U.S. crude rose to 105.83 dollars a barrel and Brent crude to 108.75 dollars on September 15 amid disruption to traffic through the Strait of Hormuz and security incidents linked to oil routes and the Red Sea, raising energy import, shipping and insurance costs for China and threatening to transmit pressure to domestic production and prices.
The cost of direct U.S. defensive operations reached about 38 billion dollars through early August, according to data attributed to the U.S. Congressional Budget Office. But the wider economic fallout spread to energy, shipping and inflation markets.
Oil costs spread to factories and households
Pressure on China’s economy begins before the oil reaches refineries, as higher crude prices increase the import bill while geopolitical risks raise marine insurance, shipping and trade-finance costs. Changes in tanker routes or longer waiting times also reduce supply-chain efficiency and tie up capital in shipments delayed beyond their scheduled arrival dates.
These burdens are passed on to factories through fuel, electricity and raw materials. More expensive diesel also raises the cost of transporting containers, raw materials and goods, while higher energy prices squeeze the steel, cement, chemicals, plastics, glass, textiles and electronics industries.
Cost pressures may prompt companies unable to absorb them through profit margins to raise prices, cut production and investment, or delay hiring. But intense competition and weak domestic demand may lead producers and traders to absorb some of the increase rather than pass it directly on to consumers.
Domestic regulation of some energy-product prices and strategic stockpiles can limit the immediate jump in fuel prices. But the impact may initially show up in producer-price inflation and weaker corporate profits before gradually feeding into shipping costs, airfares, food transported over long distances, and industrial and consumer goods.
U.S. rates narrow Beijing’s room for monetary easing
Higher oil prices affect China through U.S. monetary policy, as persistent energy and inflation pressures could prompt the Federal Reserve to keep interest rates high or raise them further. The Fed raised rates by 25 basis points to a range of 3.75-4%, its first increase in more than 3 years, after U.S. inflation remained above the target level.
Shi Junyang, a professor at Shanghai University of Finance and Economics, said developments in the Gulf region had driven up global oil and energy prices, adding an important external source of inflation in the United States. He said inflation remaining above the 2% target could require further tightening.
China, by contrast, is facing weak domestic demand, consumption and investment, increasing its need for greater liquidity and lower borrowing costs. But rising yields on dollar-denominated assets are widening the gap with Chinese yields and making U.S. assets more attractive. As a result, a rapid or aggressive cut in Chinese interest rates could put additional pressure on the yuan and increase incentives to shift funds into dollars.
Yang Delong, chief economist at First Seafront Fund, said domestic conditions remained the main factor in Chinese monetary policy, and expected the central bank to maintain low interest rates and ample liquidity to support growth rather than mirror the Fed’s moves.
Shao Yu, chief economist at Fudan University’s Center for Scientific and Technological Innovation, also said the Fed’s increase had not significantly narrowed China’s scope for monetary easing, and that cutting the reserve requirement ratio and interest rates remained possible during the year. He said China’s economic cycle was moving in the opposite direction to the dollar cycle: the United States was facing high inflation, while Beijing was seeking to address weak demand.
The yuan and reserves cushion the shock
The independence of China’s monetary policy remains tied to Beijing’s ability to manage the exchange rate, curb expectations of a weaker yuan, and preserve trade and investment flows. Higher U.S. interest rates do not automatically force the yuan lower, but they make the dollar more attractive and render decisions to cut Chinese interest rates more sensitive as the yield gap widens.
Lin Song, chief economist for Greater China at ING, said the yuan’s strength this year reduced the likelihood that the U.S. rate increase would be a major factor in the People’s Bank of China’s interest-rate decision. He added that a widening yield gap had not prevented the yuan from appreciating so far, but could become a more important factor in the next phase.
Strong exports provide a steady inflow of foreign currency and reduce demand for dollars. Shi Junyang said energy reserves, relatively low domestic inflation, export flexibility and the central bank’s ability to maintain exchange-rate stability reduced the likelihood of the yuan suffering a sharp shock.
Energy reserves give China time and reduce the need to buy immediately at peak prices, but they do not lower oil prices or guarantee the safety of maritime corridors. Prolonged supply disruption could increase the import bill and reduce profits in energy-intensive industries, while the dollar becomes more attractive if U.S. monetary tightening continues.
Alicia Garcia Herrero, Natixis’ chief economist for the Asia-Pacific region, expected Beijing to turn to targeted domestic fiscal support, including the issuance of special bonds and financing for infrastructure, networks and data centers, rather than broad monetary easing amid the interest-rate gap with the United States.
China’s ability to contain the fallout will depend on the duration of the energy-market disruption, shipping costs and the course of U.S. monetary policy. Energy reserves, strong exports, exchange-rate management, and fiscal and monetary policies can delay the transmission of the shock and limit its severity, but their effectiveness will diminish the longer supply disruption lasts and dollar pressures persist.
