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Developing Asia Faces Tough Choices amid Rising Oil Prices

MANILA, PHILIPPINES (8 September 2005) – With signs of economic stress starting to emerge, developing Asia needs to make some hard decisions to cope with high oil prices, according to an Asian Development Bank (ADB) report released today.

The price of world crude has risen by nearly 75% since the start of 2005, says Asian Development Outlook 2005 Update (Update), the supplemental issue of ADB’s flagship publication forecasting economic trends in the Asia and Pacific region. As a net oil importer, Asia is vulnerable to high oil prices, which are likely to remain high for some time and could hurt the region’s growth momentum.

“As developing Asia consumes more oil than it produces, higher oil prices are likely to eat into its income growth,” the Update warns.

“Higher oil prices also add to inflationary pressures, and, since many countries in developing Asia subsidize or directly control the retail prices of oil products, this will create additional fiscal burdens.”

Some countries in Southeast and South Asia could see growth trimmed by more than one percentage point if oil prices stay high through 2006, the Update says. But there are still offsetting positive factors that vary from country to country that will influence the actual growth outcomes.

Despite the risks, countries in Asia are considered to be in a better position to absorb the shocks than they were at the time of previous oil price shocks. The recent run-up of nominal oil prices also has been more modest and gradual than the earlier shocks.

“[Further] External payments positions are more secure, monetary policy is more credible; fiscal strength is greater, and economic structures are more flexible and capable of adjusting more quickly than before,” the Update adds. Some economies, such as the Philippines and Thailand, have taken preemptive tightening of monetary policy in order to help contain inflationary impact.

Developing Asia has a large appetite for oil, producing about 11% of the world’s crude oil, but consuming more than 20% of it. And this gap is widening as the two regional giants – PRC and India – continue to need more oil. In 2003, 44.7% of oil consumption in the region was imported, compared with just about 10% in the mid-1980s.

At the subregional level, South Asia is the most reliant on imports followed by East Asia. Southeast Asia has also become a net importer as Indonesia’s production has failed to keep pace with consumption. Central Asian countries are net oil exporters, except for Kyrgyz Republic and Tajikistan, which are highly reliant on imports. The Pacific economies are oil importers, except for Papua New Guinea and Timor-Leste.

In net oil-importing economies, rising oil prices will squeeze income and demand, present an inflationary threat, and have fiscal consequences, especially where oil products are subsidized.

Governments of net oil exporters also face challenges. The Update says there is a need to consider how best to use the additional revenues generated by oil and, if higher prices persist, how to manage pressure for exchange rate appreciation.

For poor countries with large external debts, smaller reserves, and limited borrowing capacity, higher import fuel bills could present financing difficulties.

There is no “one size fits all” response to the high oil price situation, the Update says. Across developing Asia, circumstances vary greatly and countries need to respond in different ways. However, the countries need to reevaluate decisions that have been made in the belief that higher prices would be temporary.

“Although subsidies may provide short-term relief from the pain of higher oil prices, they do so at high opportunity cost and at the risk of upsetting macroeconomic stability,” the Update says. Thailand has announced that all fuel subsidies would be removed by February 2006, while Malaysia has declared its intension to scrap subsidies on gasoline and diesel.

Given the likelihood of an exponential increase in the demand for energy in the coming decades and Asia’s reliance on oil, taxes on oil products will have an important part to play in promoting sustainable energy use. “The pain from higher taxation of oil products is more than likely to be compensated by greater energy efficiency, a more diversified energy mix, and a cleaner environment,” the Update adds.

For net oil exporters, higher prices will provide resources that if used wisely can help accelerate development. However, a measured approach is needed in which the use of oil revenues is planned over a medium- to long-term horizon. Care must be taken to avoid a rapid and excessive appreciation of the real exchange rate.

ADB is dedicated to reducing poverty in the Asia and Pacific region through pro-poor sustainable economic growth, social development, and good governance. Established in 1966, it is owned by 63 members – 45 from the region. In 2004, it approved loans and technical assistance totaling $5.3 billion and $196.6 million, respectively.

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