Oil and
exchange rates
Due to the
falling price of oil, net oil-exporting countries, such as Norway and Russia,
have seen their currencies depreciate over the past year. The Russian rouble
has seen a 45pc decline against the dollar since June 2014, whilst the Brazilian
real has declined by 40pc.
Firstly, the declining demand of oil from China has
decreased global demand for oil, meaning that there has been reduced demand for
the currencies of oil exporting nations, which in turn has resulted in their
decline. Moreover, the decline in the global price of oil has also resulted in
other foreign importers needing to purchase fewer roubles, for example, in
order to obtain the same volume of oil. Therefore, these foreign importers have
demanded fewer roubles, thus contributing to the decline in the value of the
rouble. Due to a
fall in the total value of exports countries, oil-exporting countries have seen
an increase in their current account deficit. For example, The Economist
Intelligence Unit estimates that, over the past 2 years, Norway has seen a 3.3pc deterioration in its current account.
On the other
hand, not all net-oil exporting nations have seen a decline in their
currencies. Both Australia and New Zealand have a triple-A credit rating which
acts as an incentive for investors to buy sovereign bonds, as they offer high
yields. This high demand for the Australian dollar outweighs the decrease in
export volumes of commodities. However, analysts at Nomura argue that when the
US Federal Reserve increases interest rates, investors will have a greater
incentive to buy the US dollar and so the Australian dollar will decline in
value.
Recently,
the Nigerian government has tried to reduce the rate of depreciation of the
naira by imposing import bans which are hoped to try to decrease the trade
deficit. 41 items have been banned, but rather than stabilising the currency,
it has increased the trade deficit. The price of the products that have been
banned has increased. However, this is hurting Nigeria’s manufacturers because
the cost of production has increased, which in turn has increased the price of
manufactured goods. Therefore, the demand for manufactured goods has also
decreased, thus reducing total export revenues. Restring trade will not solve
the problem, on the contrary it will hinder recovery.
Should we
peg exchange rates?
Most net oil-exporting countries have pegged their exchange
rate against the dollar. This could help to reduce the rate of inflation. If an
oil-exporting country were to have a freely floating exchange rate, its
currency would be extremely volatile, as it would be heavily dependent on the
price of oil. However, pegging the currency against the dollar would ensure
that the exporting country’s central bank increases in credibility, and so the
rate of increase in inflation is reduced when the price of oil plummets.
Alternatively,
if the country has large foreign exchange reserves, the central bank could sell
these reserves, increasing the supply of the foreign currency, and so
decreasing the rate of its appreciation and so decreasing the relative
depreciation of the country’s own currency. Moreover, by selling the foreign
reserves, the supply of the country’s own currency would decrease, thus helping
to reduce the rate of depreciation of the currency. Saudi Arabia has
accumulated large foreign currency reserves and it is thought that she will
engage in such methods in the future to ensure that her currency does not
depreciate at as great a rate against other currencies, due to the falling price
of oil.
However,
currencies that are pegged are prone to speculation. Therefore, speculators
sell the currency, and so produce a downward pressure on its price by reducing
the demand for the currency. This could hurt the underlying economy because the
country may increase interest rates in order to increase the demand for the
currency, but these high interest rates would act as a disincentive against
domestic investment.
References
Image: http://www.wetrade4you.com/wp-content/uploads/2015/02/oilcartoon2.jpg
References
Image: http://www.wetrade4you.com/wp-content/uploads/2015/02/oilcartoon2.jpg
