By Joost van Leenders
Assessing the overall impact of lower oil prices initially looks simple: is the impact on importers’ and exporters’ terms of trade positive or negative? However, the transmission mechanism by which lower commodity import prices – where lower prices of other raw materials must also be factored in – feed through to different areas of the economy is a complex one.
Markets have yet to effectively assess this. Consumers in oil importing countries will be positively impacted as lower fuel prices mean more money to spend on other goods and services. The extent to which consumers benefit varies between countries, depending on levels of fuel taxes or subsidies. Net importers’ budget deficits should fall if they subsidise fuel, and their current account balances improve. However, even oil importers may feel some negative impact if they have an energy-producing sector. Furthermore, improvements in current account balances may be partly undone if windfalls are spent on other imported goods.
The lagged impact of the transmission mechanism means that China, one of the biggest commodity importers – which should benefit from falling prices – has yet to benefit significantly. No miracles should be expected though. Economic growth has been slowing as the authorities try to balance economic growth with too strong credit growth, a softening housing market and overinvestment in some sectors. Low oil prices should mitigate the slowdown, but cannot stop it completely.
Lower oil prices will help large developed market economies such as the US, the eurozone and Japan; the impact on GDP could be as large as 0.5%. As an oil producer, the impact on the energy sector in the US will be negative as employment and investment are affected, although the positives for households and energy-consuming corporates substantially outweigh the negatives. One key benefit is the boost to consumer spending. As fuel taxation is less than in many other economies, the effect on gasoline prices is magnified. So far though, households have decided to save the windfalls, while the economy has felt the impact of cuts in capital expenditure in the energy sector. Given the recent surge in household real disposable income, we expect this to change in the coming quarters. Germany and Japan will benefit similarly, although higher fuel taxes in Germany will mitigate the positive effect for consumers. For the eurozone and Japan there is another positive factor for growth: depreciated currencies. Here, it will be difficult to disentangle the economic effects of commodity price changes and currency changes. However, in contrast to the US, both factors will have a positive effect. Falling oil prices also have a darker side for the eurozone and Japan. They have pushed headline inflation into negative territory and with core inflation (ex volatile food and energy prices) low, it could lower inflation expectations and even trigger deflation. But with the economies in an economic recovery period, we expect the positive oil price impact to dominate.
Falling oil prices could disadvantage net importers by causing them to defer necessary structural economic reforms, although we are not generally seeing signs of this. In fact, countries may continue with current reform agendas, spurred on by the tailwind of lower oil prices. If shifts in competitiveness materialise after structural reforms, slower-moving governments are being pushed to make adjustments to keep pace with their neighbours.
Oil price moves therefore appear to be pushing reform further, rather than halting restructuring. Importers did not anticipate the price decline, but are using windfalls to help finance change. Indonesia (an energy trade breakeven country) and India have both cut fuel subsidies, releasing investment for infrastructure and education. Japan has been moving slowly forwards with important reforms, which have become easier to implement. In peripheral Europe, structural moves have already been forced to some extent upon Greece and others. Change is underway in Spain and even in France, given the need for some broader structural measures. Within emerging markets, in China there is a realisation that steady change is needed, with or without lower oil prices; fuel tax has been increased, so the benefit of lower prices is not really passed on to consumers. Meanwhile oil-exporters also appear not to have anticipated the sudden decline in prices, so their policy changes are reactive and often include non-beneficial responses. Recent tactical moves include currency depreciation, increased taxation and measures to tighten monetary policy and avoid capital outflows. If countries assume (and it is a big assumption) that lower oil prices are here to stay for a few years, there could be longer-term reforms to modernise some of their business models. But few, if any, are planning for oil to remain really low for the long term. And exporting nations, with falling revenues, are unlikely to implement large structural reforms on this basis alone.
Joost van Leenders is chief economist, Multi Asset Solutions team at BNP Paribas Investment Partners
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