Higher oil prices redistribute income and hence demand from oil-importing economies to oil-exporting economies. This redistribution aspect provides a useful angle on the economic effects of oil price shocks (see Box 1 in the full report). As oil exporters save more than importers, on net demand is destroyed in the global economy. We ask the following questions: 1) what is the size of the current wealth transfer from oil importers to exporters? 2) How much of this flows back into oil-importing economies through goods imports of the oil exporters, and hence how much demand is actually destroyed? 3) What does the transfer mean for asset markets? 4) How high will the income transfer and demand destruction be if oil prices rise further? And 5) What are the consequences for the global economy?
Answers: 1) Nearly US$2.5 trillion, or more than 3.5% of oil importers' GDP. 2) Around half, as oil exporters have been spending 50% of their revenue on goods imports from oil importers in recent years. Going forward, this ratio may be materially higher, as some oil exporters could step up spending to maintain political stability. 3) Probably somewhat less than the remaining 50% not spent on goods imports will be saved and hence support global asset markets - our rough estimate puts this figure at around US$1 trillion. 4) If the price of crude were to average US$140/barrel for the whole of 2011, the (gross) transfer would be just shy of US$3 trillion, or 4.5% of net oil importers' GDP. 5) Our global economics team's scenario analysis suggests that an average price of US$140, sustained for the whole of 2010 and 2011, would result in stagflation for the global economy.
1. The Gross Transfer
The gross transfer is economically significant - no news here. For 2010, the aggregate wealth transfer from oil importers to exporters was about US$1.6 trillion, or around 2.6% of oil-importing countries' GDP - (see also Box 2 in the full report on the measurement of the oil bill).
• Historical perspective 1: On current oil prices, the 2011 oil bill could increase to US$2.4 trillion on our calculations - 3.7% of oil importers' GDP (and well above the 2003-10 average of 2.3%). This year's oil bill therefore looks likely to exceed the 2008 level, certainly a reason to worry.
• Historical perspective 2: While the aggregate oil bill may well exceed 2008 levels this year, we are still some way from the highs of the 1980s - back then, the gross income transfer was around 6% of oil importers' GDP. (It then declined quickly and remained low throughout the 1990s; from 2002 onwards the value of oil imports grew faster than importers' economies, so the oil bill increased steadily - from 1.3% of importers' GDP in 2002 to 3.3% in 2008.)
Note that the income transfer is very large in terms of the recipient countries' - the oil exporters' - income or GDP. In recent years, oil-exporting countries have been receiving in excess of 20% of their (aggregate) GDP, a number that will climb this year to more than 25% on our calculations. For these economies, the outcome should be fast growth and higher inflation - especially since spending is likely to be higher than usual.
2. Recycling, Mark I - Goods
For the net transfer, we are interested in finding out how much of the first stage oil transfer flows back to oil importers through oil exporters' import demand. A simple way to net out spending by oil exporters on oil importers' goods is to look at oil exporters' merchandise imports from oil-importing economies, as a share of their oil revenue (the ‘average propensity to import out of oil revenues').
Over the last few years, oil exporters have been spending half of their oil revenues on goods (merchandise) imports from oil-importing countries - (the 2005 to 2010 average is 50%): that is, roughly half of the resources oil importers spend on oil flows back over time. Note that this ratio has come down significantly from the 1980s and 1990, when oil-exporting countries spent around two-thirds of their oil revenue on imports from oil importers (67% on average in the 20 years between 1981 and 2000 and close to 100% in some years).
Spend more, faster. Indeed, under current circumstances it is reasonable to expect that oil exporters will step up spending quickly in a bid to maintain social stability. In other words, exporters are likely to spend more than usual, faster than usual (that is, the marginal propensity to import out of oil revenue will likely be higher than the average propensity, and should rise more quickly).
3. Recycling, Mark II - Assets
If 50% of the US$2.4 trillion oil transfer is used to buy goods from oil importers, the remainder could be saved. This means that saving could be up to US$1.2 trillion, but almost certainly somewhat less. (Some of the remainder will be spent on domestic rather than imported goods and services - ‘domestic absorption'.) If, say, 20% is spent on domestic goods and services, this would leave around US$1 trillion in saving.
To put this in perspective, this is a similar order of magnitude to the entire flow of US net private saving (US$945 billion in 2009 and US$1,135 billion in 2010) or around 2% of current global equity market capitalisation. It is reasonable to assume that most of this saving flow will be used to buy assets in oil-importing economies, supporting markets there - though the net effect of an oil shock on importers' asset prices is likely to be negative, at least on aggregate.
Note that as a result of the income transfer from economies with relatively low saving rates to economies with relatively high saving rates, the global saving rate increases.
4. Stagflation Risk: An Assessment
Any increase in oil prices increases the income transfer from oil importers to oil exporters. The global economy slows as a consequence because this redistribution of income means a net destruction of demand, since oil exporters on aggregate have a higher saving rate.
We do not believe that there is a ‘threshold' for either the oil price or the oil bill, a ‘magic number' at which the global economy would roll over. Rather, climbing oil prices exert a more and more constricting effect on expansion by transferring increasingly larger chunks of income from oil importers to oil exporters. Therefore, the larger the income redistribution, the larger, all else equal, will be the demand destruction and the more the global economy will slow.
We maintain that the current level of oil prices will not derail the recovery. Ultimately, how the economy fares depends - for a given oil bill - also on what else happens to demand (see also The Global Monetary Analyst: This Time Is Different, March 2, 2011). The evolution of demand depends on:
• How supportive monetary (and fiscal) policy is: at present, global monetary conditions remain very loose.
• How resilient private spending will be. With saving rates and corporate profit margins at relatively high levels, spending should suffer less.
Indeed, our global economics team's base case remains for healthy growth and relatively benign inflation this year and next (see Global Forecast Snapshots, April 6, 2011).
Still, upside risks to the oil price and bill - and hence downside risks to the economy - remain significant. We illustrate gross and net (assuming 50% of revenue is recycled into imports from oil importers) income transfers for different levels of the average oil price. In the worst case of US$140/barrel, the gross transfer is nearly US$3 trillion, i.e., 4.5% of oil importers' combined GDP. In the most benign case, where the price of oil averages US$90/barrel, the gross transfer is around US$1.9 trillion or 3% of oil importers' GDP.
Our scenario analysis indicates that in the former, adverse, scenario, the global economy would suffer a serious bout of stagflation (for details, see our TOAST-BOAST scenarios in Global Forecast Snapshots: Global Resilience, April 6, 2011):
• Global real GDP growth would be about 1pp below baseline for 2011 and 2012 (baseline: 4.2% in 2011, 4.6% in 2012).
• Global CPI inflation would be about 1pp above our baseline for both years (baseline: 3.9% in 2011, 3.4% in 2012).
In the benign scenario of average oil prices at US$90/barrel:
• Global real GDP growth would be 0.6pp and 0.8pp above our baseline for 2011 and 2012, respectively.
• Global CPI inflation would be half a percentage point below our baseline for both 2011 and 2012.
Upshot. While in our base case the global economy remains resilient, a ‘stress' scenario of an average oil price of US$140/barrel for the whole of 2010 and 2011 would mean stagflation for the global economy.
For full details and appendix, see Global Economics: Barrel Bill, April 13, 2011.
High Inflation, Robust Growth
The March/1Q NBS data pack is broadly in line with our expectations, with both inflation and growth tilting to the upside. CPI recorded the new high of this round of the inflation cycle on the back of intensified food inflation and reaccelerating non-food inflation, while PPI continued to trend up as the result of elevated international commodity prices, led by crude oil. The underlying growth momentum remains robust, with marginal moderation in GDP growth. Meanwhile, the stronger-than-expected fixed asset investment and industrial production may help to dismiss worries of a potential slowdown after the phase-out of policy stimulus. Despite dipping consumer confidence, retail sales are showing extraordinary resilience, which can be explained by the underlying structural changes as China rebalances its economy towards becoming more consumption-oriented, in our view.
Policy Implications
The positive assessment of the economic developments in 1Q11 during the State Council meeting held on April 13 shows the strong confidence of the Chinese government in the economic outlook against the backdrop of the rising complexity and uncertainty in the external environment. However, the rather hawkish talk about inflation and property prices made us believe that the ongoing tightening would be carried out decisively without compromise. In this context, we expect at least one more rate hike, together with multiple RRR hikes in 2Q, to help CPI reach its peak in mid-year. We feel comfortable with our 9% GDP growth and 4.5% CPI inflation forecasts this year, but see the balance of risks to both tilting slightly to the upside.
Economic Activity
Moderating GDP growth with still robust underlying momentum: Headline GDP growth edged down to +9.7%Y in 1Q11 from +9.8%Y in 4Q10, beating our forecast of +9.6% and the market consensus of +9.4%. For the first time, NBS published seasonally adjusted, quarter-on-quarter GDP growth by benchmarking the international common practice, which allows us to examine the growth momentum on a sequential basis. According to the NBS release, seasonally adjusted real GDP growth declined to +2.1%Q in 1Q11 (versus +2.4%Q in 4Q10), indicating moderating but still robust growth momentum.
Upbeat economic activity, despite of escalated tightening: Urban FAI growth strengthened to +25%Y YTD by March (versus +24.9%Y by February), beating our forecast of +24.3% and market consensus of +24.8%. On a sequential basis, FAI growth accelerated to +1.73%M in March (versus +1.51%M in February). Extraordinary strength was found in communications, computer & other electronic equipments (+62%Y YTD), electric machinery & instrument (+54.1%Y) and railway transportation (+46%Y). Defying the escalated tightening in the property sector, growth in real estate investment remained sound at +34.1%Y YTD by March (versus +35.2%Y by February), which may be explained by the speeding up of the social housing program to meet the augmented target of 10 million newly started units by the end of this year. We expect the aggressive social housing project to help to cushion the shortfall in commodity housing (see China Economics: A Year of Social Housing, April 11, 2011) and infrastructure investment as the result of tightening to rein in property prices and the gradual exit of policy stimulus.
Industrial production growth rebounded to +14.8%Y (versus +14.1%Y in January-February), beating our forecast and market consensus of +14%. On a sequential basis, growth in industrial production quickened to +1.19%M in March (versus +1.02%M in February). Heavy industry continued to outperform light industry (+15.6% versus +12.8%). Although the headwinds from high inventory levels and continued efforts in energy conservation and emission reduction may get stronger in coming months, resilient overseas demand and the aggressive social housing plan may help to keep industrial production well on track in the longer term.
Defying the historically low reading of the consumer confidence index recorded in February, growth in retail sales rebounded to +17.4%Y in March (versus +15.8%Y in January-February), slightly lower than our forecast of +17.5% but higher than market consensus of +16.5%. On a sequential basis, growth in retail sales edged up to +1.34%M in March (versus +1.33%M in February). Although heightened inflation has undermined consumer sentiment in the short run, we believe that the growth in retail sales is now driven primarily by underlying structural factors as China rebalances its economy towards becoming more consumption-oriented (see Chinese Economy through 2020 (Part 3): A Golden Age for Consumption, October 31, 2010).
Policy implications and outlook: Despite the escalated tightening to control inflation and rein in property prices, the economy is showing high resilience. The rather positive assessment of 1Q economic development by Premier Wen at the State Council meeting shows the strong confidence of the Chinese government in the economic outlook against the backdrop of the rising complexity and uncertainty in the external environment. In this context, the rather hawkish talk about inflation and property prices during the meeting made us believe that the ongoing tightening would be carried out decisively without compromise in the coming months before seeing concrete evidence of easing inflation pressure.
Although the trajectory of quarterly GDP growth on a year-on-year basis may feature a continued slowdown throughout the whole year, we expect economic growth to regain momentum on a sequential quarter-on-quarter basis in 3Q after inflation reaches its peak at mid-year and the policy stance shifts back to pro-growth. Our baseline forecast of 9% GDP growth and 4.5% CPI inflation, with which we still feel comfortable, largely hinges on the tightrope walking-style policy maneuvers by the government to deliver the delicate balance between growth and inflation in the context of rising external uncertainties. The primary risk to this outlook stems from potential policy missteps. As the current rate hikes are already slightly behind the curve, it may run risks of over-tightening to induce another round of a boom-bust cycle if more aggressive tightening is introduced in coming months but the ongoing recovery in the rest of the world is found not to be sustainable. Of course, if this time is different, namely that the 8% GDP growth target set for 2011 represents the government's base case scenario instead of its worst case one as usual, we think it may be too early to worry about the growth outlook for now.
Inflation
New high of current cycle: After plateauing at +4.9% for two consecutive months in January and February, CPI inflation intensified to +5.4%Y in March, recording the new high of the current cycle, beating our forecast of +5.2%. On a sequential basis, CPI inflation contracted 0.2%M but gained +0.6%M sa (versus +1.2%M and +0.4%M sa in February) before and after seasonal adjustment, respectively. Despite the phasing out of Chinese New Year seasonality, food inflation worsened to +11.7%Y (versus +11%Y in February), which is consistent with the stubbornly high food prices we observed from the NBS and MoC's high-frequency food prices. Non-food inflation rebounded to +2.7%Y (versus +2.3%Y in February) on the back of a noticeable rally in residential prices (+6.5% in March versus +6.1%Y in February) as a result of escalated tightening in the property sector and a lifted weight in the latest CPI re-weighting.
Escalating upstream inflation: Against the backdrop of surging international commodity prices, led by crude oil, PPI inflation accelerated to +7.3%Y in March (versus +7.2% in February), beating our forecast of +7.1% and market consensus of +7.2%. On a sequential basis, PPI inflation rose 1.0%M and 0.1%M sa (versus +0.5%M and +1.1%M sa in February) before and after seasonal adjustment, respectively. RMPPI rose to 10.5%Y (versus +10.4%Y in February), led by non-ferrous and ferrous metals at +14.2%Y and +13.9%Y, and fuels & power at +9.9%Y.
Outlook and policy implications: We expect CPI to continue to trend up in the coming months and not reach its peak until mid-year as the result of elevated food prices and reaccelerated non-food CPI. The recent price control measures (on fast noodles, daily use chemicals, liquor and edible oils) suggest that underlying inflation pressure might remain strong and that the Chinese authorities are highly alert to any inflationary elements. In contrast, the government's tolerance to upstream inflation seems relatively high, given recent fuel price hikes in February and April. We believe that the artificial disruption of the pass-through between upstream and downstream industries may lead to a disconnect of CPI and PPI in the coming months and result in a less volatile, but more prolonged, inflation cycle, as the administrative price controls are unlikely to remain in effect for long.
Monetary
Higher-than-expected new loan creation for March: New loan creation rebounded to Rmb679.4 billion in March (versus Rmb535.6 billion in February), beating our forecast and the market consensus of Rmb600 billion. As a result, loan growth accelerated to +17.9%Y in March (versus +17.7%Y in February). Thanks to the higher-than-expected new loan creation, M2 growth rebounded to +16.6%Y in March (versus +15.7%Y in February), much stronger than our forecast of +15.5% and market consensus of +15.4%, although the recent RRR hike and net liquidity withdrawals from open market operations might have reduced the money multiplier to some extent.
Policy implications: We don't think the notable rebound in new loan creation in March indicated any loosening of ongoing credit control to combat inflation. We think that it might be explained by bank financing to facilitate the kick-off of the even more aggressive social housing project this year (10 million units in 2011 versus 3 million units in 2010), which is highly encouraged by the government. Given the hawkish tone at the State Council meeting presided by Premier Wen on April 13, we expect the ongoing tightening to be carried out decisively under the name of prudent monetary policy, without any compromise. In this context, although we currently forecast one more rate hike in May-June, we believe that the likelihood of more than one rate hike is rising. In addition, we expect that the quantitative tightening in the form of RRR hikes and net withdrawals through open market operations will continue to address the excessive liquidity. Under these circumstances, we believe that the 16% M2 growth target set by the government for this year is very achievable. Although, as usual, China has not released the annual quota of new loan growth this year, we estimate it to be around Rmb7.5 billion on the back of total new loan creation of Rmb2.24 trillion in 1Q11 and quarterly distribution of 3:3:2:2. If it is true and strictly implemented in practice, overall liquidity conditions this year should be much tighter than last year (targeted for Rmb7.5 trillion, but resulted in Rmb8 trillion in 2010), given the lack of a cushion from bill financing and escalated regulation on off-balance lending (see China Economics: Prudent Monetary Policy Remains on Track Despite Higher-than-Expected New Loan Growth in March, April 14, 2010).
Trade
March trade data came in stronger than expected: Export growth rebounded strongly to +35.8%Y in March from the single-digit growth of +2.4%Y in February, beating our forecast of +23.7% and market consensus (Bloomberg Survey) of +23.4%. Imports rallied to +27.3%Y in March (versus +19.4%Y in February), higher than our forecast of +20.6% and market consensus of +20.7%. As a result, a marginal trade surplus of US$0.14 billion was recorded for March (versus a trade deficit of US$7.3 billion in February), defying our forecast of a US$5.4 billion deficit and market consensus of a US$3.4 billion deficit.
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