Is an oil-induced economic slowdown inevitable? Experts weigh in

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In a potential full-blown oil-price shock scenario, rising fuel costs could trigger an economic slowdown, inflation-driven interest-rate hikes, and shifts in consumer behavior. Transport and hospitality sectors may see significant spending reductions as households adjust budgets.

With domestic fuel prices expected to jump in early April, businesses and consumers alike are bracing for the far-reaching economic impacts of this escalating Middle East crisis.

While any forecasting of this conflict, and therefore of oil prices, is a hazardous business, there are a few mechanisms through which a mounting global oil shortage and price shock can feed through to the South African household sector.

Firstly, if oil supply to the world is restricted due to the conflict situation, it can mean that global economic output is restricted, because the world economy is an energy intensive place. So, if it gets bad enough, it can mean the world going into recession, or at least a major growth downturn.

For South Africa, this would negatively affect demand from other countries for a wide range of its exports, whether manufactured goods or minerals. Therefore, South African exports could slump, potentially resulting in those export-driven sectors either curbing new employment or even implementing job cuts.

It could also mean reducing services from certain input suppliers, which would limit their work and create a ripple effect through the economy. This in turn could restrict household sector/consumer income growth in South Africa, implying weaker purchasing power growth for households as a group.

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The second impact is via prices. A scarcity of oil in the world implies a higher oil price. We have seen very significant oil-price increases already, and there is little telling how much further this may go. Not only does this have a direct impact on how much consumers pay for fuel domestically, but petrol/diesel prices are a major input right down the supply chain, so with some lag it feeds through into the prices of other consumer goods too.

As a result, many products may see higher price inflation, pushing up the overall consumer price level and eating into disposable income. It then extends to a third significant impact, as the South African Reserve Bank (Sarb) has a 3% Consumer Price Index (CPI) inflation target.

Should an oil-price shock lead to a noticeable rise in consumer price inflation, the Bank could possibly start to hike interest rates. A higher cost of repaying outstanding credit would further eat into disposable income, and raise the cost of many new credit-dependent purchases.

What would the consumer-spending response be?

The broad consumer spending response would likely be in the following ways:

• To cut back on spending on luxury and non-essential items. While some may think this only includes the likes of high value goods such as jewellery for instance, it can actually be far broader than that. Even certain foods, and eating out, can be regarded as luxuries and non-essential. Holidays, too, are in many instances not essential.
• To put “postponeable” spending (often essential items) on hold. Many postponable expenditure items are low-frequency purchases, typically classified as durable or semi-durable goods. For example, an aging but still functional motor vehicle may soon require replacement, yet the purchase can often be deferred for a considerable period. The same applies to furniture, household appliances, clothing, and footwear. Similarly, certain maintenance tasks for homes and cars can frequently be delayed without immediate consequence.
• To postpone credit-dependent purchases during times of interest-rate hiking. These items include homes, vehicles, and durable consumer goods such as furniture and appliances. Some aspirant homeowners often prefer to rent or remain in their original family homes for longer in such times. This would be the likely result of an increase in interest rates.
• While not always a wise idea, some households even cancel certain forms of insurance and vehicle maintenance, or scale back on medical cover.

Hardest hit sectors

Looking ahead these are the major consumer spending categories that will most likely experience the most pressure:

• Durables and semi-durable consumer product categories would likely be most impacted. In an oil-price shock scenario as outlined above, real (inflation-adjusted) Durable Goods consumption spend is likely to slow most significantly, with the Semi-Durables category not far behind. While Non-Durable, and Services consumption spend can also be expected to see slowing growth, typically these latter 2 categories are less cyclical than the former 2 categories.
  Going all the way back to 2009 for past insights, a major oil-price and food-price shock took CPI inflation up into double digits, causing interest rates to rise by 5 percentage points from mid-2006 to mid-2008, with a recession included. Real household disposable income declined by -2.1% in that year, and real household consumption expenditure declined by a more significant -2.6%.

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• Transport, and Restaurant and Hotel spending appear highly vulnerable. Classifying industry consumption according to purpose (COICOP), the 2009 shock saw Restaurant and Hotels consumer spending experience the most extreme dip to the tune of -12.2%. Admittedly, at the time there was also a major food-price inflation surge, which may have been in part responsible for curbing spend in this category.

  However, this dip is hardly surprising given the non-essential and postponeable nature of much of this spending. A transport cost surge would surely also have played a key role in curbing the leisure accommodation side of that spending purpose category.

  The next biggest dip in 2009 was a -6.1% real decline in the Recreation, Entertainment and Culture category, also falling very much into the non-essential and often postponeable categories.

• Third on the list was the -5.7% real decline in the Transport category, driven largely by a sharp -20.4% drop in highly credit-dependent personal transport equipment spending, which consists predominantly of motor vehicles. This was accompanied by a -19.5% decline in spending on motor vehicle tyres, parts and accessories.
• Furniture, Household Equipment and Routine Maintenance also declined, by -3.3% in real terms.

One can see the pattern here, the biggest drops in spend being in highly credit-dependent categories, such as motor-vehicle purchases, largely in the non-essential or less essential categories such as restaurants and hotels, or in postponeable expenditure categories such as furniture, household equipment and routine maintenance.

Should the current events unfolding continue into a full-blown inflation shock, with interest-rate hiking and economic growth slowdown, I would expect the above-mentioned consumer spending categories to be among the most impacted yet again.