Running down the oil stimulus Part 1

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The global economy is looking increasingly fragile over the past year. After conditions looked ripe for a sustained recovery in the start of 2014, the global economy looks to have taken a turn – or several turns – for the worse.

Geopolitical uncertainty in the Middle East and Ukraine, the re-escalation of the Eurozone crisis (twice) and the impact of the collapse in commodity prices on emerging markets have taken the steam off the global growth engine. The latest addition to this ‘rollercoaster of risks’ (see our latest Manufacturing Outlook report) is a couple of stock market crashes in China and a deepening of concerns over a significant slowdown in its real economy.

A persistent counter-vailing force to these headwinds has been the stimulus provided by the low oil price to net oil importers, which includes most major advanced economies, as well as the big ‘emergers’ China and India. According to the Citigroup in October 2014, the oil stimulus amounts to about $1.1 trillion boost to the global economy.

A lot of discussion has revolved around how dependent global growth is on the persistence of the oil stimulus propping up household consumption and investment in consumer-facing sectors. Attempting to approximate an answer to this question we have modelled the impact of the oil price jumping back to $100 per barrel in q4 2015 and staying put for the next two years. The scenario is premised on a supply-side response by OPEC, whereby the cartel cuts output to allow prices to climb up to pre-June 2014 prices.  

 

Global growth tanks

A near-doubling of the oil price in the final quarter of 2015 would have important ramifications for the global economy over the next two years. Our scenario pushes the rate of global growth down to 2.3% in both 2016 and 2017 - the lowest since 2009.

OilStimulusWorldGDP 

Consumer the loser

As expected, household consumption – the largest component of world GDP – would suffer from a steep rebound in the oil price. An increase in the global inflation rate of around 2pp above our baseline in 2016 and 0.7pp in 2017, would erode consumer purchasing power and push central banks to tighten monetary policy.

 OilStimulusWorldHHC 

Ten year government bond yields would double to 6.2% in 2016 compared to 3.1% in our baseline, as central banks hike interest rates to stave off inflation, encouraging consumers to save, increasing debt servicing costs and the price of lending. The scenario shaves off 1pp in 2016 and 0.5pp in 2017 from annual growth in household consumption compared to our baseline.

 

Investments bears the brunt

An increase in the cost of capital in conjunction with a fall in consumer spending means that total fixed investment would bear the brunt of the negative impact from a higher oil price. A pickup in capital expenditure in the oil & gas industry would help cushion the blow in 2016 but that impact dissipates in 2017. As a result, investment in the global economy would grow by just 1.9% in 2017 compared to 4.4% in our baseline.

 OilStimulusWorldIXM 

Finally, under our scenario, the weakness seen in world trade in 2015 would extend for another two years. Trade volumes would stall, growing by 1.5pp and 1.2pp lower than our baseline in 2016 and 2017 respectively, with imports – via subdued household consumption – losing out more than exports.

All in all, our modelling shows that global economic growth would be seriously undercut should the oil price jump back up to $100 p/b. In the second part of this blog – published next week – we will look at the ‘winners and losers’ from a higher oil price in terms of individual countries as well as exploring the likelihood of our scenario becoming reality.

 

To be continued…

 

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