Immunity From the Oil Curse
- By Martin Gilman
- Jun. 11 2008 00:00
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Oil is so central to the existence and development of modern economic life that it has inevitably become the focus of global concerns as prices have doubled since 2006. Oil complicates economic decisions, macroeconomic policy, domestic politics and the foreign policy of virtually every country. Russia is no exception.
For most other countries -- especially in the West -- the oil shock of 2008 has been an unexpected surprise, and it could not have come at a worse time in cyclical terms. Prices have spiked -- reaching almost $140 per barrel on Friday -- even though the U.S. economy is recessionary, with Europe and Japan not doing much better. This development is utterly different from the past, when commodity price cycles tended to follow the ebb and flow of aggregate demand in the largest industrialized economies. The oil shocks of 1974 and 1979 were exceptions related to major political events in the Middle East. This time there has been no obvious external supply-side shock.
Prices are rising as the demand in China and in other emerging economies surges, while at the same time we are seeing short-term supply constraints. There is no doubt that U.S. negative real interest rates, which came about as a consequence of a dramatic loosening of monetary policy since last fall, have also played a role in fueling the 40 percent increase in oil prices since the beginning of the year.
So now the burden of adjusting to drastically higher oil prices comes just as battered consumers in Western countries have cut back on consumption in the face of some of the weakest readings of confidence indices in 20 years. Paying for dearer oil will necessarily require even less consumption of other goods and services.
Western governments and other oil-consuming nations are hard-pressed to address the challenge of high oil prices. In desperation, some countries like India, by refusing to allow a significant pass-through of higher prices, are subsidizing oil consumption. Recent proposals to reduce oil taxes in France and the United States on a temporary basis during the summer are a clear sign of political recklessness. In any case, the transfer of resources to oil producers from the consuming nations is having a profound deflationary impact. Yet any attempts to compensate with a loosening of macroeconomic policy just seems to feed inflation and inflationary expectations, which are at the highest levels in over 20 years in a large number of oil-importing countries.
As a result, we are seeing serious political strains. Fortunately, no price riots have been reported in Western countries, but it is clear that politicians are groping defensively to cope with the impact. With election season in full swing in the United States, a lame-duck Congress is flirting with ideas such as accelerating biofuel development; opening exploration of off-shore regions and in northern Alaska by setting aside ecological concerns and restrictions; and further subsidizing nontraditional energy sources, such as solar and wind power. U.S. politicians are also searching for scapegoats by investigating the role that speculators have played in driving up oil prices. Nothing is likely to happen until a new U.S. president is sworn in next January, but the mood of the electorate is getting ugly.
On the foreign policy side, the mood is no better. U.S. Treasury Secretary Henry Paulson traveled around the Middle East early last week warning that soaring oil prices are putting a burden on the global economy and asking countries to maintain their peg to the dollar. In addition, OPEC has been the center of controversy in its refusal to consider an immediate rise in output, while many analysts doubt that it really has any spare capacity. Iran and Venezuela have also been fanning international tensions. After an Israeli deputy prime minister threatened last week to attack Iran's nuclear facilities if Tehran continues with its program for developing nuclear weapons, it certainly did not help calm concerns about future oil supply.
For Russia, the stakes are different. As the world's second-largest oil producer, it is almost the mirror image of many Western countries. Higher oil prices are fueling a boom in domestic aggregate demand, with real gross domestic product expanding by more than 8 percent for the year through May. Government revenues are rising so much that, even with the supplementary budget, the fiscal surplus is expected to decline only slightly to 5 percent in 2008. Foreign-exchange reserves have hit almost $550 billion as the country attracts foreign investment on a net basis on top of the current account surplus.
This oil boom comes at a price, however. The continuing rise in private spending, along with the acceleration in government spending since the second half of last year and a loose monetary policy, have fueled a doubling in the rate of inflation in just a little over a year. Hopefully, recent steps to tighten monetary conditions and the deceleration of fiscal expansion should help to prevent Russia from following Ukraine's path toward inflation rates exceeding 30 percent.
Furthermore, the current level of oil prices is a mixed blessing in another sense. There is considerable uncertainty about the direction and magnitude of future oil prices. Experts predict prices in 2009 ranging from $60 to $200 per barrel. This is a headache for consumers and producers alike. For producers, given the long lead times for exploration and development, investment decisions become a stab in the dark. Furthermore, medium-term budget planning, longer-term export contracts and issues of wealth management become much more complicated. The cost of being wrong has never been higher.
For Russia, the stakes are especially high as critical decisions about future oil output are overdue. The country already produced 0.8 percent less oil in May than in the same month last year, bringing the country closer to the first annual decline in oil output in a decade. Total exports also fell by 4.6 percent less than in May last year.
The government plans to offer a 100 billion ruble ($4.2 billion) package of tax breaks and incentives to stimulate production growth, including a cut in the mineral extraction tax, incentives for production of high-quality and environmentally cleaner fuels, tax holidays for offshore exploration and changes to the excise duties on high-quality oil products. But with higher costs of development, it is unclear if the proposals, which will go into force in 2009, will go far enough to boost production.
Russia's leaders are well aware of the poor track record of oil and other commodity producers in squandering their natural wealth inheritance on wasteful spending, white-elephant projects and corruption. Good examples of this phenomenon include Gabon, Iraq, Libya, Nigeria, Venezuela and Zambia. These countries have all gambled their future on the hope that high commodity prices would continue for the foreseeable future. The problem is that they rarely do.
Russia has done well so far in avoiding this infamous "resource curse." The budget surpluses, the reserve fund, a three-year rolling budget for planning purposes, the analytical use of a non-oil budget and its high external reserves underscore its commitment to maintaining a prudent stance. Moreover, with a booming economy, medium-term prospects are favorable. Relative to most other countries, Russia is in an enviable position.
For Russia, oil is not a curse. But it does certainly complicate life.
Martin Gilman, a former senior representative of the IMF in Russia, is a professor at the Higher School of Economics in Moscow.