impact of oil price - increase in vn and policy response

8/7/2019 Impact of Oil Price - Increase in Vn and Policy Response

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Impact of Oil PriceImpact of Oil PriceIncrease in VietnamIncrease in Vietnam

and Policy Responseand Policy Response

Seminar at the Institute for

Price and Market Research

October 21, 2005


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Outline

Key stylist facts (Price developments)

Net impact on the economy to date

Outlook and assumptions for 2006

Possible outcomes and Policy options


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Crude oil price has been rising for the last severalyears. But domestic price is adjusting with a lag.

0

5

10

15

20

25

30

35

40

45

50

2003 2004 2005 20060

10

20

30

40

50

60

70Crude oil USD/barrel (RHS)

Crude oil (% change)

Domestic price (% change)


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Domestic petrol price adjustment has been largest,with other products only catching up in 2005

43.223.26.3Simple average45.711.60.0- Fuel Oil (FO N 2B)

56.311.60.0- Kerosene

54.610.20.0- Diesel 0,5%S

35.236.513.0- Unleaded petrol RON 83



End period

33.011.96.3Simple average

28.37.90.0- Fuel Oil (FO N 2B)

30.18.10.0- Kerosene

31.97.00.0- Diesel 0,5%S




Period average

200520042003


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The worlds experience: passthrough for oil products

Domestic gasoline prices in a majority ofcountries have increased in absolute terms bymore than in the United States, where adjustmentis generally regarded as complete.

Nevertheless, in a number of countries theabsolute price increase has been significantlysmaller than in the United States, suggesting the

pass thought may have been incomplete in thosecountries. The incomplete pass through issignificant in most oil-exporting countries.


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Domestic Retail Fuel Price inVietnam and in the world

0.780.910.96634834Vietnam

1.621.781.78928563Crude oilImporters

1.271.461.52726954Crude oil

Exporters

1.561.721.74898262World

Mid

2005

End

2004

End

2002

Mid

2005

End

2004

End

2002

Price level relative to U.SPrice level in U.S. cents per

liter


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Crude oil export volume peaked in 2004; surprisingly import volumeincrease has been remarkably low relative to real GDP growth.

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

2003 2004 2005

0

5000

10000

15000

20000

25000

Crude oil exports (US$ mn) Petroleum imports (US$ mn)Exports ('000 metric tons) (RHS) Imports ('000 metric tons) (RHS)


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Oil revenue has been rising steadily, but not as fast as nominal GDP.

Crude oil export revenue is by far the single largest revenue source.

0

10000

20000

30000

40000

50000

60000

70000

2003 2004 2005

7.0

7.2

7.4

7.6

7.8

8.0

8.2

8.4

Oil export revenue (VND bn) Duties on imports (VND bn)VAT and excise (VND bn) In percent of GDP


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Contribution to inflation from higher oil prices has been modestpartly because of the low weights in the CPI basket, and slow

adjustment in administered prices.

2003 2004 2005

Direct 0.17 0.71 0.78

Fuel for cooking 0.07 0.25 0.29

Fuel and lubricants 0.10 0.46 0.49

Implied inflation (weight 3.3%) 5.42 24.04 26.95

Indirect 0.06 0.04 0.07

Electricity 0.03 0.00 0.01

Public transportation 0.04 0.04 0.06

Total 0.24 0.75 0.85

Implied inflation (weight 5.9%) 4.09 13.49 15.49


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Net impact of the oil sector on the economy(In percent of GDP)

-1.2-0.50.4Net external balance from oil trade

15.312.59.7Exports of crude oil

Memorandum items:

1.50.80.7Government subsidy

10.37.96.2Imports of petroleum product

Private sector

1.61.71.7From petroleum imports

6.56.65.8From crude oil

8.18.27.5Government

-6.1-5.1-3.1Net profit remittances by FIEs (estimates)

4.94.63.5Net oil impact on the trade balance

Overall economy

200520042003


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Looking aheadBasic assumptions on outlook

2005

Case 1 Case 2

Crude oil (US$/barrel) 54.23 61.75 71.75

GDP (USD bn) 50.8 56.0 56.0Percent change 12.0 10.2 10.2

Crude oil export volume (% change) -5.0 0.7 0.7

Petroleum import volume (% change) 2.2 8.5 8.5

2006


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Understanding the flow of funds of oil exports andimportskey role played by the government

Natural (oil)

resources

Government

Private

sector

Taxes Petroleum

products

imports

Crude oil revenue

Spending Subsidy

Crude oil

exports

State

asset


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What should the government do?Objectives

As a general principle Ensure that natural resources remain at least as valuable

in another form for future generation than in the currentform of crude oil

Investment with efficiency considerations Avoid Dutch disease phenomenon

When faced with higher oil prices

Ensure aggregate demand is contained Dampen any adjustment costs

Allow relative price changes to provide appropriatesignal to the economy


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What should government do?Instruments

Fiscal policy Spending allocation of oil revenue

Saving vs. spending

Price control

Control of price pass through

Subsidy Other policy measures

Monetary and exchange rate policy


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Quantitative assessment of possible scenarios in2006 under policy neutrality (In percent of GDP)

2005

Case 1 Case 2 DifferenceOverall economy

Net oil impact on the trade balance 4.9 4.5 5.2 0.7

Net profit remittances by FIEs (estimates) -6.1 -5.4 -6.2 -0.9

Government 8.1 10.1 11.8 1.7

From crude oil 6.5 8.2 9.6 1.3

From petroleum imports 1.6 1.9 2.2 0.3

Private sector

Imports of petroleum product 10.3 11.4 13.2 1.8

Government subsidy 1.5 1.4 1.4 0.0Implied domestic petroleum price change 15.5 36.8

Memorandum items:

Exports of crude oil 15.3 15.9 18.5 2.6

Net external balance from oil trade -1.17 -0.85 -0.99 -0.14

2006


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Some trade offs!

Subsidy vs. inflation using 2006 as an example

Dampening the impact on the poor vs. providing

correct price signal upfront

Would depend on the nature of the oil price increase;

and

Policy responses in other countries.

Subsidy (VND trillion) 12.5 28.9

In percent of GDP 1.4 3.2

Domestic petroleum price inflation (in %) 15.5 36.8

Contribution to overall inflation (in %) 0.5 1.0


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More specifics on recent inflation developmentsNon-food inflation is catching up!

-0.5

-0.3

-0.1

0.1

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

J an-0 3 Mar-0 3 M ay-0 3 J ul-0 3 Sep -0 3 No v-0 3 J an-0 4 M ar-0 4 M ay-0 4 J ul-0 4 Sep -0 4 No v-0 4 J an-0 5 Mar-0 5 May-0 5 J ul-0 5 Sep -0 5

Food Housing Transport (inl. petroleum) Other

Contributions to inflation

(seasonally adjusted, in p ercent)


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Possible implications on aggregate demandfrom higher oil price

Aggregate demand could weaken as the privatesector is faced with higher input cost and prices.

Will observe both income and substitution effect.

If the net impact on the external current accountbalance is indeed negative, then higher oil price

will lead to loss of income, and compound the

contraction effect noted above.

But the role of the government is key!


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In standard oil importing country case(No government involvement)

Result of an oil price increase C/A deficit widens

Income effect (demand contained)

By higher imported price

Substitution effect

By exchange rate depreciation Secondary effect from loss of income

C/A deficit contained


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In oil importing country case(Government is the sole importer)

Result of an oil price increase C/A deficit widens If government passes on the cost fully, then the same

process as in the above case.

If government takes on the cost (in whatever form),then it will need to raise more resources to cover for thecost. If the money is raised from additional tax, the the end result

will be the same as before, except that there will be distortion

(domestic relative prices do not reflect international pricechanges), and have redistributional effect (from general to taxpayers).

If the money is borrowed, then the government is holding offadjustment at the cost of liabilities that future generation has to

bear (inter-generational transfer).


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In oil exporting country case(Government is the sole exporter)

Result of an oil price increase C/A surplus widens,

if government saves, nothing happens.

If government spends (net injection), C/Asurplus will induce income to rise.

Income effect (demand expands) and will

either lead to inflation or higher imports; Will be assisted by exchange rate

appreciation (real appreciation).


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Vietnam:The government is the (de facto) importer, and exporter

Result of an oil price increase C/A subject to profit transfers; assume that

the overall impact is negative

Government passes on the cost partially andwith delay.

The cost is borne by oil export receipts (wind

fall gain), and hence no additional absorption.Hence government is holding off (or delayingadjustment).

But


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Vietnam:Government is the (de facto) importer, and exporter

But Income is generated from higher oil revenue, inaddition to the subsidy.

Government spends the extra income on

investment (net injection). However, this additional amount of injection is

less than the amount spent on oil imports due tothe increase in oil prices.

Hence, real income will fall, and the CA deficitwill adjust, but the substitution effect will be lessthan under no government intervention.


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Oil related Interaction between thegovernment and the rest of the economy

2004 2005

Case 1 Case 2 Case 2a Diff 1 Diff 2aGovernment

Revenue 8.2 8.1 10.1 11.8 11.8 1.7 1.7

Crude oil export (windfall) 6.6 6.5 8.2 9.6 9.6 1.3 1.3

Petroleum imports (absorption) 1.7 1.6 1.9 2.2 2.2 0.3 0.3

Expenditure

Subsidy (injection) 0.8 1.5 1.4 1.4 3.2 0.0 1.8Net balance (injection-absorption) -0.8 0.0 -0.4 -0.8 1.0 -0.3 1.5

Net balance plus injection of windfall gai 5.7 6.5 7.8 8.8 10.6 1.0 2.8

Economy

Government net injection 5.7 6.5 7.8 8.8 10.6 1.0 2.8

Spending on imports -7.9 -10.3 -11.4 -13.2 -13.2 -1.8 -1.8

Net cost on the private sector -2.2 -3.8 -3.6 -4.4 -2.6 -0.8 1.0Financed from foreign borrowing 0.5 -1.2 -0.8 -1.0 -1.0 -0.1 -0.1

Financed from domestic saving 2.6 2.7 2.7 3.4 1.7 0.7 -1.1

Contribution to inflation 0.71 0.78 0.47 1.03 0.47 0.6 0.0

2006

Assume subsidy is financed from borrowing


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Higher oil prices will require more private sectorsavings (if subsidy is financed by taxation)

More (less) private sector saving is neededfor less (more) subsidy (forced saving) and

higher (lower) inflation;

More foreign borrowing is needed the

higher oil prices. This can be contained

either through policies to reign aggregate

demand, and expenditure switching through

the exchange rate.


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So, what should the government do?

If oil price increase is permanent, allowrelative price adjustments to provide theright signal to the market.

If oil price increase is temporary, there isbenefit to wait the pass through to avoidprice fluctuations.

If oil price leads to excessive borrowingneed, contain aggregate demand, and asnecessary through expenditure switching.


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What about monetary and fiscal policy mix?

For containing aggregate demand more on apermanent basis, use fiscal policy;

For reducing price fluctuations, and

expenditure switching, monetary policy isnecessary.


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Presenters contact detail:

Il Houng LeeSenior Resident RepresentativeIMF, Vietnam

Tel: 8 24 33 50E-mail: [email protected]/hanoi

The views expressed in this presentation are those of the author

and should not be attributed to the International Monetary Fund,

its Executive Board, or its management.

impact of oil price - increase in vn and policy response

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