NO GROUND FOR COMPLACENCY OVER OIL PRICE FALLS.

Mar 27, 1986

NO GROUND FOR COMPLACENCY OVER OIL PRICE FALLS.

GENEVE, MARCH 26 (IFDA/CHAKRAVARTHI RAGHAVAN) – The complacent and even euphoric view of the benefits of the sharp falls in oil prices to the world economy, currently projected by western policy-makers and media, is not being shared here by GATT economists.

In a report written before this week’s failure of the OPEC Ministers, GATT economists struck a note of caution and warned against complacency that the lower petroleum prices by itself would put the world economy back on the prosperous growth path of 1950-1973.

In striking a note of caution, the GATT economists note that there are too many "fundamental changes" taking place in the world economic environment.

These include: depreciation of the dollar and movements in exchange rates and interest rates, declines in petroleum prices, coming on top of sharp declines in commodity prices, and resulting in sharp falls in inflation rates in industrial and even some third world countries.

All these would take time to work themselves through the economy, and much would depend too on policy responses of governments.

It would be hence difficult to make projections on the basis of change in one variable only – petroleum prices – and that too when there is no certainty as to the level at which those prices would stabilise themselves and when, the GATT economists explain.

Among the other variables, the developments of 1985 have added to a series of weakness on food and non-fuel raw material markets.

A number of factors have been responsible: structural changes in world economy resulting in less use of raw materials; high real interest rates inducing economies in raw materials use and stocks; domestic price supports in food and agricultural commodities reducing import demand; subsidised disposal of surplus production on world markets depressing prices; and increased export efforts of heavily indebted countries.

This would mean that while at some future boom of world economy primary commodity prices could stage a strong recovery, at present the longer-term income and trade prospects of primary commodity exporters appear to be "less promising" than for those involved in manufacturing and service activities.

On the interest rates front, while rates in many industrial countries have declined substantially, this would be beneficial only if it widens the margin between real cost of capital (excepted rate of interest adjusted for expected inflation) and the expected real rate of return on investments.

In many industrial countries the rate of inflation has come down, and is expected to decline further, because of fall in commodity prices and now of oil.

As a result the real cost of capital has decreased less than indicated by fall in nominal interest rates, and in historical perspective it remains at a relatively high level.

GATT economists note that for the third world countries, the real cost of imported capital would depend on the interest rates adjusted for the terms of trade of the country concerned.

On the debt front, while declines in nominal interest rates should benefit the servicing of debt, this has to be seen against trends in prices for all their exports and imports.

For many heavily indebted petroleum exporters, the benefit of lower interest rates will be wiped out by lower dollar price of petroleum.

For many other heavily indebted countries, non-petroleum primary commodities figure heavily in their export baskets, and the depressed dollar prices for these in 1985 has a negative impact.

Hence, in the short to medium term, there is still need to find variable financial solutions to suit needs of both debtors and creditors, and this involves continued restructuring and rescheduling of debt along with increased new net inflows of foreign capital, GATT economists stress.

Also, there is need to stimulate savings and efficiency of investments.

So far, the major focus has been on import restrictions and the longer these are in placing the greater the damage to the export sectors of these countries.

Liberal trade policies by debtor countries require improved trade policies by creditor countries so as to facilitate access to their markets by debtor exporting countries.

On the exchange rate front, the real effective exchange rate of the dollar (trade-weighted nominal exchange rate adjusted for inflation differentials with trading partners) has come down by 15 percent in 12 months up-to February 1985, and another 15 percent by end of year.

But while this should reduce U.S. trade deficits, after a lag, much would also depend on U.S. domestic macro-economic policies.

The U.S. trade deficit is a direct reflection of excess of expenditure (public and private sectors) over output in the economy, and the depreciation of the dollar would reduce trade deficit only to the extent that it leads to higher output and/or lower expenditure.

In the short term, and depending on government policy responses, the drop in oil prices, would help increase demand, but on the supply sides there would be uncertainties inhibiting investments that would influence sustained growth and recovery.

GATT economists point to the uncertainties about future price developments for oil, noting that very few analysts now predict a rise above 20 dollars a barrel soon.

"Since trade in fuels accounts for nearly 20 percent of value of world trade, a price change of this magnitude will have a major impact on world trade and national economies", according to a GATT report.

An average 20 dollars a barrel in 1986 would bring real oil prices (nominal prices adjusted by export unit values of manufactures) to the lowest levels since 1979, a 15 dollar average to the 1978 levels, and 10 dollar price to the 1973 levels.

On effects of oil price falls on trade, GATT notes (on the basis of 1984 preliminary figures), and 16 of the countries on the list of the 20 largest petroleum importing countries are also on the list of the 20 largest exporters to the petroleum-exporting countries.

Only four of the major oil-importing countries – India, Greece, Philippines and Portugal – who are not on the list of the 20 largest exporters to the petroleum-exporting countries, could benefit from the lower petroleum prices without suffering from the reduced export opportunities.

The opposite will be true of U.K., Canada, Australia and Austria.

However, in the case of India, remittances from workers, an important source of foreign exchange, is likely to be adversely affected.

Of the 20 leading exporters of crude petroleum and products, petroleum accounted for 90 percent or more of total merchandise exports in 1984.

China and U.K. at the lower end of the spectrum with 20 percent each, Norway with 30 percent, the Soviet Union with 40 percent, and Indonesia with 55 percent.

In terms of oil exports to GDP, the ratio ranges from a low five percent for U.K., China and USSR, to 50 percent for Kuwait, Qatar and Oman.

According to GATT, predicting the net impact of lower oil prices on the petroleum-importing countries is not easy.

Among other thins, GATT economists note, both the terms of trade gain on petroleum imports, and the potential decline in export sales to the major petroleum exporters, have to be taken into account in making an overall assessment.

GATT economists also note that apart from the five (Brazil, Philippines, India, South Korea, and Yugoslavia) third world countries who are in the top 20 oil-importing countries in the world, all other third world oil-importing countries should also benefit from the fall in price of oil.

But much would depend on whether they import oil directly and refine it, and who handles this, or whether they import petroleum products from the oil companies, and how much of the fall in oil prices is going to be passed on to them.

GATT notes that beyond the immediate trade effects of decline in petroleum prices, there is a strong presumption that the net impact on the world economy will be positive.

However, in view of the size and speed of the price decline, and uncertainties over both investors’ and consumers’ reactions and the policy stance that individual governments would adopt, it would be premature to attempt more precise projections.

This would apply to the nature of the gains (lower prices to consumers, reduced government budget deficits, higher economic growth, etc.), the distribution of gains and losses among regions, countries, enterprises and individuals; and the extent to which potential net gains to an economy would be reduced by inappropriate policy responses to the lower price.