Notes from Russia and Kazakhstan
Oil prices tumbled dramatically since July when they reached US$115 per barrel to below US$65 per barrel in recent days. Despite the sharp price decline, OPEC signaled no intention to cut production. The oil market remains well-supplied and there is demand-driven pressure on oil prices, following weak economic data from the Euro zone and a number of emerging economies, including Turkey, Brazil, Russia, and China which means that the oil price could fall even further and remain low for longer.
The economic prospects of many resource abundant economies are tied to oil prices. Russia and Kazakhstan are two extreme cases. Such dependency translates into volatility of export receipts and government revenues and, depending on the exchange regime, to a decline in the national currency. For Russia, oil and gas provide about 70 percent of its exports and 50 percent of its federal budget. In Kazakhstan, oil revenues constitute about half of government’s total revenues and 45 percent of foreign exchange earnings.
The literature suggests that commodity-exporting countries should let their exchange rate float, allowing independent monetary policy to respond to commodity shocks (Frankel 2014, Broda 2004, Edwards and Yeyati 2005, and Céspedes and Velasco 2012). If monetary policy is being constrained in tackling this challenge as a result of prevailing exchange rate regimes in the form of fixed pegs or tightly managed floats, fiscal policy is left to carry the main burden of macroeconomic stabilization.
For Russia, which had a managed float since 1999, recent oil price developments translated into a serious erosion of the value of its currency since July (Figure 1). The Ruble depreciated by 55 percent versus the US Dollar by early December. In October alone, the Central Bank of Russia spent about US$30 billion to support the Ruble (reducing its reserves to around US$420 billion). The sharp drop in oil prices was one factor which accelerated the central bank’s transition to a free-floating exchange rate (originally planned for January 2015) unexpectedly to November 10.
In Kazakhstan, where the exchange rate regime is a tightly managed float (Figure 2) the authorities spent an estimated US$9 billion (or about half of their foreign exchange reserves) between July and October 2014 to stabilize the tenge.
Both governments are now also facing fiscal challenges and are considering an appropriate fiscal policy response.
Revenues from natural resources, especially oil and gas, are inherently volatile, uncertain and dependent on external demand. To maintain prosperity in the long-term, resource rich economies should either save resource revenues in order to accumulate financial assets or to invest them in physical assets, i.e. use them for capital expenditure in the good years. The short-term challenge for both macroeconomic management and fiscal planning stems from the volatility and unpredictability of oil prices. This often contributes to a pro-cyclical pattern of government expenditure in resource-exporting countries and calls for a smoothing of public expenditure by using strong fiscal anchors.
The immediate policy question for Russia and Kazakhstan concerns the adjustment of their budgets.
The Russian Duma and the president decided to go ahead and approve the budget draft for 2015 as planned (which balances the budget at an oil price of slightly over US$100). It also committed to adhere to its existing fiscal rule which puts a ceiling on federal expenditure. This will allow the government to make use of its Reserve Fund. Under the flexible exchange rate regime, the drop in oil prices will be translated into a depreciating Ruble, and both effects on the budget partly cancel each other out. A plan on reviving the economy in a counter-cyclical fashion started to be implemented this year through a strategic investment program which is largely financed off-budget through commitment from the National Welfare Fund, Russia’s second reserve fund put aside to cover future pension liabilities.
The government of Kazakhstan decided to follow a different path; it revised its 2015 budget to account for lower oil prices (now set at US$80 per barrel in the budget instead of the initial US$90) but then unexpectedly laid out a new massive investment program for 2015-2017 in November 2014. This US$18 billion program is funded by a US$9 billion withdraw from the national oil fund (US$3 billion over 3 years), and by about US$9 billion Program Framework Agreement it has with several International Financial Organizations, including the World Bank. The program focuses on medium-term investment in roads, housing, utilities and social infrastructure, as well as continued support for SMEs.
For both countries, using better stabilizers such as strong fiscal anchors like the non-oil deficit ratio and well-targeted social safety nets, would help weather short-term shocks better and reduce the need for ad hoc or reactive fiscal policy interventions. If the drop in oil prices will persist as we project there would be a limit to a publicly driven investment stimulus.
Finally and perhaps most importantly, the impact of fiscal stimuli varies from country to country and public investment may not always yield the desired positive effects: in the case of Russia public investment showed a large potential to crowd out private investment. Russia’s former Finance Minister Alexei Kudrin, recently proposed to upgrade Russia’s institutions to regain the trust of businesses, including making government administration more efficient and extending subnational authority, and rebuilding public trust in the judiciary and the pension system. In short, these measures would help revive the private market and entrepreneurial activity, rather the ones which aim to increase public capital expenditure decided on the federal level.
In the case of Kazakhstan, the impact of the envisioned investment program on GDP may be little in the next year or two, in the absence of shovel-ready projects. Also, the authorities would need to be vigilant about repeatedly dipping into their national oil fund to ensure fiscal discipline and consider the economy’s absorption capacity, the viability of projects, and efficiency of expenditure.