Feeling the Pain

If oil stays high, Asia and Europe will suffer the most

Chinese officials are scrambling for backup fuel supplies. Beleaguered European airlines and hotels are fretting about another year of tourist no-shows. Indians are bracing for surging inflation and faltering car sales just as the economy seems ready for takeoff. In Singapore, another storm cloud is forming that could derail a promising recovery.

The bogeyman haunting all these economies is the specter of rising oil prices as a U.S.-led war against Iraq seems near. If Saddam Hussein is toppled quickly and oil settles back below $30 a barrel, as most traders and executives predict, that concern will pass. But what if the battle and its aftermath prove messier than military strategists envision, keeping oil at $35 or higher for most of the year? While America will bear most of the military burden of ousting Saddam, the heaviest economic collateral damage will likely be inflicted abroad.

Expensive oil, which has risen 60% to around $36 a barrel in a year, already is rippling through the global economy in different ways. Most economists predict a modest impact on the U.S. (page 24). And in countries like Japan and Korea, which have amassed big oil reserves or fix energy prices, it will take a while before serious pain is felt. But in other nations, pricey oil already is translating into higher prices for airfare, consumer goods, and raw materials for manufacturers.

Asia is most vulnerable, since most economies depend heavily on manufacturing exports and imported fuel. Goldman, Sachs & Co. figures oil costing $35 a barrel for at least nine months could clip 0.9 percentage points off the region's growth -- three times the impact on G7 economies -- and 1.6 points if it hovers at $40. That could send Japan right back into recession. Japan has five months' worth of reserves but imports 88% of its oil from the Persian Gulf. "If the war is prolonged, it will have a very significant impact," says Nomura Holdings Chief Executive Junichi Ujiie.

Neighboring China also is at risk. It imports 34% of its energy to feed its manufacturing boom. Beijing is stocking up on supplies but may be caught short in a crunch. Singapore, thriving as a petrochemical hub, imports all its fuel. Thanks to its nuclear plants, South Korea uses oil for just 15% of its energy. And Seoul fixes electricity prices. Still, Korea is led by power-guzzling industries -- at the same time that world prices are falling for many key goods. "Semiconductors, steel, you name it," says Goldman Sachs Asia economist Kim Sun Bae. "Margins are getting squeezed."

Not all emerging markets will lose big. Russia and Mexico, both big oil exporters, will reap windfalls. But weak demand in the U.S., which consumes 80% of Mexico's garment, electronics, and car exports, would pummel manufacturers. In Russia, the big inflow of oil revenue is fueling 15% inflation and a rise in the ruble that saps industry competitiveness.

An oil shock also would spread unevenly through Western Europe. Norway and Britain both produce oil. And because oil is traded in U.S. dollars, the strong euro will ease some pain for importers. Still, unexpectedly high oil prices are boosting costs for European chemical makers, engineering firms, and airlines. If war breaks out, Lufthansa expects passenger traffic to drop 15% to 20%. Its fuel bill could jump by up to $100 million if turmoil keeps prices high all year. To minimize losses, Lufthansa plans to cut flights soon after a U.S. invasion. "One of the lessons we learned from the past is that we have to act quickly to get our costs down," says Helmut Fredrich, Lufthansa's corporate fuel manager.

In Europe, the surge in oil prices above $35 "already probably neutralized" a Dec. 5 rate cut to juice growth, says one central banker. European Central Bank President Wim Duisenberg says the volatility "makes it very difficult to forecast prospects for inflation movements accurately." Washington seems so bent on war that the outside world probably has little influence over the outcome. Coping with the economic fallout, though, is everybody's problem.

By Pete Engardio in New York, with Carol Matlack in Paris, Brian Bremner in Tokyo, and bureau reports

— With assistance by Carol Matlack, and Brian Bremner

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