? Objectives As a general principle Ensure that natural resources remain at least as valuable in another form for future generation than in the current form of crude oil Investment with efficiency considerations Avoid Dutch disease phenomenon When faced with higher oil prices Ensure aggregate demand is contained Dampen any adjustment costs Allow relative price changes to provide appropriate signal to the economy 13

14 What should government do? Instruments Fiscal policy Spending allocation of oil revenue Saving vs. spending Price control Control of price pass through Subsidy Other policy measures Monetary and exchange rate policy 14

15 Quantitative assessment of possible scenarios in 2006 under policy neutrality (In percent of GDP) Case 1 Case 2 Difference Overall economy Net oil impact on the trade balance Net profit remittances by FIEs (estimates) Government From crude oil From petroleum imports Private sector Imports of petroleum product Government subsidy Implied domestic petroleum price change Memorandum items: Exports of crude oil Net external balance from oil trade

16 Some trade offs! Subsidy vs. inflation using 2006 as an example Subsidy (VND trillion) In percent of GDP Domestic petroleum price inflation (in %) Contribution to overall inflation (in %) Dampening the impact on the poor vs. providing correct price signal upfront Would depend on the nature of the oil price increase; and Policy responses in other countries. 16

17 More specifics on recent inflation developments Non-food inflation is catching up! Contributions to inflation (seasonally adjusted, in percent) Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Food Housing Transport (inl. petroleum) Other 17

18 Possible implications on aggregate demand from higher oil price Aggregate demand could weaken as the private sector is faced with higher input cost and prices. Will observe both income and substitution effect. If the net impact on the external current account balance is indeed negative, then higher oil price will lead to loss of income, and compound the contraction effect noted above. But the role of the government is key! 18

19 In standard oil importing country case (No government involvement) Result of an oil price increase C/A deficit widens Income effect (demand contained) By higher imported price Substitution effect By exchange rate depreciation Secondary effect from loss of income C/A deficit contained 19

20 In oil importing country case (Government is the sole importer) Result of an oil price increase C/A deficit widens If government passes on the cost fully, then the same process as in the above case. If government takes on the cost (in whatever form), then it will need to raise more resources to cover for the cost. If the money is raised from additional tax, the the end result will be the same as before, except that there will be distortion (domestic relative prices do not reflect international price changes), and have redistributional effect (from general to tax payers). If the money is borrowed, then the government is holding off adjustment at the cost of liabilities that future generation has to bear (inter-generational transfer). 20

21 In oil exporting country case (Government is the sole exporter) Result of an oil price increase C/A surplus widens, if government saves, nothing happens. If government spends (net injection), C/A surplus will induce income to rise. Income effect (demand expands) and will either lead to inflation or higher imports; Will be assisted by exchange rate appreciation (real appreciation). 21

22 Vietnam: The government is the (de facto) importer, and exporter Result of an oil price increase C/A subject to profit transfers; assume that the overall impact is negative Government passes on the cost partially and with delay. The cost is borne by oil export receipts (wind fall gain), and hence no additional absorption. Hence government is holding off (or delaying adjustment). But 22

23 Vietnam: Government is the (de facto) importer, and exporter But Income is generated from higher oil revenue, in addition to the subsidy. Government spends the extra income on investment (net injection). However, this additional amount of injection is less than the amount spent on oil imports due to the increase in oil prices. Hence, real income will fall, and the CA deficit will adjust, but the substitution effect will be less than under no government intervention. 23

24 Oil related Interaction between the government and the rest of the economy Case 1 Case 2 Case 2a Diff 1 Diff 2a Government Revenue Crude oil export (windfall) Petroleum imports (absorption) Expenditure Subsidy (injection) Net balance (injection-absorption) Net balance plus injection of windfall gain Economy Government net injection Spending on imports Net cost on the private sector Financed from foreign borrowing Financed from domestic saving Contribution to inflation Assume subsidy is financed from borrowing 24

25 Higher oil prices will require more private sector savings (if subsidy is financed by taxation) More (less) private sector saving is needed for less (more) subsidy (forced saving) and higher (lower) inflation; More foreign borrowing is needed the higher oil prices. This can be contained either through policies to reign aggregate demand, and expenditure switching through the exchange rate. 25

26 So, what should the government do? If oil price increase is permanent, allow relative price adjustments to provide the right signal to the market. If oil price increase is temporary, there is benefit to wait the pass through to avoid price fluctuations. If oil price leads to excessive borrowing need, contain aggregate demand, and as necessary through expenditure switching. 26

27 What about monetary and fiscal policy mix? For containing aggregate demand more on a permanent basis, use fiscal policy; For reducing price fluctuations, and expenditure switching, monetary policy is necessary. 27

28 Presenter s contact detail: Il Houng Lee Senior Resident Representative IMF, Vietnam Tel: ilee@imf.org The views expressed in this presentation are those of the author and should not be attributed to the International Monetary Fund, its Executive Board, or its management. 28