China, oil, panic and recession….(Part 2)

In this post, I am going to opine on another panic-spot in today’s global economy: Oil

Global crude oil prices have fallen more than 150% within the last year. And this has been a major source of concern throughout the world. People looking from the supply side are frightened at the prospect of supply spinning out of control and reaching levels that could crush many oil-exporting countries and companies – resulting in massive bankruptcies and sovereign defaults – which could then lead straight to banks that are highly exposed to the debt of these countries and companies. 

People looking from the demand side are even more frightened at the thought that the global demand is so weak that oil could plunge to such low price levels within such a short time frame. And then there are people who look from both the supply side and demand side and are equally frightened – especially from the threat of global deflation.  

Now, putting the supply and demand dynamics aside for a minute, I would like to look at this whole situation from a different viewpoint. This collapse in global crude oil price is the single largest wealth and cash transfer, in the order of trillions of dollars, from not-so-productive, not-so-innovative and not-so-creative economies to productive, innovative and creative economies. And that is a HUGE positive for the global economy which will pay off in the longer run.

For years, a country like India that is quite dynamic, creative and a demographically favored nation has suffered due to high oil prices. It suffered in the form of very high inflation in the last decade – to the point where millions of Indians literally went hungry because of soaring food prices – which was directly linked to soaring global crude oil prices (remember the $130 per barrel oil?). It suffered in the form of its government wasting hundreds of billions of dollars in subsidies and welfare programs to cushion the impact on the poor from sky high inflation. It suffered in the form of massive wealth-inequality. It suffered in the form of reduced demand for global products from these poor and middle-income Indians as all the productivity and income was spent on buying oil and other price-inflated basic necessities. 

But now, this fall in global crude oil prices have managed to reverse, to-an-extent, some of the problems that I outlined above. Billions of dollars of diesel subsidies have now been eliminated. Billions of dollars of losses on transportation of products have now been reversed. Inflation has come down considerably. Poor and middle-income people are rewarded through low diesel and petrol prices at the pump. All this savings has led to (and will lead to) an increase in demand for quality products – like motor-cycles, fans, air-conditioners, healthier food, better education, cars, mobile phones etc. From the government standpoint as well, these savings from diesel-fuel subsidy elimination and reduced welfare programs has given it the room to invest in public infrastructure like highways, rail lines, airports, sanitation infrastructure etc. 

Now compare what I said above to a wealthy oil exporting country like Saudi Arabia – which already has world-class infrastructure and where the population is so low that the many hundreds of billions of dollars of foreign-exchange from high oil prices in the past was just sitting in its coffers without any productive investment. That money mostly ended up as freebies to its people – who were already well-off and were generating less demand for global products.  

The case of India I presented above will also fit the narrative of many other productive/innovative nations – both developing and developed – like China, ASEAN nations, the United States and many European nations. These are also some of the nations that have a larger population with a considerable amount of middle-income people who will directly benefit from these low oil prices – and who will create an increase in demand for global products. 

Now, all this doesn’t mean that I discount the fear that many global investors have today – especially the threat of deflation – which stems primarily from the twin scenarios of oil crash and a slowing Chinese economy. But this threat, in my opinion, is manageable, and in fact, over the medium to long term, I believe the benefits that I outlined above from low crude oil prices will outweigh any negatives we might see today. 

Now, with respect to banks’ exposure to defaulting oil companies and sovereign-defaults (Russia, Brazil and Venezuela come to mind) – that is indeed a real concern, albeit something that can be contained. I don’t think that any of these default scenarios will affect the global economy as a whole and it possibly, in my opinion, will be contained to one particular sector and few possible companies and countries. 

I would urge that many of these oil exporting countries also take this opportunity to diversify their economies – especially Brazil, which has a sizeable population with a tremendous talent-pool. And I think that the G-20 countries should come together sometime this year and co-ordinate some of their fiscal policies. Such a move will once again inspire confidence in the global markets and more importantly, will help abate the fear that exists in the global markets today. And in my opinion, that fear elimination should act as a priority for these G-20 countries now if they want to sail through the current muddy waters of global economy without pushing any of its members down the ocean.  Will they do it? – is the billion-dollar question. If they do, they can sail smoothly, and if they don’t, the ride might be a little rough this year, but I still believe that they will sail through and reach the shores.