Select Page

Justin Farr-Jones FX ReservesThe bear market in global commodities has had a severe impact on commodity producers and their currencies. Brent Crude has fallen 43 per cent over the past year, trading currently in the $44 per barrel range. As dual concerns persist around both the strength of global oil demand and an enduring price war between shale and OPEC producers, many commentators expect this current oil downturn to be a survival of the fittest.

Commodities other than oil have also suffered, with the Bloomberg commodity index falling 27% in the past year and 42% over the past five years. Specifically the drop in natural gas, coffee, iron ore and copper have exceeded 25 per cent since mid 2014. For commodity exposed currencies, further headwinds also lie ahead in the shape of the US FOMC as it prepares to tighten US interest rates in 2016.

So where you may ask is the a silver lining for commodity producer economies? Couldn’t commodity producers just pivot away from oil and diversify their economies?  Well the grim answer is an emphatic ’no’ , and that history suggests once trapped and dominated by a single commodity (the so called ‘Dutch Disease’ effect) there a few successful examples of breaking free. It is therefore hardly surprising that a decade of strong economic and fiscal revenue growth fuelled by natural resources creates bloated and complacent governments. So what other steps should or could have been be taken?

The conventional answer to this dilemma has been to build substantial buffers or Sovereign Wealth Funds (’SWF’) in the form of fiscal and foreign exchange ‘reserves’ during the ‘boom years’ that can be drawn upon during the ‘bust’. In this current environment you really want to be the commodity producer country with (1) low indebtedness (government debt /GDP) (2) substantial FX reserves and (3) fiscal reserves and deposits in a SWF . With this so-called ‘fiscal flexibility’, you have sufficient headroom to run a counter cyclical budget to maintain economic output, growth and most importantly social cohesion. Most countries have tried to follow this blueprint with varying degrees of success which ultimately boils down to whether those SWF reserves are actually sufficient for a rainy day?

For Saudi Arabia, the IMF estimates oil would need to reach $87 for fiscal break even and nearly 90% of its revenues and 85% of exports derive from oil. The Saudi fiscal deficit of $14.4 billion deficit in 2014 has risen to $38.6 billion in 2015 to be funded by increased issuance of public debt.  This is largely due to the collapse in total Government revenues from $278.9 billion in 2014 to $190.7 billion in 2015 resulting from the oil price collapse. So where you may ask is the silver lining? Well from 2015 and onwards according to the IMF, oil revenue as a percentage of total revenue will fall to 81% and Saudi Arabia is well prepared.  As oil prices surged, public debt was eradicated to 1.4% of GDP by 2014 and FX reserves stood at $654 Billion as of September 2015 (from a peak of $800 billion in 2014). Those reserves are now being called upon to fund and finance deficits during the downturn. In FX terms the SAR has been held at its peg of 3.75 to the US dollar. You could could say so far so good.

Russia, another oil and gas dependent exporter has been under sustained economic pressure from an unwelcome combination of sanctions and the oil price. Russian MinFin estimates its own FX reserves now stand at $322 billion as of September 2015 despite russian ruble volatility, (down from a peak of $596 billion in 2008). Whilst the Trading economics estimates government debt to GDP of only 18% , Russia estimates it’s own budget break even for oil is between US$ 80-$85 per barrel. Importantly for Russia, despite oil and sanctions the MinFIn reported the National Wealth Fund stood at $73 billion as of September 2015, or 6.7% of GDP demonstrating additional buffers. In FX terms, the ruble has continued to depreciate, with 1 US dollar worth 66 rules compared to 45 rules twelve months prior.

Finally in Nigeria, Africa’s largest economy, an economic transformation agenda has been promoted as a means of promoting non-oil revenue growth. This is because according to the IMF oil exports are expected to fall from $88 billion in 2014 to $52 billion in 2015. Nigeria’s importance is seen in the light of it accounting for 35% of sub-Saharan African GDP. Nigeria ultimately needs US $ 65 per barrel oil to achieve fiscal break even and is therefore currently running a budget deficit. However Nigerian debt to GDP stands at a modest 12% of GDP, whilst Nigeria’s weakness stems from declining FX reserves down to $34 billion (from $62 billion peak in 2008) and the depletion of Nigeria’s Excess Crude Account (ECA/SWF) to near zero balance from a peak of US$ 20 billion plus. In FX terms, the Naira’s depreciation has caused the economy significant problems with 1 US dollar worth 198 naira, compared to 167 naive twelve months ago. There are legitimate grounds for concern in how Nigeria can withstand further external economic shocks. Oil is the most important commodity traded in Sub Sahara Africa followed by gold and natural gas. According to the World Bank, eight of the major oil-exporting countries can attribute 90% of their total exports to the trade of their top three commodities; meaning the other 10% of the exports are spread amongst the rest of the economy. Unsurprisingly terms of trade have generally declined too among different economies in the Africa region. “ The 36 African economies with expected terms of trade deterioration are home to 80 per cent of the population and 70 per cent of economic activity in the region” states the World Bank.

We can see clearly differing dynamics in three major oil dependent economies, but fundamentally if you want a good idea of how any commodity dependent country will fare during this current downturn, you could do worse than to take a close look at their FX and SWF reserves since they will need both in abundance to manage both budget deficits and an orderly currency.