Surging oil and food costs may swell budget deficits in Asia as governments spend on subsidies to keep consumer prices low and avoid inflation protests that helped topple regimes in the Middle East this year.
India, Indonesia, Malaysia and Thailand, Asia’s biggest fuel subsidizers, will probably all miss fiscal deficit targets due to higher oil outlays, according to a March 10 Bank of America Merrill Lynch research note. Ten-year bond yields in India are trading near a six-week high, while those in Malaysia are close to levels last seen in January.
The threat of further oil-price increases has become a “key downside risk” for global growth, the International Monetary Fund said on April 11. Oil at $120 per barrel would shave 0.5 to 1.2 percentage points off gross domestic product growth this year in most of Asia’s biggest economies, Oversea-Chinese Banking Corp. said in a March 10 report.
“If we continue to see this upward pressure on oil prices, that becomes one of the key risks to pretty much most markets,” said Kenneth Akintewe, a Singapore-based money manager at Aberdeen Asset Management Plc, which oversees $287 billion. Crude prices, which traded close to a three-year high at as much as $112 per barrel last week, may force governments to sell more debt, pushing up yields across the region, he said.
Citigroup Inc. cut its mid-year target for South Korea’s Kospi Index by 7 percent on March 8 on concerns higher oil prices will hurt corporate profits. Indian stocks, Asia’s worst performers this year after Japan, are likely to become cheaper relative to regional equities as oil prices climb and growth slows, Credit Suisse Group AG said March 21.
Thai Airways International Pcl, whose fuel purchases account for about 60 percent of its operating costs, has dropped 24 percent this year, while China Southern Airlines Co., the country’s second-biggest airline by market value, has fallen 21 percent. PetroChina Co., China’s largest oil company, has gained 14 percent in that time.
Singapore and Hong Kong, which don’t subsidize oil costs for consumers, along with China, have unveiled budgets that give cash or tax breaks to help low-income earners cope with higher food and housing costs. Elections due over the next two years in Thailand, India, Singapore, Hong Kong, Taiwan and Malaysia give politicians little incentive to cut debt as they strive to keep gas and food prices low for Asia’s 4 billion people.
“These governments feel very susceptible to populations that are under pressure, especially from food price increases, so they will basically do everything they can to try and head off trouble,” said Jim Walker, managing director at Hong Kong-based Asianomics Ltd. and former chief economist at CLSA Asia-Pacific Markets, in a phone interview. “That means subsidies and sometimes inappropriate spending from the public purse.”
India’s bill to keep cooking gas, kerosene and diesel prices low for the country’s 800 million poor people threatens to undermine Finance Minister Pranab Mukherjee’s goal of slashing the budget deficit.
His plan to reduce total subsidies to decrease the budget shortfall to 4.6 percent of gross domestic product in the next fiscal year from 5.1 percent looks “ambitious at best,” Goldman Sachs Group Inc. said in a March 9 report.
Federal and state debt levels in India, which meets about three-quarters of its annual energy needs from imports, are among Asia’s highest at 73 percent of gross domestic product, according to data compiled by Bloomberg. The nation will hold five regional and state-level elections starting in April, testing support for Prime Minister Manmohan Singh’s government.
Biting the Bullet
Indian policy makers “will probably bite the bullet and absorb the subsidies for a few months,” said Killol Pandya, who manages about $300 million as head of fixed-income investments at Daiwa Asset Management (India) Pvt Ltd. in Mumbai. “After the election, they could bring about the price hikes.”
The conflict in Libya, holder of Africa’s largest crude reserves, has pushed oil prices up about 20 percent since the first large protest on Feb. 17, six days after Egyptian President Hosni Mubarak stepped down. Uprisings across the region gained steam after Tunisian President Zine El Abidine Ben Ali’s promises to lower bread and sugar prices failed to placate street protesters as global food costs surged to a record.
Oil has closed above $100 per barrel for all but two days since March 2 and had its biggest two-day drop in almost 11 months yesterday on investor concerns high prices were hurting the global economy. Moves to scale down subsidies three years ago when oil surged to a record high of $147.27 per barrel led to street protests in India, Indonesia and Malaysia.
“If oil prices keep on climbing, in the next few months pressures will build,” said Chua Hak Bin, a Singapore-based economist at Bank of America Merrill Lynch. Prices exceeding $140 per barrel “will be the terrain where something can break, when governments will have to make some big decisions.”
The yield on India’s generic 10-year government bonds increased 6 basis points, or 0.06 percentage point, to 7.99 percent on April 11, while the most-active 8.13 percent bond maturing in September 2022 yielded 8.18 percent, the highest level in two months. Benchmark 10-year bonds in Malaysia yielded 4.08 percent today and reached an eight-week high of 4.11 percent on April 4.
Malaysia’s fuel subsidies bill could jump to 14 billion ringgit ($4.6 billion) this year if local fuel prices aren’t raised, Prime Minister Najib Razak told reporters on March 9. His government is “looking at” whether it needs to pause subsidy cuts in the short term, he said in a March 29 interview.
Thai Prime Minister Abhisit Vejjajiva’s plans to hold an election in June or July will make it difficult for him to lift a 30-baht ($1) per liter cap on diesel prices, Bangkok-based Phatra Securities said on March 4. Thailand may need to curb diesel subsidies as funding runs out, likely in July, Finance Minister Korn Chatikavanij said March 28.
Indonesian lawmakers agreed on March 21 to delay a plan to ban most Jakarta residents from buying subsidized fuel that was set to take effect in April. Southeast Asia’s biggest economy has subsidized pump prices since the 1950s and moves to reduce them since then have triggered protests, including those in 1998 that helped end dictator Suharto’s three-decade rule.
Indonesia’s fiscal deficit target of 1.8 percent of GDP this year gives it more room to maneuver than Malaysia, which is targeting a budget gap of 5.4 percent of GDP, the OCBC report showed. Thailand’s budget deficit may be 5 percent this year, Korn said March 28.
Feeling the Pain
“Fiscally, India and Malaysia are feeling the pain already, while in Indonesia it’s many months away,” Robert Prior-Wandesforde, head of Southeast Asia economics at Credit Suisse Group AG, said in a telephone interview from Singapore. “Thailand is somewhere in between.”
In China, Premier Wen Jiabao told visiting business executives, including JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon and Royal Dutch Shell Plc CEO Peter Voser, on March 21 that he was “surprised and shocked” to see the price of oil had exceeded $100 a barrel.
China responded to the recent drought in major wheat-producing provinces with direct subsidies to farmers, while South Korea froze electricity and gas prices during the first half of 2011, World Bank staff said in a March 21 report.
“The increased use of subsidies to counter rising food and fuel prices presents an important risk to the fiscal outlook,” the World Bank’s East Asia and Pacific Economic Update report said. “Additional increases in food or fuel prices will not only exacerbate the cost of these policies but may also prompt governments to adopt new measures.”
Oil prices would need to climb to 2008 levels before budgets face enough pressure to trigger debt rating changes, said Kim Eng Tan, a credit analyst at Standard & Poor’s.
Vietnam is the only Asian country with a negative rating outlook from S&P because of concerns over financial management, according to a March 7 report. The outlook is positive for Indonesia and stable for every other country in the region, including India, a rating S&P reaffirmed on April 6.
Still, “the risk premium is up,” Singapore-based Tan said in a telephone interview. “If it becomes a real supply shock, as in a major supplier stops exporting, then we are in for some really tough times.”