Largest dip in oil prices bound to affect government revenues, economists say

Poovenraj Kanagaraj and AFP

Arab stock markets plunged almost a quarter in value in the first three months of 2020 because of the Coronavirus pandemic and the collapse in oil prices, a UN agency said.

Arab stock markets plunged almost a quarter in value in the first three months of 2020 because of the Coronavirus pandemic and the collapse in oil prices, a UN agency said.

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“The drop in oil prices and the COVID-19 pandemic resulted in a 23 percent average loss for major Arab stock markets by the end of the first quarter of 2020,” the Economic and Social Commission for Western Asia said.

The twin crises have “shattered the stock market in Arab countries, putting the performance of financial markets below the 2008-2009 collapse”, ESCWA said in a report.​​​

It said share price values of the largest banks of the oil-rich Arab states in the Gulf also crashed by 25 percent in the first quarter of this year.

ESCWA and the Union of Arab Banks said credit to the private sector is expected to contract by $14.5 billion in the six Gulf Cooperation Council states, and by $11.3 billion in non-oil, middle-income countries, totalling a decline of about $26 billion in 2020.The UN agency said a regional economic revival could be dependent on support from Arab sovereign wealth funds.​​​​​​​​​​​​​​​​​​​​​​

“Shifting part of these funds’ global investments towards investing in Arab economies may ease the pandemic’s repercussions and reduce rampant unemployment in the Arab region,” it said.

Such a strategy would also “limit the exposure of these funds to the volatility of international financial markets”.​

ESCWA urged Arab central banks to “continue providing adequate liquidity to the financial system at any cost during the relief period and during recovery”.

For small- and medium-sized businesses, loan restructuring was essential to head off default risks.

The oversupply of crude oil as a result of the ongoing Coronavirus crisis recently saw a historic outcome as US oil prices turned negative for the first time as oil producers ran out of space to store them.

This had resulted in a collapse that saw the price of the US crude oil crash from $18 a barrel to minus $38 in a matter of hours recently.

Oil prices jumped 40 percent, recovering from early losses. However, with the global demand for oil having fallen dramatically, the pain for the oil prices is far from over.

According to economics and strategy head at Mizuho Bank in Singapore, Vishnu Varathan, oil prices do not seem to be in a position where they can sustainably recover in the near term. “Markets are taking that as a barometer for the demand and currently the demand deficit is deemed to be rather severe,” Vishnu says.

Vishnu points out that some of the factors that have costed the demand for oil such as the ongoing lockdowns which has also resulted in a huge drop in international and domestic travels will see the issue linger around in the second half of the year.

And the US is not going to be the only country affected by the dip. Malaysia being the only oil net exporter in the region saw its bourse react negatively to the change in oil prices. Malacca Securities in a statement to Bernama said, “We remain no change to our views that the Malaysian stocks are increasingly strong and warrant a consolidation. At the same time, the weakness on Wall Street, coupled with the slumping crude oil prices may add to further woes on the key index’s performance over the near term.”

“The dip in oil prices will amplify some of the stresses Malaysia is going through. One of the key things relied on to surpass the stress caused by the pandemic was having a strong fiscal position to be able to spend,” Vishnu says, however with the negative price change taking place, the ability to offset without having to borrow is going to be infringed.

The broken oil prices, according to Vishnu will also pressure the cash cycle among energy-related corporates within the country. “Unfortunately, offset from consumers having lower fuel and energy cost may fall far short from offering any meaningful relief,” he added.

As the present situation takes place at a time when oil demand is expected to be weak, Bank Islam chief economist, Mohd Afzanizam Abdul Rashid says the 6.8 percent contraction for the Q1 2020 gross domestic product (GDP) would mean oil demand may not be forthcoming from China this year as China’s demand for oil accounted for more than 80 percent of global oil demand growth last year.

Speaking on the impact towards the Malaysian economy, Afzanizam says consumers would typically be the main beneficiaries.

While he sounds a similar sentiment on the weak demand due to the Movement Control Order (MCO) enforcement, Afzanizam says food delivery services that have been receiving huge orders during the MCO would see their fuel cost reduced, leading to a better profit margin.

“The government’s revenue, on the other hand, would be affected. However, their reliance on oil-related revenue has been reduced by 41 percent in 2009 to about 20 percent this year,” the chief economist says.

Afzanizam also tells Business Today that the government revenue is still sturdy as corporate income tax and personal income tax share to the government revenue have risen from 23 percent and 11 percent in 2010 to 29 percent and 14 percent in 2018 respectively.

Manokaran Mottain, chief economist at Alliance Bank Malaysia Berhad says the impact on the country will also affect both government revenue and investor sentiment.

“For example, if we were to assume that with RM300 million losses in government’s oil revenue for every $1 decline in oil prices, at the current $16 level, there will be a revenue loss of RM13.8 billion, when compared to last year’s oil price forecast of $62,” he says.

Manokaran points out that the country can expect the oil price to recover after the Covid-19 pandemic is contained or when economies regain traction after the withdrawal of cities lockdown, driving up oil demand.“OPEC and other non-OPEC oil-exporting countries are joining hands to cut oil production and taking measures to oil prices,” he says.

In terms of any recovery measures, finance minister, Tengku Zafrul has pointed out that they have factored the low oil prices in their fiscal deficit and GDP forecast. And if the low oil price persists, the government will reprioritize its expenditures to meet the fall in revenue.Alternatively, the government may consider cutting down the dependency on oil revenue.“Even as recovery comes through, there will be precautionary conservation of cash where general demand will be weak. A lot of businesses and consumers will conserve cash where they can and this will continue to linger up till the third quarter of the year,” Vishnu tells Business Today.

Vishnu points out that the government will have to start streamlining its operational and sufficient funding to cushion business so that cash flow doesn’t become an insolvency crisis. He also urges to not lose sight of job preservations and of the economy as well.

“Sufficient borrowing and pumping will have to take place while the central bank (Bank Negara Malaysia) comes in with the backstops to ensure the financial market functions smoothly,” Vishnu tells Business Today Malaysia.

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