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22 Feb 2005


Diesel Price Hike: Impact on Business Sector and Inflation


The government announced an increase in the diesel fuel price ceiling by 60 Satang per liter to Bt15.19 per liter, effective from February 22, 2005, onwards. The diesel fuel price had been capped at Bt14.59 per liter since January 10, 2004. After the announcement, diesel prices then jumped to their highest level in two years, or since April 2003. Kasikorn Research Center (KRC) has analyzed the trend for domestic oil prices and the impact that it may have on the business sector and the inflation rate, post-hike, as follows:

ท The increase in the diesel price ceiling announced by the government, being the first in more than one year, was the result of pressure from the world's oil prices that have been fluctuating at high levels. (On February 21, 2005, oil prices in the New York market had surged to USD48.82 per barrel, while the Brent Crude price was moving in a range of USD44-45 per barrel.) It is likely that the average oil price in 2005 will stay high, close to the level seen last year when Brent Crude averaged USD38 per barrel.

ท If the diesel price cap measure were kept intact, the state oil fund would shoulder heavier burdens. So far, the state oil fund has faced a loss of as much as Bt68 billion due to subsidies for domestic retail oil prices. Despite the fact that the ceiling for diesel oil prices will be gradually lifted, the state oil fund will remain saddled with higher debts unless prices are floated with the market. By then, the state oil fund may have plunged at least Bt80 billion into the red. Worse, the oil price freeze has caused the public to be less disciplined than they should be, which also does not help support the measure to reduce energy consumption by the general public. At the same time, rising imports of oil have put greater pressure on the trade and current account deficits.

ท Concerning the impact on the business sector, according to KRC's analysis on oil costs to various businesses, it was found that the direct impact of higher oil prices toward the price levels of goods should be limited. In the immediate case, diesel fuel prices that have risen by 4.1 percent to 15.19 Baht per liter will boost the production costs of businesses by around 0.3 percent, on average. In a second scenario, if in the future the government floats diesel prices with world market levels, the cost of diesel fuel may increase by 25 percent (over 14.59 Baht per liter). Overall, the production costs of the business sector would increase by around 2 percent, on average. Businesses most impacted would include the transportation sector - particularly land transportation; the agricultural sector - especially fishing; and construction.

ท Concerning the impact to inflation, rising oil prices, particularly for diesel fuel, will cause inflation through the energy price index. It is expected that for the entire year, oil prices will rise 12.5 percent, on average, over 2004 when the index increased 9 percent. This direction is still subject to influence from forecasts on the economic trend for 2005, for which KRC has forecast inflation of 3.0 percent. This figure would include 1.1 percent as a result of the price of energy on goods; meanwhile, economic expansion is forecast at 5.2 percent. The price level of domestic goods will still depend on other variables apart from oil prices. Other pressures that are expected to affect inflation are the prices of agricultural goods - where drought may cause damage to crops, resulting in price hikes - as well as the price of consumer goods that are still tending toward increase.

ท Moreover, although the impact on production costs may not be that serious, a point that cannot be forecast is consumer self-adjustment toward acknowledgement of the situation in rising prices. Price level increases usually affect consumer confidence and investment, which could be viewed from the response of the stock index that plunged immediately after acknowledging the news of hiked diesel fuel prices, even though the business sector and the general public have known for some time that the government had planned to gradually increase diesel fuel prices to better conform with the market, this year. Consumer self-adjustment by cutting expenses may be more serious than expected as a result of deterioration of confidence, which is a risk factor toward slowing consumption and investment that may soon follow. In addition, international political tensions, such as the nuclear standoff with North Korea and the conflicts between the US, Iran and Venezuela are still something that must be watched because, as it has been demonstrated in the past, unexpected circumstances that induce anxiety toward a steady supply of oil have been an important factor causing volatility in oil prices. KRC