Crude oil price jump prompts inflation scare

By James T. Areddy

HONG KONG (Dow Jones): At a time when crude oil prices are rising, Asian demand has picked up, which may make inflation a more immediate concern in the region's rebounding economies.

Policy makers in South Korea, Thailand and the Philippines have recently tipped markets that their attention has turned to rising global oil prices, which hit a 2 1/2-year high last month, threatening the low interest rates that generated this year's economic recovery.

With South Korean economic growth seen at 8.8 percent this year, "there are inflationary concerns, such as rapid economic growth and surging international oil prices," Bank of Korea Governor Chon Chol Hwan warned last week.

He forecast 0.8 percent inflation this year, well below the government's 1.5 percent outlook. The central banker stopped short of signaling a tighter interest rate policy, but some analysts believe higher rates will come in 1999.

Analysts said Seoul is right to be vigilant.

Oil is one of South Korea's largest imports, and analysts are concerned higher crude prices may start "to feed through to other prices," such as wages, said Rob Subbaraman, a Lehman Brothers Asia Ltd. economist in Tokyo.

"They are deeply focused on inflation, and I think the oil factor is coming more into play," Subbaraman said, adding he expects an official interest-rate hike in South Korea by the end of the year.

A Korea Development Institute economist in Seoul, Hong Ki Seok, calculated that a sustained 10 percent rise in the price of oil has historically lifted the consumer price index by 0.3 to 0.4 percentage point, with more impact on producer prices.

Inflation isn't a new worry for South Korea or other reviving Asian economies, but the source of the price strain is.

As it became apparent months ago that some Asian economies were rebounding quickly, analysts began looking for signs of a buildup in demand-side pressures, such as calls for higher wages and producer price hikes.

Until recently, the supply side wasn't getting much attention because the costs of international commodities appeared benign. Generating economic growth, not limiting it, in a deflationary environment was seen as the greater challenge.

Analysts at the World Bank didn't help matters by predicting at the beginning of the year that commodity prices, including crude oil, would fall in 1999.

Instead, crude oil prices have gained steadily since the first quarter of 1999, when major world exporters signaled they might tighten controls over output. For the producers, the move dovetailed well with an improvement in world-growth prospects, including the Asian recovery.

But the region's only significant exporters are Indonesia and Malaysia. Still, for Asia, the effect of higher crude prices had initially been muted by recovering currencies and generally uninspired international prices for traded goods.

The problem is Asian currencies have now stalled, but oil has kept gaining.

Crude oil futures traded at their highest level in 2 1/2 years late in September in New York, hitting US$25.12 a barrel. Benchmark New York Mercantile Exchange crude futures have since eased, trading around $22.50/bbl, but oil still costs about twice the $10.50/bbl it did last December.

In contrast, South Korea's won is basically unchanged since the end of 1998, while currencies such as the Thai baht and Philippine peso have weakened.

Part of the reason for higher global oil prices is Asia's revival. Trade figures from around the region suggest that oil demand has picked up, just as it tailed off when the economies slipped in 1997 and 1998.

In the first eight months of this year, South Korea had imported about $8 billion of crude oil, or about 71 percent of its total 1998 imports. Analysts said it is difficult to determine whether the rise stems more from higher prices or higher demand.

"I don't think it's 100 percent the oil price rise," said KDI's Hong.

To suppress inflation, South Korea and Thailand have temporarily adopted policies that reduce the impact on consumers of the oil price hike, such as delaying electricity rate increases and lowering excise taxes.

Other Asian countries are also affected by the crude price increase.

Li Lian Ong, an economist at Macquarie Bank Ltd., said rising oil prices will spark more inflation in Taiwan than the rebuilding associated with last month's earthquake, the island's most destructive in this century.

Meanwhile, Adrian Foster, an economist at Nomura International (Hong Kong) Ltd., pointed out that oil prices have been rising throughout 1999 with little impact on Asian inflation. But his analysis suggests it may take 12 months for crude prices to lift consumer prices in Southeast Asia.

His charts show that when oil prices rise, overall inflation tends to fall by exactly the same amount, only to rise back a year later. He theorized that higher oil prices may lead to reduced spending on other goods and, in turn, lower prices.

"From the chart, you could argue that there is a deflationary impact elsewhere in the economy when oil prices rise," he said.

Dependency On Per Capita Oil Use, Inflation

Oil Imports Equivalent In Kgs Outlook

Net Importers HK 66% 2185 Prices down India 19% 274 Stable South Korea 68% 2887 Unstable Pakistan 39% 249 -- Philippines 93% 292 Slowing Singapore 145% 6988 Stable Sri Lanka 101% 122 -- Taiwan 56% 2730 Low, rising Thailand 60% 863 Slowing

Net Exporters China 1% 680 Index up Indonesia 41% 396 Falling Malaysia 53% 1671 Stable

Source: SG Securities Research Ltd., Oct. 1999