A Dutch Disease in Arabia
Oct 19, 2006
Serhan Cevik (from Copenhagen)
Petrodollar liquidity has driven oil-producing economies to overheat. The global commodity boom has certainly been a huge burden on importing countries, but higher prices also provided a significant stimulus to oil-rich economies in the Middle East and North Africa. As a whole, oil exporters experienced a marked surge in output growth — from an average of 3.7% a year in the 1990s to 6.3% in the last five years — and a more than fourfold increase in the current account surplus. With soaring oil and natural gas prices, export revenues of oil-producing countries increased from US$251 billion in 2002 to US$593 billion in 2005 and about US$780 billion this year, raising the cumulative account surplus from 5.4% of GDP in 2002 to 22.7% last year and 25.5% in 2006. In previous reports, we highlighted how the recycling of petrodollars has kept fuelling liquidity-driven capital flows around the world (see, for example, Can the IMF Tame Gorillas? October 3, 2006). Of course, such an abundance of liquidity has also led to rapid credit growth, speculative equity valuations, and booming property prices in oil-producing countries. And signs of overheating have lately become more apparent, with higher inflation rates across the region.
The oil-driven liquidity boom is pushing inflation beyond the comfort zone.Holland’s discovery of vast natural gas and oil deposits in the North Sea introduced a new term to economic literature — the Dutch disease — describing how the wealth of natural resources may also cause economic and financial distortions. There are of course several options to deal with the resource curse, but the volatility of commodity prices nevertheless makes it a challenging task. The sharp increase in oil and natural gas prices, for example, has led to a flood of export earnings and raised income growth well beyond the underlying trend rate in the Middle East and North Africa. The resulting liquidity boom increased money supply by 20% a year and put upward pressure on domestic prices. According to official statistics, inflation in oil-exporting countries accelerated from 5.7% in 2002 to 6.4% in 2005 and 7.8% this year. Albeit well above the ‘price stability’ range, the latest figure is oddly not seen as an immediate threat. Price indices with unrealistic and distorted weights do not reflect ‘true’ inflation. The muted level of inflation is a curious development, especially considering the fact that monetary expansion has reached to an average annual rate of 20% in the past five years. Can financial innovation account for such a significant divergence? We think not. In our view, the real culprits are measurement errors in constructing price indices that underestimate inflation and fixed exchange rate regimes that partly divert inflation pressures from consumer prices to asset markets. Indeed, independent surveys suggest that inflation, for example in the United Arab Emirates, is running at an annual rate of 15-20%, as opposed to 8% according to official figures. The key source of underestimation is also the major source of inflation: non-tradables. With petrodollar liquidity and accommodative monetary and fiscal policies, it is not surprising to see accelerated credit expansion and booming real estate prices. And, of course, consumer price indices based on unrealistic weights of non-tradable components fail to capture these underlying inflation pressures in the region’s oil-rich countries. Pegged currencies and negative real interest rates complicate the adjustment process.Although abundant liquidity creates a window of opportunity to accelerate structural reforms, oil producers have so far failed to take advantage of windfall revenues. Instead, the great majority is still relying on subsidies to curb inflation pressures. For instance, the average pass-through from oil prices to consumer prices in oil-exporting countries was just 20% in the last five years. Furthermore, wage increases — reaching as much as 25% in the case of the United Arab Emirates — worsen inflation dynamics as well as the ‘core’ fiscal stance excluding oil revenues. On an aggregate basis, the non-oil budget deficit of oil-producing countries widened from an average of 27.2% of non-oil GDP in the 1998-2002 period to 37.5% this year. Higher commodity prices may continue bringing windfall gains, but loose fiscal policies and negative real interest rates still make a dangerous mix of economic and financial instability, in our view.
Important Disclosure Information at the end of this Forum
'Fast and Steady'; Macro Controls Maintained
Oct 19, 2006
Denise Yam (Hong Kong)
Economy expands 10.4% YoY in 3Q06. Economic growth decelerated in 3Q06, led by a slowdown in fixed asset investment that more than offset the further pick-up in exports. Real GDP growth came in at 10.4% YoY, down from 11.3% in 2Q. Nominal GDP reached Rmb5003.4 billion in 3Q06, with the YoY increase slowing to 11.7%, down from 14.3% in 1H06. For the first three quarters in aggregate, the economy grew 10.7% in real terms and 13.4% in nominal terms. Fixed investment slowed in response to macro tightening. The slowdown in (urban) fixed asset investment growth from 33% YoY in 2Q to 24% in 3Q was the main driver behind the growth deceleration. Including capex in rural areas, total fixed investment in the economy also cooled somewhat, up 27.3% in the first nine months, down from 29.8% in 1H06, totaling Rmb7.2 trilion. Administrative controls on lending and capex in specific industries, as well as stricter rules on land use, appear to have brought down gains in investment, and the government first ‘celebrated’ such success with the August urban FAI data, which showed growth dropping significantly to 21.5% YoY. Nevertheless, the gain in September actually reaccelerated to 23.6% YoY. This probably helps explain the faster-than-expected gain in industrial production in September, at 16.1% YoY (+15.7% in Aug) to Rmb775.4 billion. Robust and resilient consumer demand. As policymakers intended, macro tightening was not targeted at consumption. Support given to the household sector, such as raising minimum wages in cities and subsidies and support to rural households, has given a boost to consumer demand. Retail sales growth stayed strong at 13.9% YoY in September (+13.8% in August), maintaining such a strong pace in the past two quarters. Although we remain wary that China’s ‘retail sales’ data incorporates part of the fixed investment story, such as the sales of construction and renovation materials and furniture, consumers are indeed spending more. There has been some genuine pick-up in sales of non-investment-related consumer goods, such as cosmetics, jewellery and autos. On track to reach 10.5% growth forecast for 2006. As macro tightening softens domestic investment demand, strong exports and the expanding trade surplus have once again regained importance as a driver of growth. We believe that real GDP growth, having averaged 10.7% in the first three quarters, is on track to reach our 10.5% forecast for 2006. Meanwhile, Chinese producers are continuing to push output onto the international market. Our forecasts incorporate further expansion in China’s trade surplus, to US$154 billion this year (US$110 billion in the first nine months), and US$178 billion in 2007. The current account surplus is expected to remain above 7% of GDP this year and next. Enhancing controls in place; wait and see before more measures. With respect to whether further tough measures on the economy will be introduced, recent statements by Premier Wen Jiabao, NDRC Chairman Ma Kai and Statistics Bureau spokesman Li Xiaochao today send a consistent message. While claiming success of the tightening policies so far, they all reiterated the need to maintain and even strengthen controls on the economy. In particular, Mr. Li stated that external economic conditions and trade data in the next few months will help determine the need for further policy moves. China rolled out a wide range of tightening measures over the past few months, and the impact of such measures is just showing up in the latest economic indicators. The macro controls currently in place, in the form of raised barriers for market entry, stringent approval criteria for new investment projects and strict controls on land use, should help contain the growth in capex. Inspection teams have been dispatched this week to 12 provinces to investigate and ‘clean up’ investment projects that are not consistent with national economic planning. Cooling excessive investment should help ease the pressure on the environment and the supply of natural resources, and hence their prices. We agree that tight controls need to be maintained to prevent overheating again. Excessive investment in China has been supported by the availability of low-cost capital, made possible by the large balance of payments surplus over the past few years. China has continued to run surpluses on both the current and capital accounts, amounting to US$91.6 billion and US$37 billion, respectively, in 1H06. Capital inflows sustained by the gradual currency appreciation and expectations for further advances is one of the biggest determining factors for monetary conditions. In our view, the liquidity injection from capital inflows has been offsetting the impact of interest rate hikes, sterilization in the interbank market, and increases in reserve requirements, hence the need for such a complex combination of administrative and market-based measures in managing the economy. The shift in China’s policy focus from growth to rebalancing, restructuring and redistribution underlies our medium-term outlook for the economy. We believe that even if the government does not raise interest rates again in the near future, rates will need to head higher towards a more neutral level consistent with the pace of economic growth. This should enhance the efficiency in capital and resource allocation. Investment opportunities will likely come through sustained gains in domestic consumption over the long term, as opposed to exports and investment over the past few cycles.
Important Disclosure Information at the end of this Forum
BoT Maintains Status Quo
Oct 19, 2006
Deyi Tan (Singapore) and Chetan Ahya (Singapore)
Rates left unchanged, no surprises. The Bank of Thailand (BoT) left the policy rate unchanged at 5.0% in its meeting today. This was in line with market and our expectations. Inflation pressure dissipating, creating room for rate cut. We believe that inflation pressure is dissipating with the recent decline in oil prices and weak domestic demand. Inflation has dropped to a 17-month low of 2.7% YoY in September 06 (versus 3.8% in August). However, the BoT remains cautious regarding uncertainties in the global economy, and highlights that there is still a risk that world oil prices could pick up again. BoT not so concerned on growth. The BoT cited improvement in economic stability and the growth outlook from its earlier assessment. In particular, the central bank underlined that “although domestic demand in the second half of this year softened from the first half, export growth remained robust and economic stability improved. In addition, the decline in inflation was likely to help boost consumers’ purchasing power”. We believe that early rate cuts are needed to revive domestic demand. Domestic demand continues to slow, as reflected in private consumption and investment indicators. While declining oil prices should help to improve household purchasing power, it may not be enough to offset the weak fiscal policy and the current cautious monetary policy stance. Rate cut before the year-end or early next year? We believe that the BoT prefers keeping real rates higher to maintain a slight appreciation bias in the exchange rate to ensure stability in times of political uncertainty at the cost of growth. We believe that the BoT will likely start cutting rates from January 2007, although continued weakening in growth is increasing the possibility of a rate cut at the next meeting on December 13.
Important Disclosure Information at the end of this Forum
Disclosure Statement
The information and opinions in this report were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley & Co. International Limited and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley & Co. International Limited, Taipei Branch and/or Morgan Stanley & Co International Limited, Seoul Branch, and/or Morgan Stanley Dean Witter Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents), and/or JM Morgan Stanley Securities Private Limited and their affiliates (collectively, "Morgan Stanley").
Global Research
Conflict Management Policy
This research observes our conflict management policy, available at www.morganstanley.com/institutional/research/conflictpolicies.
Important Disclosures
This report does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. This report is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.
With the exception of information regarding Morgan Stanley, reports prepared by Morgan Stanley research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in this report change apart from when we intend to discontinue research coverage of a company. Facts and views in this report have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
To our readers in Taiwan: This publication is distributed by Morgan Stanley & Co. International Limited, Taipei Branch; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Dean Witter Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.
This publication is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents. Morgan Stanley & Co. International Limited, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned. In Australia, this report, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act.
Trademarks and service marks herein are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. This report or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request.
|
