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Economic Prognosis
It’s June and, as always, time for a new economic prognosis for the month. The following questions will be examined: what will happen with the dollar’s exchange rate to the ruble, what will the inflation rate be on the Russian consumer market, where are world oil prices going and where are the dollar and euro going on the world market. But first, a look at the main economic events of May.
The main economic news of last month has to be the new unbelievable hike in oil prices. Its price rose above $135 per barrel. On May 22, a barrel of North Sea Brent set a record at $135.14 and American WTI reached $135.09. The speed with which the prices are rising is stunning. It reached the landmark $100 mark not so long ago – January of this year. Then it reached $120 at the beginning of May, and $130 on May 21. Thus, the price of a barrel of oil has risen $35 since the beginning of the year. That price change is more than three times what a barrel itself of oil cost in 1998, and ten times what it cost in the early 1970s. Since 2002, the price of oil has risen sixfold. Last year, a price of $100 per barrel was considered a theoretical possibility, and only in case of a catastrophic breakdown in supplies, such as might be cause by military action. At the beginning of this year, when the $100 price was a reality, without any catastrophes, a price of $200 began to be talked about not only as a possibility, but as a likelihood.
The circumstances have lined up to cause price growth. IMF experts described the situation in April of this year, saying that high and growing demand for oil and other raw materials has been driving prices up, as have the low reserves of refiners. Demand in developing countries remains the main mover on raw materials markets. Financial tendencies have also played a role in the growth of raw materials prices. The shrinking exchange rate of the dollar has increased buying power for oil everywhere except in the United States. The continual reduction of the interest rate in the U.S. has also stimulated price growth since it has made it easier to finance purchases of oil for the creation of reserves and has encouraged the use of oil futures as investment instruments, which produce greater income than investment in securities under conditions of shrinking credit. Rising oil prices in the second half of 2007 were also stimulated by increasing political tension in the Middle East interruptions in deliveries from several fields connected with natural conditions.
In the general speculators (that is, investment and pension funds managing billions of dollars) that are now making a grandiose play on rising oil futures prices are looking at all the conditions in the world economy now – the growing demand in China and other developing countries, the falling interest rate in the U.S., the falling dollar, the geopolitical and environmental risks of oil production.
The best-known theoretician (and practitioner) of world economic development, former U.S. Federal Reserve Board chairman Alan Greenspan, considers the pricing situation on the oil market a confirmation of his claim that oil prices are determined not be real conditions present on the market, but by forecasts of what will be in the future. He said the price of oil on hand at the beginning of 2007 rose partially because of the risk of terrorism. Peace in the Middle East would cause an instant fall in oil prices. To change oil prices, it would be necessary to change (risk changing) not the current, but the future, balance of supply and demand. Market players are clearly expecting a genuine oil shortage in the future, even though there are no signs of such a shortage now.
The latest record oil prices were important for the Russian economy in May not only because they helped fill the Central Bank’s already hefty gold and currency reserves, but because they permitted the already hefty imports to increase further and the ruble to gain further against the American dollar that oil accounts are settled in. The new president and new government have been able to form a new tax policy. At the end of May, the government decided to implement the idea of easing the tax burden on oil producers. That is meant to show that there are enough petrodollars in the budget already to lower oil taxes. It also has to be shown, however, that the government is concerned about developing oil production, which has grown only insignificantly in recent years because new fields coming on line are only compensating for those that are being exhausted. It was decided to free companies that plan to produce oil on the continental shelf from taxes on mineral production. The tax vacation will last ten years if the company obtains a license for production and 15 years if it plans to conduct geological exploration as well. Producers in Yamal and the Timan-Pechora Basin will get a seven-year tax vacation.
In general, May has shown that, in modern conditions, oil has become the ultimate financial asset in the world. The authorities of oil-producing countries can allow themselves much due to their control of that asset.
1. What will happen with the dollar’s exchange rate to the ruble?
In our May prognosis, we emphasized that inhibition of the ruble’s exchange rate through purchases of dollars and upholding the banking system’s liquidity would result in the dollar’s costing not less than 23.20 rubles in May. That prognosis was completely correct. On May 29, the dollar cost 23.58 rubles.
The efforts of the world currency market definitely influenced the dollar’s course in Russia. But the actions of the Central Bank also played a role. It introduced a new procedure for monetary intervention on May 14. Central Bank chairman Sergey Ignatyev explained that “Until May 14, the algorithm of our actions was simple enough. A certain technical corridor was established for the value of the currency basket. If the value of the currency basket reached the lower limit of the corridor, we bought foreign currency and did not allow the value of the basket to sink any lower. If the value of the currency basket reached the upper limit of the corridor, we sold foreign currency. That happened extremely rarely… Since May 14, in addition to the mechanism of the technical corridor, the Bank of Russia has begun to implement regular purchases of foreign currency. The volume of such purchases is set at a size approximately equal to the volume of the income of the federal budget, and they are further placed in the reserve fund and national prosperity fund.” The Central Bank also made it clear that the currency corridor would be widened in the future to make the transition to a free exchange rate and inflation targeting easier.
In general, the players on the currency market should understand that the Central Bank will not permit excessive fluctuation in the exchange rate of the dollar in Russia. It will buy dollars in a significant volume, but it will not forget about strengthening the national theory in accordance with the theory that that strengthening is an anti-inflationary measure.
Our prognosis: To fight inflation, the dollar will not cost more than 23.80 rubles in June.
2. Where are prices going in Russia?
We forecast that inflation would not exceed 1 percent in May, and our prognosis can be considered partially correct because, although inflation rose above 1 percent, the difference was insignificant. The final data for the month has not been made available yet, but consumer prices rose 1.2 percent between May 1 and 26.
On the whole, inflation in Russia remains a critical situation. Since the beginning of the year, prices have risen 7.5 percent. By the beginning of May, it was clear that, for a second year in a row, inflation will not fall, but rise significantly. In the first four months of 2008, inflation was 6.3 percent (compared to 4 percent in the first four months of last year). In the last 12 months, April 2007 to April 2008, inflation was 14.3 percent, almost twice as high as the previous 12 months.
The Central Bank is prepared to do anything to correct the situation. As Ignatyev emphasized, “We are prepared to use any methods to lower inflation – interest rates, regulation, the exchange rate – but we will do it cautiously so as not to lower liquidity in the banking sector or slow the rate of economic growth.” The Central Bank is hoping on several circumstances. First, there is the lowest growth of the money mass in ten years this year (0.7 percent from January through April, compared to 11.2 percent in 2007). Second, the net influx of net capital will be much lower in this year than last (when it was about $80 billion), since there was net outflow of net capital in the first four months of the year of about $5 billion. Third, the Agriculture Ministry forecasts a fall in grain prices in July from 8500 rubles per ton today to 6000 rubles per ton.
Our prognosis: In spite of all of that, traders will continue to raise their prices and inflation will exceed 0.8 percent.
3. What will happen to world oil prices?
We predicted that, in the course of speculative plays, the price of oil in May would exceed $114 per barrel. And we weren't wrong. Not only that, oil prices exceeded $120, $130 and even $135.
Of course, prices fell a little from that record high. Market players scared themselves and started selling oil futures. Those who sold fast made a nice profit. But no one denied that the fall in prices was part of the play and everyone was certain that price would continue to rise in the future. The pace was such in May that, if not $200, then $150 looks like a realistic price in the near future.
Authorities in Western countries ceaselessly repeat that OPEC could help correct the situation but raising its production quota. OPEC officials call the current prices insane but repeat ceaselessly that they can do nothing in the circumstances created by the speculators, since there is more than enough oil on the market already. In any case, the situation is profitable not only for OPEC, but for other countries, among which Russia has a prominent place.
Our prognosis: In the current oil play, the lower price is a temporary phenomenon and oil will cost no less than $120 per barrel in June.
4. Where are the dollar and euro going on the world market?
We predicted that the euro would not cost more than $1.61 in May. That was completely correct. The euro reached $1.581 in May and ended at $1.557 on May 29.
Market players have decided that the American economy is not in such bad condition that the Federal Reserve Board would continue to lower the interest rate, which was already at 2 percent per annum. It was even possible that it would raise the rate, since there is a significant risk of pushing up inflation in the U.S. The players noticed at the same time that unemployment rise for the first time in two years in Germany and, consequently, the countries of the euro zone may need to lower the interest rate to stimulate economic growth. Inflation is rising in Germany and the European Central Bank is in about the same situation as the Fed – it should lower the rate to stimulate economic growth and raise it to stave off inflation. So currency speculators, who customarily subscribe to the theory that the exchange rate is determined by the interest rate, are somewhat disoriented.
In these circumstances, market participants began to pay more attention to oil prices. The current super-high prices should slow economic growth in the U.S., the world’ largest importer of oil, and stimulate inflation. Second, the higher oil prices are, the more American dollars go to the oil exporters for their ware, and they may decide to trade some of them for euros to avoid keeping all their money in one currency. (The investment bank Morgan Stanley has calculated that, at present, all the oil-exporting countries together receive $200 billion per month for their oil.) Therefore, as oil prices rise, the exchange rate of the dollar should fall.
Our prognosis: Since currency players are disoriented and oil prices are high, the euro will not cost less than $1.52 in June.
Sergey Minaev
All the Article in Russian as of June 02, 2008
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