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GDP impact of oil price shock

Theo Janse van Rensburg's picture

The current turmoil in the Middle East and North Africa has been associated with a $22/bbl increase in oil prices from $90/bbl in December 2010 to $112/bbl by late April 2011 (a 40% increase over the average price of $79.60/bbl in 2010).

In the World Bank’s latest baseline projections, oil prices are expected to gradually decline toward a long-run equilibrium price of about $80/bbl in constant 2011 dollar terms. This implies annual price levels of $107/bbl in 2011 drifting to $96.70/bbl by 2013.

But if current uncertainties persist or a major supply disruption occurs, especially involving larger oil exporters, oil prices could remain high or even rise further, with serious consequences for developing countries and global growth.

Simulations suggest that a further $50/bbl rise in oil prices for one year (beginning in the second half of 2011, for example) could shave off 0.5 and 1.0 percentage points from global output in 2011 and 2012 (see Table 1).

The initial impact of an oil price shock mainly impacts countries through their terms of trade, but it will also raise inflation and interest rates, with the inflation impact (and monetary response) of developing countries likely to be much stronger due to the larger weight of fuel in the consumer basket and/or monetary policy credibility/inflation expectations not as well entrenched as in advanced economies.

Under this scenario, oil exporting countries will see a gain in real income as prices of merchandise exports rise. The income effect will be strongest where exports represent a large share of GDP and the export basket is less diversified (for example in Angola and Nigeria). Oil exporting countries in the Sub-Sahara Africa region and the Middle East and North Africa region could see GDP gains of around 6.6% and 2.4% in 2012, respectively. The oil-importers in Europe and Central Asia will benefit from strong Russian imports.

On the flipside, the economies that will be most negatively affected are the oil-importing countries in the Middle East and North Africa region and the East Asia and the Pacific region, which could see output fall by 2.4% and 1.9% in 2012 respectively, reflecting both the direct effect of higher oil prices on incomes in these regions as well as their greater reliance on exports to other negatively affected oil-importing regions.

GDP declines in oil importers reflect real income declines as the cost of oil and related goods and services rise. This will raise inflation and interest rates, which lowers lower demand, reduces competitiveness, and as a result, output declines. Countries with close economic ties to oil exporters (for example those in Europe and Central Asia) tend to be affected less as they will benefit from higher export demand from oil exporters.

In terms of external balances, current account balances as a share of GDP are expected to rise by up to 6.2% of GDP in oil-exporting Sub Saharan Africa, and by about half that much in the Middle East and North Africa. In East Asia and the Pacific, external balances may decline by about 1% of GDP.

Under the same scenario, high-income oil exporting countries will see a fall in output, largely driven by adverse GDP impacts in Canada and the UK, whose non-oil exports are negatively affected by slowing global demand. Excluding these two countries, the impact on the remaining advanced oil exporters is positive. Also in East Asia and Pacific, the outcome for oil exporters is negative, due to Malaysian non-oil exports being adversely affected by falling global demand (once again, excluding Malaysia, the net GDP impact is positive).

Comments

Submitted by Anonymous on
Could you please explain why the inflation occurs and interest rates rise in the 5th paragraph after the table? And also how inflation creeps its way into food prices and what food items will be affected the most due to oil price increase?

When the oil price increases, it not only directly raises the cost of fuel/gas for consumers, but it also raises the costs of all other goods that are transported. These price increases will be passed on to the consumer, giving rise to inflation. With prices rising, workers (and/or unions) will pressure employers for higher wages to compensate for the increased cost of living. If there is a risk of price increases translating into a spiral of rising producer costs and wages – then central banks is likely to intervene by tightening monetary policy – by for example raising interest rates. The higher interest rates will then act as a “signal” to market participants that “monetary authorities” will not tolerate higher inflation. (Higher interest rates will lower disposable income and suppress demand – therefore making it difficult for firms to pass on price increases and/or agree to “excessive” wage demands). To come back to your question on the impact on food items, higher energy prices affect production costs (directly through fuel and fertilizers), as well as due to the higher the cost of moving food from the farmgate to the market. Obviously, the effect will be less for commodities with a high value and low weight and vice versa. Estimates suggest that a 10% increase in energy prices is associated with a 2 to 3% increase in the prices of grains and vegetable oils (also see Commodity Annex, P10 http://siteresources.worldbank.org/INTPROSPECTS/Resources/334934-1304428586133/GEP2011bCommodityAppendix.pdf). Note also that over the longer term, high energy prices tend to affect food prices through the biofuel channel.

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