Crude oil prices crashed by over 30% last Friday because of disagreements between OPEC and Russia on cuts in production. There are many episodes of plummeting oil prices in the last 50 years due to multiple causes. This short note focuses on the driver of the recent drop in crude oil prices and its implications for Vietnam’s economy, which is a net importing country as net spending reached nearly USD 1.8 Bn on purchasing offshore crude oil in 2019.
Historically, the plunge in crude oil prices has been leading to significant real income shifts from exporting to importing countries. Although that is a zero-sum game between oil-exporting and importing countries, the economic models of the World Bank showed that declines in crude oil prices likely result in a net positive effect for global activity over the medium term. The losses of oil-exporting countries are entirely offset by stronger growth in oil-importing ones via rising consumption, lower inflation and widening policy room that should lower macroeconomic vulnerabilities. However, in reality, the impact is divergent among oil-importing countries in different periods and the economic effects are dependent on at least three critical aspects of the oil price decline, including 1) Underlying drivers of the oil price decline, 2) Persistence of the oil price decline and 3) The extent of price pass-through.
The explanation for the present plunge in crude oil prices hints that both supply- and demand-side effects are dominant. Energy prices dropped by 10% since the beginning of the year as the coronavirus outbreak has darkened the outlook of global demand. Besides Italy, France and Japan, more and more countries are expected to suffer technical recessions in the first half of 2020. Crude oil producers are hurt further due to a significant shift of OPEC policies that have been unable to limit supply.
The last three plunges in crude oil prices were due to the unwinding of geopolitical risks in Middle East in 1980s, global finance collapse in 2008 and technology-driven surprises in the production of unconventional oil in 2014. The current drop in crude oil prices is highly sensitive to the effort of containing the epidemic and the deals of big oil exporters. Whether the drop is temporary or not is important to assess its impact on saving real income gains or translating into higher spending to lift economic activity.
The third factor is related to the price pass-through that determines how much of the decline in oil prices translates into a drop in gasoline and petroleum prices at the retail level. The benefits depend on the specifics of the subsidy and pricing regimes. In Vietnam, there are administrative controls on energy prices in which taxes and fees account for nearly half of retail prices which result in an incomplete transmission to demand channels. In 2014-2016, for example, gasoline prices in Vietnam decreased by approximately 40% while global crude oil prices declined by 70%.
To sum up, in the context of oil price plunging accompanied by a global economic slowdown, we believe that real income gains for consumers will be limited in Vietnam via rising savings ratios instead of boost of consumption in 2020. The clearest impact is the pass-through into slowing inflation which may ease pressure on the central bank and present a window of opportunity to implement policy accommodation. That supports our forecast of a policy rate cut at the second half of Q2. In addition, we estimate that the external balance will improve by over USD 1.5 Bn in 2020 as a result of the oil price decline. Regarding fiscal policy, we expect no unexpected changes caused by strained public finances in 2020 because of the weakening of oil revenues and taxes from export/import goods.