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Economic Prognosis
November is here, and Vlast economic weekly is making its economic prognosis for the coming month as usual. We will examine the following questions: what will happen to the dollar on the Russian currency market, how consumer prices will change, what world oil prices will be and how the dollar and euro will fare on the world currency market. But first, a look at the major economic events of October.
The main event in October has to be the resounding thud of the 8-percent inflation plan's collapse. Its failure could be seen coming since August, but the government and Central Bank insisted with rare stubbornness that consumer prices would stay within 8 percent, obviously hoping that price growth would slow down a lot at yearend. But inflation for the year was at 7.5 percent by the end of September. When prices topped 8 percent at the beginning of October, the government almost ceremonially announced the failure of the plan. All month, the government and Central Bank have been issuing competing prognoses, every one of them bleaker than the last and all acknowledging that inflation may significantly exceed 10 percent. Of course, they made up new versions of the plan in previous years when the original plan was not met (and the only year that saw its success was 2003). This time, no new promises were made by the government or Bank.
Admitting defeat in inflation gave the authorities a reason to take decisive action. Local authorities began to order traders to sell groceries at no higher prices than those set by them, and to sell the controlled items (milk, bread, eggs, etc.) , nonetheless. In some places, there were orders to sell bread and milk to pensioners at the same prices as before the autumn price jump. In those regions, pension cards are playing that same role that ration coupons did once.
Federal authorities decided in October to raise pensions on December 1, citing high prices and rapid price growth. It was also decided to impose export duties on wheat and barley beginning November 12. Wheat will be charged 10 percent of its cost and no less than ˆ22 per ton, barley will be charged 30 percent, no less than ˆ70 per ton. Then the authorities had to issue various clarifications of how those duties do not run counter to Russia's desire to join the WTO but, on the contrary, should only be hailed by the world market. In addition, the import duties on milk and dairy products were cut by two-thirds. Finally, prices for milk, vegetable oil, eggs and bread were frozen for agricultural producers and large retail chains by government initiative until next January 31.
Anti-inflationary measures held a significant place in Russian President Vladimir Putin's televised answers to his citizens questions last month. “You've most likely heard,” he said, “that I have brought the rising prices to the attention of the government. First, why is it happening? Mainly because our country is becoming part of the world economy. And everything that happens on world markets is reflected on us. In Europe, where we buy a lot of food products by import, events have taken place that have been reflected on us. The discontinuation of subsidies have led to significant price increases for agricultural products, an average of 15-17 percent. That immediately grew to 25 percent here and to 40 percent on some products and even to 60 percent for sunflower oil and several other products. In addition, what else is happening in the world economy? The use of alternative fuel, so-called bio-ethanol, has increased. That is, now grain also goes to the production of fuels that are used as a substitute for natural gas and as alternatives to oil and petroleum products. That is not a large volume so far, but it has led to higher prices on the market. What is the government doing about it? A number of measures have been passed. Which? First. Intervention is being made from stored grain reserves. Second. Export duties on grain are being increased, to keep it on the domestic market. And import duties are being lowered on shipments of several kinds of foodstuffs onto the territory of the Russian Federation, particularly milk and dairy products. But we have to do this very carefully too, not to undermine our own agriculture.”
It should be noted that Russian authorities' administrative intervention in foodstuffs trading, especially the price freeze, made a big impression on the world. As Jacques Diouf, Director General of the UN Food and Agriculture Organization, said at the beginning of October, many developing countries could follow Russia's example. “Many [countries] will have to take hard decisions because of the impact of food prices,” Diouf told The Financial Times. “In some countries there will be price controls, some will scrap import tariffs on food to minimize the impact of rising costs and others will increase food subsidies.” He added that “If prices continue to rise, I would not be surprised if we began to see food riots,” noting that such riots had indeed taken place this year in Mexico, Yemen and Burkina Faso. Clear food price increases are taking place in the developing countries. Inflation of food prices has reached 11 percent in the last year, while it is 7 percent for non-food items.
1. What will happen to the dollar on the Russian currency market?
We predicted that the dollar would cost over 24.90 rubles in October since it surpassed the 25-ruble mark too firmly in September, and Russian authorities did not want a long, fast weakening of it. That would create the impression of instability on the currency market.
The prognosis can be considered partially correct. In October, the dollar did cost more than 24.90 rubles, and even more than 25 rubles. But the month ended with an official exchange rate of 24.71 rubles/$. The authorities could not but react to the record fall of the dollar on the world currency market.
It is possible that the collapse of the annual inflation plan and the emergency measures taken in response played a role in the dollar's fall. Both the IMF and Russian authorities consider strengthening the ruble the last word in inflation fighting in Russia. The IMF suggests that the Central Bank should stop holding back the dollar's tumble (by buying up the American currency with freshly printed rubles and applying pressure on the consumer market) just as soon as there is any threat of the inflation plan not being met. Russian authorities suggest that strengthening the ruble stimulates imports and competition on the consumer market, and that holds down prices in and of itself. Therefore, the strengthening of the ruble as the inflation plan fails can be seen as an adjunct to the emergency measures. And Russian citizens can see once again that all money is becoming less valuable: the American because of the exchange rate and the Russian because of inflation.
Our prognosis: In November, the dollar will not pick up on world markets, so it will remain under 25 rubles in Russia.
2. How consumer prices will change?
We predicted that, in October, the connection between high consumer demand and inflation would be significant – no less than 0.5 percent (that is, the 8 percent planned for the year would be reached in that month). That prediction came true with a vengeance. The final data are not in yet, but the Ministry of Economic Development and Trade is estimating that inflation in October was 1.2-1.6 percent.
Thus, the annual inflation plan for 2007 was not only officially failed, but it is even possible that last year's 9-percent rate has been passed. As the Economics Ministry noted, it was already clear at the beginning of October that price conditions were worse than the year before. “Between January and September 2007, inflation on the consumer market totaled 7.5 percent, as opposed to 7.2 percent a year ago,” the ministry wrote. “The last six months have been characterized by noticeable (double digit) hastening of inflation compared to the previous year. In the second quarter, price growth reached 2.2 percent, against 1.1 percent a year ago. In the third quarter, it was 1.8 percent, against 1.1 percent.”
Inflation in Russia decreased every year, at least a little, before this year, while remaining monstrously high by the standards of both industrialized and developing countries, but this year it is increasing. It already seems strange to talk about the lower inflationary expectations of the public. The public shows with its behavior in the marketplace that it expects rising prices. Even though it complains, it buys expensive goods before they become even more expensive. In November, the authorities showed that administrative measures to contain prices had results, although it has to be noted that the goods they started to regulate or whose prices they froze play only a small role statistically in consumer inflation.
Our prognosis: Inflation will remain high in November, but under 1 percent.
3. What will world oil prices be?
We predicted that world oil prices would be no lower than $76 per barrel in October after the records set earlier. That prediction was accurate. Unbelievable new records were set. For the first time in history, the price of oil topped $90 per barrel. Thus, it passed two benchmarks – $80 and 90 – in just two months. The situation was similar to that of 2005, when oil cost more than $60 per barrel for the first time ever in June, and cost more than $70 in August. This time the record is weightier though, with a difference of $20 per barrel. There was a time when $20 wasn't the price difference, but the price itself.
After passing $90 a barrel, the price of oil fell again for a while and remained significantly lower than that mark. Then it rose above $90 again, and a lot above. On October 29, the new world's record of $93.80 per barrel was set for American WTI. On the last day of the month, a barrel was going for $94 after data were released on the low levels of oil and petroleum product reserves in the United States.
Clearly, with the continuing world credit crisis, the falling dollar and stock market instability, international pension and investment funds decided to invest as much as possible in oil futures, and that policy gave rise to the new record. And the more expensive oil gets, the more the funds become convinced of the rightness of the decision that cause the price rise.
Our prognosis: November will be another month of superhigh oil prices, which will be above $85 per barrel.
4. How the dollar and euro will fare on the world currency market?
We stated in our prognosis for October that the dollar took such a beating in September that it could not cost more than $1.38 per euro. That prognosis was on the money. The dollar cost much less. In the final days of October, the dollar hit an absolute record low of $1.44 per euro.
Even third quarter data that the American economy was growing at the at a brisk 3.9 percent annually (analysts had predicted 3 percent) could not help the dollar. Market players still thought that the Federal Reserve Board would lower the interest rate on October 31 to help the American credit system overcome the crisis caused by problems on the mortgage market. They also assumed that the American economy would experience serious problems in 2008 and the Fed would continue to lower interest rates, or at least not raise them. Following the theory that the exchange rate is determined by the interest rate, the dollar would not rise again. So why buy it?
The exchange rate of the dollar in October was harmed by the unbelievable oil prices. It was assumed that such expensive oil would sooner or later make a dent in American economic growth. It could have been interpreted differently, of course: such high oil prices would eventually speed up inflation in the U.S. and then it would have to be contained by raising interest rates. But, as long as currency players choose to see it differently, not seeing any evidence of stricter U.S. monetary policy, it will be better to play against the dollar. In exactly the same way that players on the oil market want to take oil prices to $100 a barrel, currency players want to see a euro that costs $1.50. They are not paying too much attention to the fact that there is no obvious oil crisis in the world, and the European economy has not obvious advantages over the American. They just find big numbers appealing.
Our prognosis: With things going against the dollar as they are, the euro will cost no less than $1.40 in November.
Sergey Minaev
All the Article in Russian as of Nov. 05, 2007
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Photo: Reuters
