from Follow the Money

A small but important point - China’s current account surplus is growing in the face of the oil shock

August 30, 2005

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Emerging Asian economies - as many have pointed out - are more energy-intensive than the US economy.   One reason: the US outsourced energy-intensive manufacturing to Asia, increasing the energy intensity of Asian economies while reducing (in some sense) the energy intensity of the US economy.  Manufacturing heavy economies will tend to be more energy intensive than service-based economies.   But there is more to it than that as well - lots of Asian economies subsidize domestic gasoline and energy more generally, and thus encourage domestic consumption.    The net result: China's terribly energy efficiency.  See this Time article, among others.

No matter the cause, Asian economies are more exposed to the oil shock than most. 

So any effort to explain the resilience of the global economy in the face of the recent oil shock needs to explain the resilience of Asian economies.

Part of the answer is that Asian economies have opted to take the hit  on their budgets (with subsidies) or on the profits of their state oil companies (see China) to reduce the impact on consumers.   But Asian economies are not as dependent on domestic consumption as the US or even most European economies, so that cannot be entire answer.

Part of the answer is that the borrow and spend US consumer keeps borrowing and spending, supporting Asia's export engine.

But I think part of the answer is also that Asian economies - and indeed many oil importing emerging economies - went into the most recent oil shock with large current account surpluses.  

Why does that matter?   Higher oil prices mean a smaller surplus to lend to the rest of the world, not a bigger deficit that needs to be financed.   Asian economies by and large have not had to rely on global markets(or international banks) to recycle the oil exporters petro-dollars into loans (or other forms of credit) to oil-importing emerging economies.  They could adjust by lending less to the rest of the world, not by borrowing more.  They consequently are not as dependent on the mood of the world's financial markets.

To take two examples.  According to UBS, in 2006, Korea would run a 4.5% of GDP current account surplus with oil at $30, and a 0.8% of GDP surplus with oil at 70.  Oil needs to rise to $80 or $90 for Korea to need to finance a deficit (which it could easily do).  Taiwan's surplus is estimated to fall from 5% of GDP with oil at $30 to 2.3% of GDP with oil at $70.

Some Asian economies have slipped into deficits - Thailand in particular.  UBS estimates that if oil stays around $70, its deficit might reach 4.6% of GDP.  India's deficit would be a bit smaller, 3.1% of GDP.    Of course, both countries have little external debt and tons of reserves.  India in particular should have little trouble financing these kinds of deficits.

The outlier?  China.   It is every bit as dependent on oil as the other Asian economies.  But its current account surplus is still set to rise even in the face of $70 a barrel oil.    UBS estimates its surplus would be 6.7% of GDP in 2006 even if oil is at $70 all year long - well above its 2004 level of around 4% of GDP, even if slightly below its likely 2005 surplus (likely to be 7.5-8.0 % of GDP).

Right now, China is importing about 2.6 million barrels a day of crude (OPEC produces around 30 mbd by comparison).   If oil averaged say $30 rather than $60 a barrel in 2005, China's oil bill would fall by about $30b.   Its (estimated) current account surplus would be $180 billion rather than $150 billion.

Still, that $30b swing in China's oil import bill has to be compared with China's phenomenal export growth.  Say export growth slows just a bit from 30% y/y to 25% y/y.   In dollar terms, China's exports would still grow by something like $150 billion in 2005.  China can afford to import a lot more oil if that kind of export growth continues.

To me, that is one more sign that something strange is going on in China - ok, nothing that strange.   The combination of an undervalued RMB, low domestic interest rates and high savings is fueling an enormous expansion of China's export capacity, one that is propelling enormous increases in exports that are overwhelming China's rising oil import bill.    China is not only far more dependent on exports than Japan back when Japan was growing like gangbusters, but its recent pace of export growth has been far faster (30% v 15%).

The problem: if the rest of the world has to spend more on oil, at some point, it will have less to spend on Chinese goods.  And China is becoming exceptionally exposed to the global economic cycle.  A consumer slowdown in the US - or Europe for that matter -  should translate into reduced demand for Chinese goods.  Unless China just takes market share away from everyone else, which will make it even harder for them to pay their oil import bill.

One barrel of oil buys a lot more computing power now than it did in 1973, or 1980.   It buys a lot more of other goods as well.  As the Economist has pointed out, when oil is adjusted to reflect export prices rather than consumer prices - i.e. the amount of goods the rest of the world has to sell to import a barrel of oil - it is already at a record.

There is a reason why China will be the focus of lots of attention in the run-up to the IMF's annual meetings.  China - perhaps alone among major oil importers - has a rising current account surplus.   That puts additional pressure on all the world's other oil importers.

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