Listen to Gaia
Apr 19, 2006
Serhan Cevik (from Washington)
Supply-side shocks, reminiscent of the 1970s, push energy quotes higher. The surge in crude oil prices — from $10 a barrel in 1998 to $70 this year — is a clear indication of sustained higher prices in the foreseeable future and a strong incentive for developing new energy technologies. According to the International Energy Agency, the global demand for crude oil and natural gas will be significantly higher than originally estimated, just as oil exporters operate at maximum limits. The increase in demand, especially from fast-growing, energy-inefficient economies, will keep narrowing the gap between supply capacity and demand in the global petroleum market. Although this alone is enough to push oil prices to an elevated plateau, geo-political supply constraints are also becoming far more influential over the commodity markets. Russia’s manipulation of its monopolistic position in the European natural gas market, the Venezuelan leadership’s interest in using oil as an instrument of politics, rebel attacks on oil facilities in Nigeria and, of course, the stand-off between Iran and the west show that supply-side factors, reminiscent of the 1970s, have raised the ‘equilibrium price’ of crude oil and natural gas well beyond historical valuations.
Only new technologies can reduce oil dependence and carbon emissions. With 10% of the world’s reserves, Iran is the second largest producer in the Organisation of the Petroleum Exporting Countries. Therefore, an escalation, even without turning into a military confrontation, could disrupt oil supplies and, given the state of the oil market, lead to a price explosion. However, even if we assume the peaceful resolution of the Iranian crisis and other conflicts around the world that have had adverse effects on supply conditions, the growing scarcity of fossil fuels is a wake-up call that should revive interest in conservation and alternative energy systems. In the short term, the best option for increasing energy security is demand-side measures improving energy efficiency. But, as the world’s energy requirements double almost every ten years, we also need supply-side solutions to overcome the energy crisis and to deal with the problem of global warming. Only new technologies, including nuclear power, can reduce oil dependence and greenhouse gas emissions to a sustainable level. Not surprisingly, even some prominent environmentalists now take a stance for nuclear energy. Sir James Lovelock, for example, argues that “civilisation is in imminent danger [and] we must accept nuclear energy as the one safe and proven energy source that has minimal global consequences” (see The Revenge of Gaia, London: Allen Lane, 2006). Diversifying Turkey’s energy portfolio will help reducing vulnerability to supply disruptions. Turkey’s fossil-fuel imports increased to 6.2% of GDP, as it imports 72% of its energy demand. If no measures are taken, that will increase to 82% by 2020, with 95% of oil imports coming from the Middle East and 82% of natural gas from Russia and Iran, and make the economy more vulnerable to price increase and supply disruptions. Indeed, higher prices have already created a drag on output growth, slowed the pace of disinflation and contributed almost 90% of the widening in the current account deficit. This is why we have argued in favour of developing alternative energy systems including a nuclear energy programme. Realising Turkey’s pernicious dependence on imported fossil fuels, the government has finally decided to build the country’s first nuclear power plant in an attempt to diversify energy supplies. The plan envisions building four atomic reactors with a total capacity of 5,000 megawatts, which would be enough to generate 5% of the projected electricity demand by 2015. In our view, nuclear power, accounting for, on average, 15% of total electricity generation in the EU, will also have positive externalities, like technology transfer and research capabilities, for the Turkish economy. Reliable, low-cost energy is a requirement for sustainable development. Beyond geo-political considerations, energy prices are already too high in Turkey and hurting the corporate sector’s competitiveness. Therefore, the country needs a new strategy to diversify energy supply, to increase energy security and to reduce the cost of electricity. In addition to building a network of nuclear power plants, Turkey has considerable scope to develop biofuel capacity and renewable forms of energy (which currently account for only 3% of electricity generation) and to improve energy efficiency. The ‘transmission loss’ ratio is 23%, compared to an average of 7% in other OECD countries, and even a 10% saving would pay for nuclear power plants Turkey plans to build. Going forward, greater diversity will no doubt help reduce Turkey’s vulnerability to shocks, but the path towards energy security, even with increased diversity, will be long and challenging.
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Inflation Concerns Dissipate..Rate Hikes Deferred
Apr 19, 2006
Chetan Ahya (India) and Mihir Sheth (India)
No Rate Hike For Now In its annual monetary policy announcement, The Reserve Bank of India (RBI) left the short-term policy rate and the cash reserve ratio unchanged. With headline inflation under control, the RBI opted to leave interest rates unchanged. We believe the government is keen to keep interest rates low so as to avoid adversely impacting the nascent capex cycle. The RBI’s monetary policy stance, which was earlier tilted towards containing inflationary pressures, now seems be more balanced, with an equal focus on maintaining growth momentum and price stability. While indicating its comfort with current macro conditions by leaving rates unchanged, the RBI also highlighted the risks that could swiftly alter the rate environment. Strong Growth Outlook Maintained RBI expects F2007 growth to be in the range of 7.5-8%, compared with 8.1% estimated for F2006. However, there appears to be some inconsistency in the RBI’s forecast of almost steady real GDP growth. First, the RBI is expecting a sharp deceleration in credit growth to 20% from 30% currently, even it expects investment to pickup. Second, monetary policy has recognized a significant deceleration in corporate sales growth, implying that the economic growth trend appears to be reversing. As per the monetary policy statement, private corporate sector sales growth decelerated to 13.2% during the quarter ended December 2005, from 21% during the quarter ended March 2005. This decelerating trend is also evident in industrial growth over this period. Expecting Slower Credit Growth The RBI has highlighted its concerns on strong credit growth, particularly in select sectors, such as borrowing by individuals and real estate lending. This concern appears to be justified considering that 66% of the incremental credit disbursement in April-January 2006 was attributable to non-industrial non-food/agriculture related sectors. RBI has initiated some measures to influence the quality of credit growth, including: (a) increase in risk weights on commercial real estate to 150% from 125% (the central bank had earlier effected an increase to 125% from 100% in July 2005); and (b) increase in provisioning required on standard assets in specific sectors (personal loans, capital market related loans, residential loans greater than Rs 2 mn and commercial real estate loans) to 1% from 0.4%. However, we believe that, unless these measures result in a significant rise in the cost of borrowing, there is unlikely to be any change in the behavior of borrowers. For instance, although the RBI increased the risk weights for real estate related loans to 125% from 100% in July 2005, the credit disbursed to the sector has continued to grow relentlessly. The incremental credit disbursed to the real estate sector grew at 84% in the period April-January 2006. Keeping Options for Tightening Open The RBI has continued to highlight the key risk factors that still worry it and could also potentially cause a swift reversal in stance. Some of the key risk factors highlighted by the Central Bank are as follows: Concerns arising from strong credit growth: Over the past four policy announcements, the RBI has become increasingly vocal about its concerns on credit quality. In today’s announcement, the RBI also re-iterated that the increasing reliance by banks on funding sources other than deposits warrants much higher attention on credit quality. The Central Bank also mentioned that “in the absence of firm and timely responses by all concerned, the present rate of high credit growth and increase in asset prices seem to pose a downside risk to overall financial stability.” Inflation pressures: The headline inflation rate has remained largely below the central bank’s comfort zone of 5-5.5% over the past 15 months. Headline inflation has been under control over this period due largely to a deceleration in the year on year price trend for global commodity-linked products and government tinkering with domestic oil product prices. However, the RBI today highlighted that the outlook for inflation and the choice of appropriate manner of dealing with the pass-through of oil prices remains “clouded”. It indicated that full pass-through of high oil prices would likely lead to quicker inflation in the coming year and that “there is a need for continuous and close monitoring and appropriate policy responses to contain its inflationary impact”. Global interest rate trend: The Central Bank also highlighted that, with increasing integration with the global economy, rising interest rates in major economies in response to uncertainties (including inflationary pressures) will have a bearing on monetary management in India. Asset prices: The RBI also mentioned that it remains concerned about the inadequate pricing of risk in financial markets leading to higher asset prices and that volatility in prices could become a potential source of instability. It has indicated that the upturn in housing and real estate prices, in particular, will pose a challenge to the monetary authorities throughout the world. Liquidity Reprieve in the Short Term … We believe that liquidity conditions will be stable in the near term, with excess liquidity stock (FX inflows sterilized by way of issuance of short-term paper by the RBI) having returned to comfortable levels. After witnessing a sharp fall to US$12.6 billion as of January 2006, excess liquidity stock has increased to an estimated US$19 billion as of March 2006. We believe this should ensure that short-term interest rates will remain within a band between the reverse repo rate at 5.5% and the repo rate at 6.5% over the next three months. … But We Don’t See This As a Rate Trend Reversal We believe that the current pause in the policy rate trend is not indicative of a reversal in the underlying trend of tightening liquidity. First, the risks (as discussed above) emanating from current trend of high credit will continue to concern the Central Bank. Second, we believe that the gap between domestic credit growth (at 31%) and deposit growth (17%) is unlikely to change quickly. While the recent rise in banks’ lending rates should result in deceleration of credit growth to about 25-27% over the next three months, it is still likely to remain higher than deposit growth. Hence, even if the RBI does not hike the policy rate in July, the overall interest rate environment should remain under pressure given this demand/supply mismatch. Third, a continued uptrend in the Fed rate could also add to the pressure on market-oriented rates. Indeed, currently India’s short-term (policy) real rate is lower than that of the US. We therefore maintain our year-end forecast of a 6.75% 91-day bill rate.
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