Asia keeps wary eye on oil price rise

"The impact is not very significant — yet," said Rajiv Kumar, senior economist at the Asian Development Bank in Manila. "But clearly it’s something that now needs a closer watch."

Three years after a currency crisis plunged most of Asia into recession, factories in the region are still operating well below capacity.

Even with oil prices rising, this slack in the economy keeps a lid on inflation because extra demand can be met profitably by increasing productivity — in effect reducing the gap between actual and potential output.

Analysts say the degree of economic slack varies across the region but it is greater than in the United States and Europe, which may have to face the impact of high oil prices sooner.

"The output gap remains substantial. Although it’s narrowing, it’s able to mute the passthrough of these price pressures," said Tzu Ping Tan of JP Morgan in Singapore. The point is well-illustrated by South Korea.

Even though it has staged a stronger recovery than its crisis-hit neighbours, productivity is still growing at a double-digit rate as manufacturers succeed in wringing more output per hour out of their machines and workers.

"There is no imminent demand pressure right now here inK orea," said Mun Kun Cheong, head of economic research at the Samsung Economic Research Institute in Seoul. "So we don’t expect oil price hikes will accelerate inflationary pressure here in the near future."

That is not to say dearer oil is leaving no mark at all: Malaysia is preparing its first petrol price increase since 1983 to ease swelling subsidy costs, and Cheong said Korean inflation could pick up to more than three per cent, from 2.2 per cent in June, if crude prices do not fall.

Korea, Asia’s biggest energy importer, is feeling the pinch in its trade accounts too. JP Morgan expects its oil and gas bill to surge this year to $23 billion from $14.8 billion in 1999.

But Cheong said the deterioration in Korea’s terms of trade has been offset by a brisk rebound in the price of DRAM memory chips, its principal export.

"Our exports of semiconductors are expanding very rapidly and their prices are holding up far above their costs right now. So as long as this trend continues and our trade balance doesn’t return into the red, the overall macro trend will be okay for Korea for the coming six months," he said.

For the year, the South Korean government is forecasting a trade surplus of $10 billion, down from $24.5 billion in 1999.

Other countries are not as fortunate, said the ADB’s Kumar. Thailand and Vietnam, for instance, are being hit both by higher energy bills and by weakening prices for their commodity exports.

Overall, though, Kumar said he was not worried as much by the direct impact on Asia’s terms of trade as by the collateral damage the region could suffer if lofty oil prices send US consumers and financial markets into a swoon.

"In the past, every time oil prices have been above $ 30 a barrel, you’ve seen global recessionary pressures beginning to loom," Kumar said. He stressed that, adjusted for inflation, the recent rise in oil prices was not as bad as it looks: there was no need for Asia to start running scared.

US analysts say high oil prices were not expected to spark another Federal Reserve interest rate hike in months ahead and Fed officials note the US economy has broadened and was not as dependent on oil as it was during the shocks of 1973 and 1979.

But if US consumers turn gloomy because pump prices stay high, asset prices could be hit and Asian exporters would be caught in the downdraft of any ensuing slowdown in growth.

"A persistent strengthening of the oil price, if it gets combined with an unforeseen shock, can do all sorts of negative things for consumer expectations. So every time oil prices firm up, policy makers everywhere round the world begin to notice that," Kumar said.