Russia’s Resource Curse: Oil Price Dependency Weighs on Economy

In 2011 Russia was the second largest producer of crude oil in the world. Dependence on oil has benefitted the country in the aftermath of the global financial crisis of 2008/2009, supporting a return to full capacity in the economy. Increased exchange rate flexibility since 2009 has also given the government more control over monetary policy. However a worsening global economic environment in Q2 2012 caused declines in oil prices, hampering Russia’s budget prospects for the year.

Growth Index of Russian Real GDP and Europe Brent Oil Price: Q1 2007 – Q4 2012


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Source: Euromonitor International from national sources, International Monetary Fund (IMF)

Note: Real GDP is in seasonally adjusted terms.

Global energy prices have fluctuated significantly since the financial crisis of 2007/2008. The Europe Brent spot price crashed to US$40.0 per barrel in December 2008, heavily impacting government revenue streams in Russia and worsening the country’s downturn. A rebound in the price of Europe Brent crude to US$111 per barrel on average in 2011 supported an average real GDP growth rate of 4.3% in 2010 and 2011;

Since 2009 the government has shifted its exchange rate policy, incrementally moving away from the heavy handed steering of the currency to a more flexible floating rate. The fluctuation band was widened in July 2012 to a lower limit of RUB31.7 and an upper limit of RUB38.7 against a hypothetical US dollar – euro basket,
allowing the government more freedom in its monetary policy and helping the economy against external shocks. Monetary policy has become progressively looser in 2011 and 2012. The refinancing rate, a central bank lending rate declined from 13.0% in April 2009 to 8.3% in September 2012;

Russia is highly dependent on oil revenues for output growth. However progress in technology and slowing demand in developed economies is creating downward pressure on prices.

Implications

Russia’s dependence on external demand, especially for energy, is providing risks for the economy. According to the World Bank, in 2011 the non-oil government deficit was approximately 10.0% of GDP; a contraction in oil prices will therefore have considerable impact on the government’s budget position. Oil prices declined between March 2012 and June 2012, with the Europe Brent spot price declining by 24.1%. Real GDP output is therefore expected to slow to 4.0% in 2012, from 4.3% in 2011;

Declines in oil prices tend to have only a marginal short term effect on consumers in Russia. Russian government buffers allow the consumer markets to remain relatively stable in the short term, while the capital intensive nature of the oil industry means employment is lower than in other sectors of the economy. For example employment in mining and quarrying made up just 1.8% of the employed workforce in 2011. However long term subdued oil prices will impact government revenues (impacting public sector workers after foreign exchange reserves are used up) as well as wider economic growth and income potential;

Since 2009 Russia has allowed a progressively more flexible exchange rate, having two important effects on the economy. First of all this has given the country increased monetary policy freedom, allowing it to react to external shocks more effectively. Since 2009 the country has maintained relatively loose monetary policy in an attempt to support Russia’s recovery. This increased flexibility is particularly important in allowing Russia to deal with the aftermath of shocks from the notoriously volatile oil markets;

Greater flexibility in Russia’s exchange rate is also expected to allow the external sector of Russia’s economy to become more reactive to shifting global trade winds. However a weaker economic environment in Europe amid recession and public debt crises is strengthening the ruble against the euro, negatively impacting exports. In the three years prior to the change in exchange rate policy the ruble averaged RUB35.2 against the euro. Between 2009 and 2011 however the exchange rate averaged RUB41.7 per euro.

Russian Exchange Rate Against the Euro: 2003-2013


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Source: Euromonitor International from European Central Bank (ECB)/national statistics/International Monetary Fund (IMF), International Finance Statistics (IFS)

Note: Statistics for 2012 and 2013 are forecasts

Prospects

A weakened European Union and a more generalised slowdown in global economic growth is affecting Russia’s economic outlook in 2012. Euromonitor International expects Russia to grow by 4.0% in 2012 and 3.8% in 2013 in real GDP terms, while Russia’s exchange rate against the euro is expected to remain high averaging RUB40.3 in 2012 and 2013. There has been little meaningful action in balancing the economy away from oil. By December 2012 Euromonitor International expects the Europe Brent crude oil price to rise to US$116 per barrel, however risks to this price remain from the eurozone crisis and political uncertainty from the USA;

There are however three sources of optimism for Russia’s economy. Firstly large foreign exchange reserves, which held at US$465 billion in August 2012 provide a cushion for Russia’s economy to any major external shocks. Secondly, wage growth has been relatively strong; between 2009 and 2011 the average annual growth rate of real disposable income was 5.8%, strengthening the country’s domestic market. Finally in August 2012 Russia became the 156th member of the World Trade Organisation. Long term prospects for the country’s external sector are therefore strong as costs of trade decline.