Disinflation pressure from falling oil prices is highest in Frontier Asia, especially Thailand and India, and may be beneficial for Thai Baht and Indian Rupee, write Citi analysts:

“Oil prices have fallen 16% since mid-April on US drilling and demand slowdown concerns, despite OPEC led efforts to curb supply.

It is unclear how much of the recent oil price decline is driven by supply vs. demand, and comes at a time when inflation momentum is already abating.

Disinflation pressures from lower oil highest in Frontier Asia, TH, IN, SG. Fuel weights relatively high and historical sensitivity to oil price changes is also high after controlling for food prices. SG’s high inflation sensitivity to oil when fuel weight is very low can probably be explained by the highly cyclical nature of SG’s inflation and should probably be discounted if we see the oil price decline as being more supply-driven.

Given where we are in the inflation/output gap, persistent oil slump may matter most in influencing monetary policy expectations in TH and IN.

Supply side shocks emanating from oil are more likely to be met by a monetary policy response if growth/inflation momentum is weak, output gap is negative, and thus, greater risk that disinflationary shock feeds into expectations (especially if inflation is far below central bank’s “target”; Fig 4) and where external imbalances are non-existent. The latter would rule out an easing in LK. TH, IN and SG have economic slack (see here, here, here), but improving SG domestic momentum makes MAS less likely to ease except within the existing NEER band. IN and TH is where rates market may price in more easing. With positive terms of trade from lower oil for both (Figure 6), we think Thailand is likely particularly sensitive to any outperformance of THB given how low inflation is relative to its target. India’s economic outlook is more favorable than Thailand, but given relatively high real yields, may remain susceptible to a rates re-pricing (we expect 50bps cut in 2H17).

Indonesia seems least sensitive to oil led disinflation. In fact, Indonesia’s fuel/transport prices are expected to be hiked in 2H17—we see little risk BI will adjust policy rates because of this. Malaysia’s low inflation sensitivity to oil prices in Fig 2 is distorted by the period prior to fuel prices being floated in Dec 2014 – recent data show higher oil sensitivity in 2017, though with still decent growth, we think the risk from an oil-led disinflation is for rate hike to be delayed. Potential MYR underperformance from being the only net oil & gas exporter in Asia can help ease monetary conditions to offset any possible rising real rate from lower inflation.

Strategy comments

Declining oil prices are likely to further lower inflation expectations. Rates particularly in India and Thailand may continue to outperform on back of this. FX reaction may be more nuanced. A gradual decline in oil prices may remain beneficial for INR and THB. But an accelerated decline may have negative spillovers for broader risk sentiment and hurt Asian currencies.”