Asia and oil! What's going on?

We haven't seen oil being this cheap for a while. In fact, some of us (most?) weren't even in the financial sector when crude was trading at USD 30 per barrel, says Frederic Neumann, Co-Head of Asian Economic Research, HSBC.

Asia and oil

Crude is down, way down. Shouldn't that give Asia a nice lift? After all, most of the region imports the stuff. A lower purchase bill should therefore give a boost to the spending power of consumers, governments and companies. Alas, growth keeps slowing. What's missing? For one, lower commodity prices, including oil, partly reflect weakening demand itself. In addition, the downturn in mining capex and the declining income of commodity producers is weighing on exports from Asia. So don't expect the plunge in crude to lead to a swift bounce in Asian demand - it ain't as easy as that.

We haven't seen oil being this cheap for a while. In fact, some of us (most?) weren't even in the financial sector when crude was trading at USD 30 per barrel. And it's been on a rapid descent, too. Here's the thing though: lower prices should in principle be a boost to a region that for the most part imports oil. Think of Japan and Korea, each barely producing a drop of their own. Or China: now the world's largest energy consumer and biggest buyer of crude on world markets. Or Taiwan, or India, or the Philippines, or...

But that isn't happening. Growth has decelerated virtually everywhere alongside the decline in oil prices.

What's going on?

A couple of things. First, falling prices for raw materials, including oil, partly reflect cooling demand in Asia. Yes, the shale oil revolution and OPEC pumping away have increased supply (a positive for importers). But weaker demand is also playing a role. In fact, what's true for oil is true for other commodities as well. Take iron ore: extra supply (think Australia) has helped to depress prices globally, but so has the fact that China's demand has slowed. Even if the country still imported a record amount last year, this failed to meet bullish expectations set at the height of the boom. So, yes, softer demand is part of the story, even if only relative to expectations, whether for iron ore or crude.

Second, there's an income shift under way that's hurting Asia, at least in the short-term. The drilling and mining boom that higher commodity prices encouraged helped boost demand for some Asian exports. Korea and Singapore are good examples: their offshore engineering industries having taken a hit through lower orders.

More importantly, commodity exporters throughout the world spent their windfall gains freely in recent years, including on Asian goods. As they are now cutting back, crude importers such as advanced economies are not stepping up to make up the difference, preferring to, well, save their savings, rather than splurge, leaving the world short of demand (only witness disappointing retail sales in the US last month, reflected in a rising household saving rate). Of course, this is a broader commodity story, and doesn't apply just to oil, but the latter plays a major part in this.

None of this, of course, is to say that lower oil prices don't help at the margin. Only imagine where growth across the region would be right now if crude was still above USD 100 per barrel (say, because of a supply shock). A lot lower, presumably. Yet this raises a worrying prospect: if underlying growth is even weaker than currently reported, we might see activity sag further once the cushion from the fall in oil prices fades. (True, falling energy prices raise the income of importers, and even permanently so if they stay low. But they don't add anything in themselves to growth over time after the initial boost wears off.)

Our broader point is this: tumbling crude prices are not going to be a quick fix for Asia's growth malaise - rather, they are part of the symptom. A bounce in Asian demand thus appears unlikely on the account of oil. Looks like we'll be stuck in a slow grind for a while.