Monday, December 1, 2014

Sliding oil price and the solvency of governments

As the oil price continues to slide to lower levels, the potential effects on government finances becomes more evident, especially since the slide does not appear very likely to be reversed majorly [] in the near future. (Opec did not cut [], but the major new supply from unconventional oil in North America such as fracking and the Canadian oil sands is not profitably at the current levels. It is only natural that the this new production will be cut [] if prices do not increase for other reasons.)

One major difference in how countries may handle this new reality comes from their exchange rate regime. Although the Russian rouble appears to be impacted most [], or at least receives the most attention, all currencies of oil exporting countries with flexible exchange rates have been tracking the fall of the oil price []. In fact, the Russian central recently stopped defending the currency against depreciation recently making it in fact more free floating than previously. The fall in real revenues in terms of their domestic currencies is mitigated by the depreciated currencies. Since governments have a major part of their expenses in the local currencies, the impact of the fall in oil price is partially offset by simultaneous nominal exchange rate depreciation. However, debts to external creditors, in particular those denominated in foreign currency, will become harder to finance. So even countries with floating exchange rates will probably make some adjustments to their budgets.

In contrast, the Venezuelan Peso is fixed against the US dollar. As the central government is heavily reliant on the oil revenues for squaring its budget, the impact of the oil price is stronger [] relative to the floating exchange countries. Prices of it's bonds have tumbled, reaching an annual yield of close to 20%. Venezuela is reported as having argued the most strongly for an OPEC production cut in order to support the price, but countries that argued for this lost the decision as OPEC decided to leave production unchanged [].

It should be noted that the oil price dynamics functions more like a looking glass that reveals the true characteristics of governments and an economy. Although Norway may have to make some changes in their budget, their massive savings funds allows them any adjustment to be smooth and balanced. The decisions to manage revenues in this way have been taken years ago, exactly to account for a volatile oil price. The recent Russian assertiveness into its western neighbours, with the EU and US response just adds to the nervousness of the economic prospects. That Venezuela has been mismanaged for years becomes only clearer as the government runs out of cash to finance its unfortunate welfare programs. 

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