by Enrico Colombatto
Dramatic falls in the price of oil have persuaded a number of oil exporters that major rebounds are unlikely soon. Russian authorities have revised all their forecasts for the next three years, and are likely to implement broader policies to tackle what they had initially considered a mere budgetary problem. The prevailing strategy – until recently – was to let the rouble slide to balance its rouble-denominated government budget and reduce imports. But prospects of recession, inflation, trade imbalances and greater budgetary imbalances call for a new approach. The next moves will be a mix of mild rouble depreciation, more relaxed monetary policy and regulation of foreign transactions at a cost of higher inflation.
The Dollar price of oil has dropped about 45 per cent in less than six months. Unsurprisingly, net importers are happy. Growth in the European Union would probably be nil or negative, if the Old Continent had not been showered with cheap energy.
But net oil exporters such as Russia and Nigeria are deeply worried by low oil prices. It means a decline in annual GDP growth by at least one percentage point in 2014 and probably three points in 2015.
Net exporters can do little to limit the damage. The future does not look bright from their viewpoint. Shale oil has created new scenarios with global proved oil reserves increasing from about 1,000 billion barrels in 2000 to some 1,600 billion barrels in 2014. And they are increasing.
Some key large oil exporters were not overly concerned about their balance of trade, despite the drastic cut in export revenues, until a few weeks ago.
They were more concerned about their public budgets. Oil revenues play an important role within this framework, because of the taxes levied on private oil companies and because of the profits the treasury obtains from government-owned producing facilities.
The big news of the last few weeks has been the realisation that oil prices will not recover in the short run.
Hence, while policymakers were persuaded that a transitory budgetary problem could be tackled by means of a one-shot depreciation of the currency, persistently low oil prices create new problems and need more than benign neglect of foreign-exchange markets.
So what should we expect in terms of domestic policymaking? And what are the consequences from an international perspective?
In Russia, budgetary shortcomings in the past could be contained with relative ease. Half of the Russian federal government’s revenues come from the energy sector but the oil price collapsed only in the second part of 2014.
The rouble has been weakening significantly, so that oil-related revenues have not declined much, if expressed in roubles. Finally, the government swiftly implemented spending cuts. The result will be that the Russian public deficit will be somewhere between one and two per cent in 2014.
The future looks different.
Next year’s budget deficit will approach five per cent, given current oil prices and rouble exchange rate. And the authorities hesitate to finance the gap through significant tax increases or by printing money.
Inflation is already alarmingly high at 10 per cent and rising. The original four per cent inflation target was revised to 6.5 per cent in December and new adjustments could be needed soon.
The lower oil prices during 2014 have been hitting Russia’s export revenues, but imports have also fallen because of the West’s sanctions, imposed following the Ukrainian crisis, playing an important role, too.
The result is that Russia’s trade balance and current account will still register a substantial surplus of some US$12 billion and US$11 billion respectively in 2014.
However, 2015 will present a much bleaker picture as the impact of lower oil prices will show up in the more recent export contracts.
Pressure on the rouble will intensify, especially if Russian oligarchs continue selling their rouble-denominated assets and buying euro and dollar-denominated funds.
Capital ouflows from Russia in 2014 amount to some US$80 billion, according to the official statistics, but the real figure is probably higher.
The size of the discrepancy is confirmed by the fact Russia’s Central Bank has already spent more than US$70 billion since January 2014 – a sum which has failed to stem the slide of the rouble, and is probably creating tensions within the government.
Someone will have to explain why so many hard currency reserves have been wasted.
President Vladimir Putin’s government will be facing recession. The Russian authorities predict low growth of 0.6 per cent in 2014, stagnation in 2015 and 2016, and a substantial GDP increase in 2017.
These predictions, however, are based on an ‘expected’ 30 per cent rebound in the price of oil during 2015. If this prediction fails to materialise, growth in 2015 will be about minus four per cent and zero at best in later years.
Under the present circumstances of persistently low oil prices, depreciation of the rouble is not enough to stabilise the Russian economy.
Raising interest rates will prove ineffective, regardless of what the Russian authorities are doing.
In order to glimpse at what the next few months may hold, we should speculate about Russia’s priorities once the dust settles.
Will the Central Bank stand aside and let the currency drop further, risking further additional capital outflows and rising inflation? Or will it engage in some sort of currency reform and try to stabilise its monetary scenario?
And what about Russia’s growth, can President Putin afford two or three years of recession?
President Putin’s priority, in our view, will be growth. His government will strive to offset recession by eventually relaxing monetary policy and forgetting about its previous inflationary goals.
Populism and patriotism
It will meet budgetary problems by letting the rouble drop further, and deal with the balance-of-payment difficulties by regulating capital movements rather than by raising interest rates.
A mix of populism and patriotism would probably persuade Russian public opinion to accept currency controls and higher inflation.
Some experts have suggested that the Russian Central Bank should stabilise the rouble, for example, by introducing a currency board or perhaps moving to a real-money anchor such as gold.
Both proposals would probably reduce inflationary expectations significantly. Yet, we think inflation will no longer be a priority in Moscow, and that these proposals are unlikely to be implemented.
A currency-board regime would imply linking the rouble to the euro or the dollar, and de facto transferring monetary sovereignty to Frankfurt or Washington.
This would be politically unacceptable to an elite whose political fortunes owe a great deal to the image of Russia as a re-born superpower.
A gold standard would certainly be politically appealing, as it would transform the rouble into a formidable currency, and probably reduce capital outflows significantly. But it would deprive the authorities of any discretionary power with regard to money, and force them to increase taxation.
It is not evident that the authorities are willing to accept such a substantial cut in their policymaking power, especially if the budget deficit widens and international political ambitions grow.
We believe that the future exchange rate of the rouble will feature ongoing weakness, but less marked than in the past.
Capital outflows will slow down thanks to controls, and the eventual budget-revenue shortages will be met by relatively modest increases in taxes. Populism and nationalism would make these increases acceptable.
The price for this outcome could be increased inflation, but that does not seem an insurmountable obstacle, especially if accompanied by price controls.
So should Russia’s recipe be followed by other oil-exporting countries? The answer is a clear ‘no’ as different countries would require different remedies.
Nigeria, at one extreme, has a positive current account, a limited budget deficit of less than two per cent, and significant economic growth of six per cent.
Nigeria’s instability is political, rather than economic; the macro context is relatively reassuring – November’s devaluation of the naira is minor – and if its policymakers refrain from intensifying government presence in the economy it could be that market-driven adjustment would be much more effective.
At the other extreme, dollarisation is the only way to stabilise an economy when a country like Venezuela is in a monetary shambles.