Impact of Oil Price

Increase in Vietnam
and Policy Response

Seminar at the Institute for

Price and Market Research
October 21, 2005

1
 Outline

9Key stylist facts (Price developments)

9Net impact on the economy to date
9Outlook and assumptions for 2006
9Possible outcomes and Policy options

2
Crude oil price has been rising for the last several
years. But domestic price is adjusting with a lag.

50 70
Crude oil USD/barrel (RHS)
45
Crude oil (% change) 60
40 Domestic price (% change)
35 50

30
40
25
30
20

15 20
10
10
5

0 0
3
2003 2004 2005 2006
 Domestic petrol price adjustment has been largest,
with other products only catching up in 2005
2003 2004 2005
Period average
- Unleaded petrol RON 92 12.0 15.6 34.7
- Unleaded petrol RON 90 12.5 16.2 35.9
- Unleaded petrol RON 83 13.0 16.8 37.0
- Diesel 0,5%S 0.0 7.0 31.9
- Kerosene 0.0 8.1 30.1
- Fuel Oil (FO N 2B) 0.0 7.9 28.3
Simple average 6.3 11.9 33.0
End period
- Unleaded petrol RON 92 12.0 33.9 33.3
- Unleaded petrol RON 90 12.5 35.2 34.2
- Unleaded petrol RON 83 13.0 36.5 35.2
- Diesel 0,5%S 0.0 10.2 54.6
- Kerosene 0.0 11.6 56.3
- Fuel Oil (FO N 2B) 0.0 11.6 45.7
4
Simple average 6.3 23.2 43.2
 The world’s experience: pass
through for oil products
• Domestic gasoline prices in a majority of
countries have increased in absolute terms by
more than in the United States, where adjustment
is generally regarded as complete.

• Nevertheless, in a number of countries the

absolute price increase has been significantly
smaller than in the United States, suggesting the
pass thought may have been incomplete in those
countries. The incomplete pass through is
significant in most oil-exporting countries.
5
 Domestic Retail Fuel Price in
Vietnam and in the world
Price level in U.S. cents per Price level relative to U.S
liter

End End Mid End End Mid

2002 2004 2005 2002 2004 2005

World 62 82 89 1.74 1.72 1.56

Crude oil 54 69 72 1.52 1.46 1.27

Exporters

Crude oil 63 85 92 1.78 1.78 1.62

Importers

Vietnam 34 48 63 0.96 0.91 0.78

6
Crude oil export volume peaked in 2004; surprisingly import volume
increase has been remarkably low relative to real GDP growth.

9000 25000

8000

20000
7000

6000
15000
5000

4000
10000
3000

2000
5000

1000

0 0
2003 2004 2005

Crude oil exports (US$ mn) Petroleum imports (US$ mn) 7

Exports ('000 metric tons) (RHS) Imports ('000 metric tons) (RHS)
 Oil revenue has been rising steadily, but not as fast as nominal GDP.
Crude oil export revenue is by far the single largest revenue source.

70000 8.4

60000 8.2

50000 8.0

40000 7.8

30000 7.6

20000 7.4

10000 7.2

0 7.0
2003 2004 2005

Oil export revenue (VND bn) Duties on imports (VND bn) 8

VAT and excise (VND bn) In percent of GDP
 Contribution to inflation from higher oil prices has been modest
partly because of the low weights in the CPI basket, and slow
adjustment in administered prices.

2003 2004 2005

Direct 0.17 0.71 0.78
Fuel for cooking 0.07 0.25 0.29
Fuel and lubricants 0.10 0.46 0.49
Implied inflation (weight 3.3%) 5.42 24.04 26.95
Indirect 0.06 0.04 0.07
Electricity 0.03 0.00 0.01
Public transportation 0.04 0.04 0.06
Total 0.24 0.75 0.85
Implied inflation (weight 5.9%) 4.09 13.49 15.49

9
 Net impact of the oil sector on the economy
(In percent of GDP)

2003 2004 2005

Overall economy
Net oil impact on the trade balance 3.5 4.6 4.9
Net profit remittances by FIEs (estimates) -3.1 -5.1 -6.1
Government 7.5 8.2 8.1
From crude oil 5.8 6.6 6.5
From petroleum imports 1.7 1.7 1.6
Private sector
Imports of petroleum product 6.2 7.9 10.3
Government subsidy 0.7 0.8 1.5
Memorandum items:
Exports of crude oil 9.7 12.5 15.3
Net external balance from oil trade 0.4 -0.5 -1.2
10
 Looking ahead…
Basic assumptions on outlook

2005 2006
Case 1 Case 2
Crude oil (US$/barrel) 54.23 61.75 71.75
GDP (USD bn) 50.8 56.0 56.0
Percent change 12.0 10.2 10.2

Crude oil export volume (% change) -5.0 0.7 0.7

Petroleum import volume (% change) 2.2 8.5 8.5

11
Understanding the flow of funds of oil exports and
imports—key role played by the government
State Government
asset Crude oil
exports
Crude oil revenue

Taxes Petroleum
products
imports
Spending Subsidy

Natural (oil) Private

resources sector
12
 What should the government do?
Objectives
• As a general principle
– Ensure that natural resources remain at least as valuable
in another form for future generation than in the current
form of crude oil
9 Investment with efficiency considerations
– Avoid Dutch disease phenomenon
• When faced with higher oil prices
– Ensure aggregate demand is contained
– Dampen any adjustment costs
– Allow relative price changes to provide appropriate
signal to the economy
13
 What should government do?
Instruments
• Fiscal policy
– Spending allocation of oil revenue
– Saving vs. spending
• Price control
– Control of price pass through
– Subsidy
• Other policy measures
– Monetary and exchange rate policy
14
 Quantitative assessment of possible scenarios in
2006 under policy neutrality (In percent of GDP)
2005 2006
Case 1 Case 2 Difference
Overall economy
Net oil impact on the trade balance 4.9 4.5 5.2 0.7
Net profit remittances by FIEs (estimates) -6.1 -5.4 -6.2 -0.9

Government 8.1 10.1 11.8 1.7

From crude oil 6.5 8.2 9.6 1.3
From petroleum imports 1.6 1.9 2.2 0.3

Private sector
Imports of petroleum product 10.3 11.4 13.2 1.8
Government subsidy 1.5 1.4 1.4 0.0
Implied domestic petroleum price change 15.5 36.8

Memorandum items:
Exports of crude oil 15.3 15.9 18.5 2.6
Net external balance from oil trade -1.17 -0.85 -0.99 -0.14
15
 Some trade offs!
• Subsidy vs. inflation using 2006 as an example
Subsidy (VND trillion) 12.5 28.9
In percent of GDP 1.4 3.2
Domestic petroleum price inflation (in %) 15.5 36.8
Contribution to overall inflation (in %) 0.5 1.0

• Dampening the impact on the poor vs. providing

correct price signal upfront
– Would depend on the nature of the oil price increase;
and
– Policy responses in other countries.
16
 More specifics on recent inflation developments
Non-food inflation is catching up!
1.9
Contributions to inflation
1.7 (seasonally adjusted, in percent)

1.5

1.3

1.1

0.9

0.7

0.5

0.3

0.1

-0.1

-0.3

-0.5
Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05

Food Housing Transport (inl. petroleum) Other

17
Possible implications on aggregate demand
from higher oil price
• Aggregate demand could weaken as the private
sector is faced with higher input cost and prices.
– Will observe both income and substitution effect.
• If the net impact on the external current account
balance is indeed negative, then higher oil price
will lead to loss of income, and compound the
contraction effect noted above.

But the role of the government is key!

18
In standard oil importing country case
(No government involvement)

Result of an oil price increase

• C/A deficit widens
• Income effect (demand contained)
– By higher imported price
• Substitution effect
– By exchange rate depreciation
• Secondary effect from loss of income
• C/A deficit contained
19
 In oil importing country case
(Government is the sole importer)
• Result of an oil price increase
• C/A deficit widens
– If government passes on the cost fully, then the same
process as in the above case.
– If government takes on the cost (in whatever form),
then it will need to raise more resources to cover for the
cost.
9 If the money is raised from additional tax, the the end result
will be the same as before, except that there will be distortion
(domestic relative prices do not reflect international price
changes), and have redistributional effect (from general to tax
payers).
9 If the money is borrowed, then the government is holding off
adjustment at the cost of liabilities that future generation has to
bear (inter-generational transfer). 20
 In oil exporting country case
(Government is the sole exporter)
Result of an oil price increase
• C/A surplus widens,
– if government saves, nothing happens.
– If government spends (net injection), C/A
surplus will induce income to rise.
• Income effect (demand expands) and will
either lead to inflation or higher imports;
• Will be assisted by exchange rate
appreciation (real appreciation).
21
 Vietnam:
The government is the (de facto) importer, and exporter

Result of an oil price increase

• C/A subject to profit transfers; assume that
the overall impact is negative
– Government passes on the cost partially and
with delay.
– The cost is borne by oil export receipts (wind
fall gain), and hence no additional absorption.
Hence government is holding off (or delaying
adjustment).
But… 22
 Vietnam:
Government is the (de facto) importer, and exporter

But…
• Income is generated from higher oil revenue, in
addition to the subsidy.
• Government spends the extra income on
investment (net injection).
• However, this additional amount of injection is
less than the amount spent on oil imports due to
the increase in oil prices.
• Hence, real income will fall, and the CA deficit
will adjust, but the substitution effect will be less
than under no government intervention.
23
 Oil related Interaction between the
government and the rest of the economy
2004 2005 2006
Case 1 Case 2 Case 2a Diff 1 Diff 2a
Government
Revenue 8.2 8.1 10.1 11.8 11.8 1.7 1.7
Crude oil export (windfall) 6.6 6.5 8.2 9.6 9.6 1.3 1.3
Petroleum imports (absorption) 1.7 1.6 1.9 2.2 2.2 0.3 0.3
Expenditure
Subsidy (injection) 0.8 1.5 1.4 1.4 3.2 0.0 1.8
Net balance (injection-absorption) -0.8 0.0 -0.4 -0.8 1.0 -0.3 1.5
Net balance plus injection of windfall gain 5.7 6.5 7.8 8.8 10.6 1.0 2.8

Economy
Government net injection 5.7 6.5 7.8 8.8 10.6 1.0 2.8
Spending on imports -7.9 -10.3 -11.4 -13.2 -13.2 -1.8 -1.8
Net cost on the private sector -2.2 -3.8 -3.6 -4.4 -2.6 -0.8 1.0
Financed from foreign borrowing 0.5 -1.2 -0.8 -1.0 -1.0 -0.1 -0.1
Financed from domestic saving 2.6 2.7 2.7 3.4 1.7 0.7 -1.1
Contribution to inflation 0.71 0.78 0.47 1.03 0.47 0.6 0.0

Assume subsidy is financed from borrowing

24
Higher oil prices will require more private sector
savings (if subsidy is financed by taxation)

• More (less) private sector saving is needed

for less (more) subsidy (forced saving) and
higher (lower) inflation;
• More foreign borrowing is needed the
higher oil prices. This can be contained
either through policies to reign aggregate
demand, and expenditure switching through
the exchange rate.
25
 So, what should the government do?

• If oil price increase is permanent, allow

relative price adjustments to provide the
right signal to the market.
• If oil price increase is temporary, there is
benefit to wait the pass through to avoid
price fluctuations.
• If oil price leads to excessive borrowing
need, contain aggregate demand, and as
necessary through expenditure switching.
26
 What about monetary and fiscal policy mix?

• For containing aggregate demand more on a

permanent basis, use fiscal policy;
• For reducing price fluctuations, and
expenditure switching, monetary policy is
necessary.

27
Presenter’s contact detail:

Il Houng Lee
Senior Resident Representative
IMF, Vietnam
Tel: 8 24 33 50
E-mail: ilee@imf.org
www.imf.org/hanoi

“The views expressed in this presentation are those of the author

and should not be attributed to the International Monetary Fund,
its Executive Board, or its management.” 28