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The 5th International Virtual Scientific Conference on Informatics and Management Sciences March, 21. - 25. 2016, www.ictic.sk Impact of oil prices on Russian ruble on condition of floating exchange rate regime Aliaksei Bykau, Abbas Ghodsi, Hamid Nezhadhossein Belarus state economic university Minsk, Republic of Belarus Abstract—Since crude oil prices dropped in 2014, Russian economy suffers recession and devaluation of local currency. Central bank of Russia has switched to the floating exchange rate of ruble in November 2015; as a result, the inverse relationship between oil price and Russian ruble exchange rate is clearly evident. The paper aims to measure the given statistical dependence and examines its limitations. Keywords - Russian economy, oil prices, exchange rate, monetary policy I. INTRODUCTION There is a hypothesis explaining collapse of the Soviet Union through long-run decrease of world oil prices. This hypothesis has not yet been proven, but the close dependency of modern Russian economy on oil prices is obvious. The question is: how much close. Will Russian economy be adapted to lower oil prices, and, if so, in what way? Unlike the Soviet Union of the late 1980s, burdened by a great number of political and social problems, today’s Russia has got the market economy and applies market self-regulation tools for adaptation to the new external conditions. Experts recognize that despite the importance of external shocks such as lower oil prices and sanctions, structural crisis is the key problem of the Russian economy. To overcome the crisis it is necessary to provide an adequate business climate, quality of human capital, and thus the effectiveness, competitiveness of the economy and its individual institutions [1]. II. DEPENDENCE OF THE RUBLE EXCHANGE RATE ON OIL PRICES A good example of market self-regulation in Russia is the Central Bank’s switch from the dual currency soft peg to the floating exchange rate in November 2014. Earlier Russian currency was pegged to dual-currency basket with US dollar and Euro, and the Central bank propped up the ruble when the exchange rate against these currencies exceeded its boundaries. Recently the pressure on ruble strengthened and reserves began to dwindle rapidly. Floating exchange rate as a kind of monetary policy allows the Central bank to don’t spend reserves for maintaining the desired exchange rate of ruble, which is adjusted only on the basis of market supply and demand. In turn, the supply and demand for foreign currency derives from the changes in the balance of payments. Market self-regulation reduces the exchange rate of ruble after decrease in exports. That consequently leads to reduction of imports. Thus, the floating exchange rate prevents possible trade and budget imbalances in the period of drastic decline in exports. Use of this kind of monetary policy allowed softening the negative effect of lowering oil prices on the Russian economy. In the first half of 2014 68% of commodity exports of Russian Federation were energy resources, including crude oil (32%), petroleum products (23%) and natural gas (13%). In the first half of 2015 exports of energy goods, valued in dollars, fell by 37%, including crude oil - by 41%. Decline in export prices had the main impact on exports decrease, while export volumes increased by 6%. Non-energy exports decreased by 13%, but the share of non-energy goods increased from 32 to 40% of total commodity exports. The trade balance of services reduced from -10% of commodity exports in the first half of 2014 to -7% in the first half of 2015 [2]. Such a drastic decline in exports could be dramatic for the economy if the Central bank applied pegged exchange-rate regime. In fact, Russian foreign trade surplus has not changed significantly due to reduction of commodity imports by 39%. This was happened because real incomes of all sectors of economy were reduced proportionally to drop of exchange rate of ruble, and imports became more expensive compared with domestic goods and services. The switch to the floating exchange rate made the Russian economy more predictable relatively to its response to the oil price changes. Is there correlation between the oil price and exchange rate of ruble to US dollar? High volatility of oil price makes this problem topical not only for Russia. Western scholars investigated how the exchange rate regime has an influence on relationship between real exchange rates and commodity prices in developing countries [3]. Prof. K. Korischenko proposed a simple model for Russia [4]. Taking over the equilibrium price of oil in 3050 rubles per barrel, he derives (1): OP RER 3050 , where OP – oil price, USD/Barrel; RER – ruble exchange rate, RUB/USD; 3050 – constant oil price, RUB/Barrel. Using (1), it is easy to predict the exchange rate of ruble to the US dollar at a given oil price. Indeed, the predicted oil price of 3050 rubles per barrel is close to the average for the last 5 years (Fig. 1). Financial markets, asset prices, international finance 10.18638/ictic.2016.5.1.274 (1) eISSN: 1339-9144, cdISSN: 1339-231X - 67 - ISBN: 978-80-554-1196-5 The 5th International Virtual Scientific Conference on Informatics and Management Sciences March, 21. - 25. 2016, www.ictic.sk However, detailed analysis identifies certain changes in the ruble price of oil. The upward trend was observed from the beginning of 2011 until November 2014, and the downward trend was observed from October 2014 to the beginning of 2016 (Fig. 2). The percentage change in price was determined with respect to the maximum in October-November 2014. 4000 3800 3600 3400 3200 3000 2800 2600 2400 2200 2000 The statistical significance of these trends is not high: coefficient of determination for linear models, which show the dependence of the ruble price of exported oil on time, equals 0.54 and 0.60 (see Fig. 2). Meanwhile, in the last year we can note with a certain probability decreasing of oil price measured in rubles, if the ruble exchange rate is really equilibrium. Figure 2. The dynamics of the ruble price of exported oil, RUB/Barrel. Source: worked out by authors. 80 60 Exchange rate, RUB/USD 3000 130 2500 110 2000 90 1500 70 3000 50 2000 30 1000 500 0 0 40 20 Exchange rate, RUB/USD - left scale Oil Price, USD/Barrel - left scale Oil Price, RUB/Barrel - right scale Figure 1. The relationship between the exchange rate of ruble and the oil price. Source: calculated by authors using data from [5] and [6]. 60 80 Actual exchange rate, RUB/USD (left scale) Predicted oil price, RUB/barrel (right scale) Actual oil price, RUB/barrel (right scale) 0 18 .1 1. 20 10 14 .0 9. 20 11 10 .0 7. 20 12 06 .0 5. 20 13 02 .0 3. 20 14 27 .1 2. 20 14 23 .1 0. 20 15 0 40 Oil price, USD/Barrel 1000 20 3500 150 4000 100 4000 Predicted exchange rate (PER ), RUB/USD Oil price, RUB/Barrel 170 It is also significant that during the period of ruble oil prices increase from the beginning of 2011 to November 2014 (the red line in Fig. 2) there was no correlation between the oil price in US dollars and the ruble to US dollar exchange rate. From November 2014, when the Central bank switched to the floating exchange rate, to January 2016, statistical dependence between these parameters proved to be quite close (Fig. 3). 120 - 16% per year R2 = 0,54 18 .1 1. 20 10 14 .0 9. 20 11 10 .0 7. 20 12 06 .0 5. 20 13 02 .0 3. 20 14 27 .1 2. 20 14 23 .1 0. 20 15 The growth of ruble price of exported oil has a positive effect on profits of mining companies, as the gap between their dollar revenues and ruble costs increases. Growing profits can then be reinvested to output extension so the overall increase in the ruble price of oil contributes to the expansion of the mining sector of Russian economy. The decline in ruble oil prices reduces profits of mining companies, declining their investments and adversely affecting the mining sector. However, stronger ruble boosts domestic market that is more favorable for non-energy domestic producers. +7% per year R2 = 0,60 Figure 3. Statistical dependence between oil price in US dollars and ruble to US dollar exchange rate in the period from November 2014 to January 2016. Source: worked out by authors. The dependence of ruble exchange rate (PER) on the price of oil (OP) can be described by a power function (2): PER 656, 79 OP 0,001 0,6125 0,001 , R 2 0,80, DW 1, 75 (2) where PER – predicted exchange rate of ruble, RUB/USD; OP – oil prices, USD/Barrel. According to the received power regression model (2), the oil price below 10-15 USD per barrel could be critical for the Russian economy and trigger hyperinflation. Full costs of oil production including taxes for Russian companies vary from 10 Financial markets, asset prices, international finance 10.18638/ictic.2016.5.1.274 eISSN: 1339-9144, cdISSN: 1339-231X - 68 - ISBN: 978-80-554-1196-5 The 5th International Virtual Scientific Conference on Informatics and Management Sciences March, 21. - 25. 2016, www.ictic.sk to 35 USD per barrel [7] but they can be reduced with the depreciation of ruble against US dollar. It is also noteworthy that the power index in the given model (-0.6125) approximately corresponds to the share of energy exports in total commodity exports and reflects oil price elasticity of the exchange rate of ruble to US dollar. Comparison of the predicted values of ruble exchange rate to the actual values in January 2016 showed the high accuracy of the model. But the given model is static, like any other regression model. In the dynamics, the balance of payments always changes after the change in the structure of exports. The share of energy exports in total merchandise exports declining due to lower oil prices and higher US dollar to ruble exchange rate. This reduces the absolute value of the elasticity coefficient, which initially equals -0.6125. The ruble exchange rate becomes less sensitive to decrease in oil prices; therefore at a lower oil price forecasts of the exchange rate are overpriced. On the other hand, the influence of endogenous factors on the exchange rate of ruble increases with the rapid decline of oil price. The risk of panic in the market becomes significant and can lead to a sharp depreciation of ruble against US dollar. In this case, there is a possibility of the Central bank’s switch back to pegged exchange-rate regime. In assessing the effectiveness of the Russian Central Bank’s monetary policy, it is important to compare it with the possible alternatives that took place in other oil exporting countries. For example, the central banks of Kazakhstan and Azerbaijan until recently tried to maintain pegged exchange rate of national currency, providing once-only devaluations [8]. In 2015 they moved to a floating exchange rate regime. As a result, for example, the Kazakhstan’s Tenge was depreciated by 1.95 times in comparison with November 2014. The Central bank of Venezuela so far adheres to pegged exchange rate. This economy is in a serious crisis in 2015, with 10% decline in GDP and deficit of any imported goods. Saudi Arabia uses fixed exchange rate since 1986. Due to the rapid depletion of foreign exchange reserves after 2014, the kingdom is trying to pay off the growing budget imbalance by the sale of their major oil company through IPO. III. CONCLUSION various goods and services. Thereby the main problem is transition from resource-based to technology-based model of economic development. Our finding is floating exchange rate regime of Russian ruble as a kind of tight monetary policy prevents trade imbalances under high volatility of the world oil prices. This policy is limited by the lowest possible market price of oil. If oil price become less 20 US dollars per barrel, we expect the ruble exchange rate exceed 100 rubles per UD dollar, as Figure 3 shows. In this case there is a risk of panic on Russian currency marked. The two types of the Russian government measures preventing currency crisis could be considered. Thirst one refers to the world oil prices stabilization. Recently, there was reached an agreement between Russia, Saudi Arabia, Venezuela and Qatar on the freezing of oil production, which should stop the decline in world prices. The second type of measures oriented towards domestic manufacturing development. Implementation of import substitution projects in manufacturing and agriculture could reduce the dependence of the Russian economy on oil exports. REFERENCES [1] [2] [3] [4] [5] [6] [7] The decline of Russia's GDP in 2015 was 3.6%, and it is too early to say that the peak of the crisis passed. Flexible monetary policy of the Central bank is necessary but clearly not sufficient condition to overcome the crisis and resume economic growth. There is a problem of expensive loans for Russian companies because of high volatility of ruble. Russian economy needs to develop non-energy sectors that produce [8] Financial markets, asset prices, international finance 10.18638/ictic.2016.5.1.274 Mau, V. "To remember 1980-th and to do not repeat mistakes" Vedomosti (in Russian), last modofied February 16, 2016, http://www.vedomosti.ru/opinion/articles/2016/02/16/629725krizisvspo mnit1980e “The balance of payments, international investment position and external debt of the Russian Federation. January – June 2015. 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Dziadko T., Podobedova L., “The end of abundance: whether the oil production in Russia will grow in 2016” (in Russian), last modified January 8, 2015, http://www.rbc.ru/business/08/01/2016/56796d749a7947023b992b1c “Ruble, Tenge or Manat: what currency fell more in the two years” (in Russian), last modified December 24, 2015, http://news.tut.by/world/478472.html eISSN: 1339-9144, cdISSN: 1339-231X - 69 - ISBN: 978-80-554-1196-5