Asia hits an oil slick

Indians know the news is bad when the Prime Minister takes to the airwaves to address the nation. That’s what founding father Jawaharlal Nehru did before India’s war with China in 1962, and just under a decade later Indira Gandhi confirmed on television that Pakistan had launched military strikes against Indian airfields.

So when current Prime Minister Manmohan Singh stared down a camera to deliver a message earlier this month, there was no doubting the gravity of the situation.

India was losing a battle of sorts: due to soaring oil prices, Singh told viewers, New Delhi was forced to roll back generous fuel subsidies, meaning everyone was going to start paying more - possibly much more - to cook their food and drive their vehicles.

“There are limits to which we can keep consumer prices unaffected by rising import prices,” Singh said, warning that without the change India could run out of funds to import oil.

A similar sense of crisis has been growing across Asia over the past few months as the price of a barrel of oil has skyrocketed to almost $140, up more than 30% since January.

The spike - coupled with galloping consumer price inflation in general and a slumping U.S. economy - is contributing to fears that an era of remarkable economic growth, particularly in developing countries such as India, may be drawing to a close.

One ominous sign: stock markets throughout the region suffered sharp declines following a record one-day surge in oil prices of more than $10 a barrel on June 6; China’s Shanghai stock market plunged 7.7% on June 10, its steepest drop in a year.

While investors and economists are worried about a number of economic headwinds, rising oil prices, said Merrill Lynch in a recent report, “pose the major growth and inflation risk for Asia going forward.”

This threat comes almost as an ambush. The region’s economies had previously shown resilience in the face of a global credit crunch and troubles in the U.S.

India, in particular, was supposed to weather a downturn relatively well because its economy depends largely on domestic consumption rather than massive exports as does China’s. But there’s nowhere to hide from higher oil prices, and several factors make the crunch particularly painful in Asia.

The vast majority of countries in the region are net importers of oil. Only Malaysia and Vietnam are able to produce enough crude to be net sellers. In addition, several Asian governments for years have spent billions of dollars subsidizing fuel costs to keep it cheap for their poor and often quarrelsome citizens.

But oil is now so expensive that subsidies and price controls are increasingly impossible to maintain. Over the last two weeks, India, Indonesia, Malaysia, Pakistan and Sri Lanka have announced they are reducing or eliminating subsidies.

At oil’s current price level, Malaysia would need to pay some $17 billion a year to hold the line on domestic fuel prices, more than it spends annually on education, defense and health care combined.

The effect of reduced fuel subsidies will ripple through economies, increasing costs across a wide range of industries, boosting inflation, undermining government budgets and stirring up unrest among citizens who are already feeling the bite of slower growth.

In India, as elsewhere, the main reason governments impose controls on petroleum products such as diesel, kerosene and liquefied petroleum gas (LPG) is to help millions who live on less than $1 a day - and to give politicians a chance to stay in power on election day.

“There’s the economics of it and there’s the politics of it,” says Suman Bery, director-general of the National Council of Applied Economic Research, a New Delhi think tank. “The politics of it is that LPG and diesel are considered to be sensitive commodities because they impact directly on family budgets.”

But regardless of the intentions of politicians, subsidies and price controls tend to produce unintended consequences. They distort normal consumption patterns and subvert the law of supply and demand.

When oil supplies are low and crude prices rise, consumption falls, bringing prices back down as demand and supply balance out. But if consumers are insulated from the market, paying an artificially low price for fuel, they tend to use as much or even more - which strains supplies further and forces oil prices even higher.

Manipulating markets is a luxury that governments increasingly cannot afford. The Indian government spent almost $9 billion last year on fuel subsidies, adding to the country’s budget deficit. State-run gasoline retailers have been losing billions of dollars as well because they are forced to sell to consumers at prices set by New Delhi.

When the three largest state-owned oil companies warned recently that they would soon run out of money to import oil, the government finally raised price caps.

Since June 4, gasoline is up by 11%, diesel by 10% and LPG by 17%. The price of kerosene, the most widely used cooking fuel, was left unchanged, but the other increases will push up India’s inflation rate, which at 8.24% is already at a four-year high. Public anger is growing.

India’s leftist parties called for a week of protests after Singh’s TV announcement. The states of West Bengal, Tripura and Kerala saw general strikes that emptied the streets.

Slogan-shouting housewives marched through New Delhi, while in Mumbai protestors rode bullock carts to show that cars are now out of reach of the common man (never mind that less than 10% of the adult population owns a car). Says Rajiv Pratap Rudy, a spokesman for the main opposition Bharatiya Janata Party: “This is an economic terror unleashed on the people of this country.” Yet the government may be forced into further hikes should crude prices remain high.

“There is still a large uncovered gap and the recent price rises announced will not cover that,” says Rajiv Kumar, director and chief executive of the New Delhi-based Indian Council for Research on International Economic Relations.

Despite the dose of economic realism that many governments are finally swallowing, there is one Asian country that has resisted any major easing of price controls. China has raised the retail price of diesel and gasoline by just 9% since January 2007. (Over the same period, the price in the U.S. has jumped 77%.) Observers say China will probably stand pat at the pump until after the Beijing Olympic Games in August.

That could keep Chinese happily burning the midnight oil - and keep global oil prices high, since growing demand from China has contributed significantly to crude’s price run-up in the past few years, according to economists. It’s too early to say, but the recent spike in oil prices could be another nail in the coffin in which Asia’s sizzling economic run of the past several years is finally laid to rest.

With reporting by Baradan Kuppusamy/Kuala Lumpur, Zamira Loebis/Jakarta and Madhur Singh/New Delhi.