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| Sunday, 15 August 2004 |
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| News Business Features Editorial
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The latest oil shock - its implications by Lloyd F Yapa Another oil shock has hit the world. The current price per barrel of crude(petroleum) oil has shot upto a high of over US $ 44, since the OPEC increased the price for the first time in 1973 from US $ 2 .5 per barrel to US$ 15.50 a barrel. Background This time around the culprit does not appear to be the Organization of Petroleum Exporting Countries (OPEC). Demand for this precious commodity has been rising with the recovery of the major world economies from a recession (or period of low demand for goods and services) and the prospect of further increases in demand for heating during the coming winter. The difference this time is that a leap in demand has manifested from the burgeoning economy of China, which last year gobbled up 5.4 million barrels a day, thus becoming the world's second largest consumer, though far behind the USA. The rising demand has been aggravated by the nervousness among buyers generated by instability in the oil rich Middle East, Venezuela and the bankruptcy faced by the Russian oil giant Yukos, due to prosecution for massive tax evasion. In the meantime the suppliers, mainly the OPEC are almost scraping the bottom of their inventories. Will the crisis abate as in the past and the price drop back to the past average level of about $28-30 p.b. ? Experts seem to be tongue tied, due to the likelihood of continued rises in demand by the oil guzzling Chinese industries and the persistence of political instability in the Kingdom of Saudi Arabia, the world's largest individual producer of oil. Therefore the indications are that the oil crisis may continue to stalk the world for some time. Implications Such a (input) supply shock no doubt could have a devastating effect on an oil dependent poor country like Sri Lanka. Apart from being used for production of energy for driving industry, for lighting and transport, it is an input into many products used in the economy such as plastics, textiles and fertilizer. Therefore, when the price of imported oil rises, costs would escalate pushing up prices of goods and services sold, ie inflation would set in. This tendency would be made worse by the depreciation of the currency mainly on account of the likely decline in foreign exchange reserves following higher payments for imports and lower export earnings in the face of increasing production and freight costs as well as a possible blunting of economic recovery in the developed world. Local consumers would then cut down on their purchases compelling entrepreneurs to invest and produce less, restricting the creation of new employment opportunities ie the economy will stagnate. Economists call this phenomenon 'stagflation'. Another shock There is another dark cloud (among other clouds) building up concurrently in Sri Lanka in the form of a second supply shock. Wage and salary earners, whose purchasing power has been eroding steadily due to creeping inflation, mainly on account of the deficit budgeting policies of all previous governments, are demanding compensation. Such wage increases, which exceed the rate of growth of productivity would have the same effect as an oil shock, as firms will then pass on the higher wage bill in the form of higher prices to consumers. If at the same time some of the factories producing textile and apparel are compelled to close down after 31st December 2004, when quotas for such products under the Multi Fibre Agreement (MFA) are phased out, the misery index of this beleaguered nation could sky rocket ! Strategies All would not be lost, however, as long as the leaders of all the political parties and the people buckle down immediately to some serious strategic management/planning without infighting and resorting to tilting against globalization and other imaginary foes. The ultimate goal of all citizens being living a peaceful life free from want, the first strategy for the nation is to settle down seriously to negotiate for a permanent settlement to the ethnic conflict, without preconditions. The ensuing peaceful atmosphere will set the stage for tackling the shocks. The foremost strategy, that can be employed to fight inflation and the decline in economic growth resulting from the above mentioned supply shocks is improvement of productivity ie slashing costs, improvement of yields, value addition and differentiation to command higher prices. For reduction of costs, containing the budget deficit as envisaged by the government (including paying up the massive debt) is a must. If the authorities in addition do not accommodate the shocks by increasing the money supply to prevent the decline in economic growth, the price level will fall back again eventually and employment creation will recover. Markets also have to be deregulated mainly to induce greater competition to reduce input prices and increase their supply. Negotiations with trade unions can be held in collaboration with the business sector, as Australia and Sweden have done, to hold wage rates down in return for benefits such as maintaining the purchasing power of workers in respect of goods and services. Infrastructure development, especially to find alternative sources of energy and for improvement of the transport system is invariably necessary. Generous incentives for research, innovation, training and branding directed at value addition/differentiation are a must to enable producers to earn higher prices. Above all, an investment strategy, inclusive of appropriate policies to reduce uncertainty plus incentives, should be in place for creating additional production capacity for increasing the supply of goods and services. The danger in this game of fighting shocks, however, is that some of the remedies may have undesired after effects, like any medicine .The concerned specialists may therefore be already examining the problem from all angles to come up with the right mix of 'decoctions' to realize the desired cures ie curbing inflationary pressures and keeping the economy humming. |
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