An Oil Slick on Asia's Road to Recovery

If energy prices keep rising, Asian economies face the greatest pain -- and export-dependent Korea and Taiwan will suffer most of all

By Bruce Einhorn

The crises in the Middle East and Venezuela are sparking worry that higher oil prices will threaten Asia's economic recovery -- and with good reason. Few regions are more at risk because of spikes in the cost of oil. "Asia is mostly about manufacturing," explains Michael Kurtz, Asia strategist at Bear, Stearns in Hong Kong. "And manufacturing uses a lot of energy."

Maybe we can look on the bright side. Yes, for most of the first three months of 2002, the benchmark cost of oil has risen steadily, from about $21 a barrel at the start of the year to more than $27 in early April. However, since then, prices have retreated some amid hope that the visit of U.S. Secretary of State Colin Powell to Ariel Sharon and Yasser Arafat would ensure that the oil keeps flowing. The situation in Venezuela, though, still bears watching with the sudden fall -- and then reinstatement -- of Venezuelan President Hugo Chávez leaving an uncertain outlook for that country's oil exports.


  What happens if the hope for moderating oil prices proves short-lived? After all, it's highly unlikely that Powell will succeed in bringing any semblance of peace to Israel and the Palestinians in the near future. And if events take another turn for the worse, oil prices could start heading north again.

That could spell trouble for Asia's nascent rebound. As Arup Raha, the Asia chief economist for UBS Warburg, points out, the region is "quite vulnerable" to an oil shock. Compared to the U.S. and Europe, most Asian countries are far less efficient in their energy use. "Unlike most of the Western world, which has reduced its dependence on oil, [Asian economies] have not made progress," he says. Japan, Hong Kong, and Taiwan compare favorably to the U.S. and the European Union, but the rest of the region, including China, India, and Southeast Asia, lags far behind.

Which countries stand to suffer the most if oil prices stay high? Both UBS Warburg's Raha and Bear Stearns's Kurtz think two of the biggest losers could be South Korea and Taiwan. These high-tech powerhouses benefited in late 2001 from an increase in prices for their chief export commodity -- dynamic random-access memory chips -- and a fall in prices for their chief import commodity -- oil.


  Indeed, from a post-September 11 low of about $1, the benchmark price for DRAMs jumped about four-fold within just a few months, at the same time that Brent Crude prices fell as low as $18. That led to a positive swing in what economists call their terms of trade -- how many semiconductors the Koreans and the Taiwanese needed to sell to pay for a barrel of oil. Unfortunately, the commodity prices have reversed course.

Another problem for the two Tigers is their dependence on exports. For all its exporting prowess, Japan is far less reliant on exports than its two neighbors. Japan's ratio of exports to gross domestic product is only about 12%, but Korea's is in the mid-30s, and Taiwan's is in the 40s. A sustained increase in oil prices that hurts demand in the U.S. and Europe for Asian electronic gizmos would therefore hurt the Koreans and the Taiwanese more than it would the Japanese.

If oil prices stay high, Korea is especially at risk. Ironically, that's a result of the Korean economy's strength relative to the rest of the region. While Japan is coping with yet another recession, Taiwan is struggling with high unemployment, and Hong Kong is suffering from chronic deflation, Korea is humming along, thanks in part to strong domestic demand. Higher oil prices won't cause much inflationary pressure in the weak economies, which have no inflation to speak of. But inflation isn't a thing of the past in Korea.


  The year-on-year consumer price inflation (CPI) rate is running at 2.3%, says Kurtz, who warns that the number is deceiving since month-on-month inflation has been rising by half a percentage point for the past three months. While the Korean central bank looks at the core inflation rate -- which strips out volatile oil and food prices -- when determining interest rate policy, higher oil prices will cause a rise in the core inflation rate as the cost of imports rise. That could force the Bank of Korea to tighten monetary policy.

Moreover, as Raha points out, historically, Korea doesn't handle oil crises well. "Since the first oil shock in 1974, a sharp increase in the price of oil has caused Korea to suffer two outright recessions and was a contributing factor to the 1998 recession," he says. A jump in oil prices also helped cause a sharp slowdown in growth in the second half of 2000.

China doesn't seem to have much reason to fret. That's surprising since China is the world's third-largest consumer of oil, after the U.S. and Japan. But unlike most other Asian countries (with the exception of Indonesia and Malaysia), China actually has an oil industry of its own. Domestic oil production accounts for about 70% of China's needs. And since Beijing regulates the price of oil inside the country, the government has less reason to fear big price swings. "China looks pretty good in a high-price oil environment," says Kurtz.


  Some economists in Hong Kong argue that there's little reason to be concerned. Says Eddie Wong, an economist with ABN-Amro: "I don't think it's a big deal at the moment." He believes the impact on the region's economies will be minimal "unless oil prices increase substantially -- which I don't think will happen."

Similarly, Jonathan Anderson of Goldman Sachs says Taiwan's economy will grow faster than he expected, at an annual rate of about 3% for 2002. Even with prices around $25 to $27 a barrel, he says, "we're not expecting a massive impact." Anderson estimates that at those levels, oil will shave about 0.3% from Taiwan's GDP.

Still, the likelihood of more volatility is undeniable. Even Beijing's mandarins aren't immune to the pressure. In early April, the Xinhua news agency reported that the government raised prices for gasoline and diesel fuel by 7.7%, the second increase in 2002. Despite Powell's mission to bring about peace in the Middle East, chances are good that more price swings are in store for consumers and manufacturers in China and the rest of Asia.

Einhorn covers technology from Hong Kong for BusinessWeek. Follow his weekly Online Asia column, only on BusinessWeek Online

Edited by Beth Belton

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