The collapse of global energy prices is equivalent to a tax cut of up to $500bn, providing a major fillip to household finances and boosting the growth prospects in emerging markets, according to Brandywine Global, an affiliate of Legg Mason.
“The collapse in energy costs is equivalent to a huge, globally coordinated tax cut,” says Francis Scotland, Co-Director of Global Macro Research. “The size of that tax cut for the upcoming year is difficult to estimate because it depends on the outlook for energy prices, but $400 billion to $500 billion would be a reasonable estimate, with roughly $125 billion accruing to U.S. consumers. That’s a lot of stimulus to add, suddenly and unexpectedly.”
While consumers in developed markets are clearly set to profit from falling energy prices, says Scotland, he believes many of the benefits will fall on emerging market (EM) countries.
“The decrease in energy costs takes inflation worries off the table for central banks in countries like India, South Africa and Indonesia, allowing them to halt rate hikes or make growth-stimulative rate cuts,” he argues. “For instance, the Indian rupee and Indian equities rallied alongside the January 2015 Reserve Bank of India rate cut, which demonstrates that the markets think the RBI should be cutting and that inflation isn’t an issue.”
Scotland points out that many market analysts believe that better global growth is dependent on EMs starting or accelerating rate cut cycles in 2015. “During the 2013 ‘Taper Tantrum,’ when the U.S. economy started to show cyclical rebounding and longer-term rates increased from very low levels, many EM countries were forced to protect their currencies by raising rates,” he says. “These rate increases, however, pushed many EMs into recession. With EMs cutting in 2015, the stimulative effects of easier monetary policy and the attendant consumer sentiment change may be enough to tip the global economy toward a sustainable lift-off speed.
“Cheaper oil also gives political cover for large energy subsidizers — again, India or Indonesia are good examples — to trim or cut those subsidies, which both countries are doing. Cutting subsidies promotes future macro stability through efficient energy usage, budget stability and better resource allocation more broadly.”
The Brandywine Global team also considers it instructive to take a China-centric view.
“China is one of the most important vectors of potential systemic risk in the global economy today,” Scotland says. “Many investors fear that a mix of high debt and supply overcapacity may drag China into a hard-landing, which would create a deflationary bust felt worldwide. Obviously a major decline in the cost of energy is an extremely constructive and timely development for sustaining non-inflationary growth and bolstering domestic demand.”
From reduced inflation worries and easier monetary policy, to the direct impact of putting money in consumers’ pockets, Brandywine Global believes cheaper oil will have positive effects on growth.
“One criticism of the global rebound from 2008 has been that economic growth is lopsided and, hence, less robust and sustainable,” Scotland says. “By nature of the fantastic recent capital gains earned by owners of financial assets and high-end property, the economic rebound has primarily benefited higher income and wealth brackets. A decrease in the price of energy bolsters real incomes at the lower end of the income curve.”