Introducing to Russia…

• Largest country in the world in terms of mass
• 10^th largest economy in terms of GDP for 2006
• Average growth of over 6% per year since 1998
• 2^nd largest exporter of oil; expected to overtake Saudi Arabia in 2007
• The Russian Ruble, Often denoted by RUB, is the name of the currency of the Russian Federation
• The modern ruble was introduced in 1992 when the former USSR split. Periods of high inflation brought about different issues of banknotes from 1992-1995. In 1998, the Ruble suffered a double devaluation following years of Crawling Peg Policy.
• From 1999 – 2005 : The Currency has appreciated over 80%.
• 3 fundamental factors include:
• Increase in Oil Export Revenues
• Balassa-Samuelson Effect
• Inflow of Capital
• 2 Non-Fundamental Factors include:
• State controlled prices of non-tradables
• Initial Undervaluation due to risks factors
• An important factor which is considered as the driving force behind the fall in 1998 and perhaps the rapid appreciation of the currency is the rising oil price.
• We will focus on the EFFECTS OF RISING OIL PRICE ON THE RUBLE
• Experts attribute the reduced supply, hence hike in Oil price to a variety of factors, including North Korea’s missile launches, the crisis between Israel and Lebanon, Iranian nuclear brinkmanship,unprecedented growth in Asia, and in particular China and reports from the U.S department of energy showing a decline in petroleum reserves
• Russia the second largest Oil producing nation, after Saudi Arabia, benefits directly from this upward movements of oil price.Evidently, the rise in energy prices have provided Russia with ahuge windfall gain
• Positive development in energy prices has boosted the Russia’s export sector. The composition of Russian exports shows that theshare of nominal exports related to the oil or gas sector has gone up from 40% in early 1999 to around 65% in mid 2006.

What is the Russian Ruble?

Factors that Affect The Ruble

Rising Oil Price and the Ruble

Russia Oil and Gas Output

Money Supply

Oil Price increases

• An increase in oil prices led to greater trading revenues,
• resulting in a large Current Account Surplus
• 2006 Surplus = $86.6 billion, up $28 billion from 2004
• Large foreign currency earnings for exporters of Russia's natural resources.
• The Central Bank of Russia requires exporters to repatriate 75% of their foreign currency earnings
• which are then sold for rubles on the domestic market.
• Current Account Surplus The conversion of billions of dollars into rubles has expanded the domestic supply of base money.
• More rubles in circulation mean higher inflation. The greater the amount rubles in circulation
• • the greater the demand for goods Increased likelihood of Producers reacting to an increasing demand of goods by rising prices, hence Inflation.
• According to the theory of Monetarism, the level of prices depends closely on the money in circulation
• The greater the money in circulation, the higher the prices and

The Value of the Ruble and Prices

vice versa MV = PT

^PRuble ^{= M S}Ruble ^{/L (R}Ruble ^{, Y}Ruble ⁾ P_us = M ^S_us /L (R_us , Y_us )

• Taking in account PPP exchange rate of

^EUS^/Ruble^=PUS^/PRuble

□ M-quantity of money, V-velocity of money, P-price level, T-transaction

Aggregate Money Demand

Also, This surplus creates an income effect and price effect

• Real National Income
• □ The greater income has led to increased demand for domesticgoods and services and a higher net demand for domestic currency
• Price Level
• □ An increase in the price level increases the amount of moneyindividuals have to hold
• Internationally, the increasing demand for oil and sale of oil in rublesmeans increased demand for Ruble
• The greater demand for currency puts upward pressure on thecurrency to appreciate.

Exchange Rate

• The exchange rate which is the relative price of American and Rubble money is fully determined in the long run by the relative supplies of those monies and the relative real demands for them.
• The demand for the Russian Ruble has soared recently due to the increased oil production and high oil prices.
• This has resulted in the appreciation of the Ruble against the dollar.

Appreciation of Ruble

• Graph showing appreciation of the Ruble against the US Dollar 2001 to 2006
• In 2005 the Ruble appreciated against a basket of currencies by 10% and by 8.3% in 2006. Current US Dollar/ Ruble Exchange rate is 1 USD/ 26.408 and the Euro/ Ruble Exchange rate is 1 EUR/ 32.243

Other ECONOMIC INDICATORS

• The Russian GDP has grown by 48% between 1999-2005
• Real Income of population grew by 46%
• The Country has experienced unprecedented macroeconomic stability and strong budgetary and current account surpluses

Costs and Benefits of Appreciated Ruble

Benefits of appreciation:

• Appreciation of Ruble lowers import prices which boosts the realliving standards of consumers in the short run
• Good for businesses as it is cheaper to import raw materials andother components
• Helps to control inflation; domestic producers face competition from cheap inputs and look to reduce costs

Costs and Benefits of Appreciated Ruble

Costs of appreciation:

• This appreciation of the ruble impacts on the competitiveness of domestic manufactures
• □ showing signs of Dutch disease symptoms
• Appreciation leads to rising imports and a larger trade deficit in the long run creates a tough situation in domestic industry; particularly in sectors that have dollar based revenues and ruble based costs
• If exports fall, there will be a negative impact on growth, i.e. GDP

Stabilization fund

Stabilization funds aim to build up reservesduring times of high commodity prices to relieve fiscal pressure and smooth spending when thoseprices fall. A stabilization fund makes sense for Russia as oil revenue makes up 30% of thecountry’s budget (and 65% indirectly), and lowoil prices over a long period would obviouslybring a significant loss of budget revenues.

By the end of 2006 it was 110 billion $

Summary

• Russia’s economy is expanding greatly and looks set to be a major power in the future
• Russian ruble’s appreciation can be largely attributed to the increase in oil prices although there are other contributing factors
• Economic performance is likely to be driven by oil and other resource revenues
• Economic dependence on these revenues and theappreciation represents risks to the economy that the government needs to address including vulnerability to external shocks and the risk of ‘Dutch disease’ with the distorted development that is often associated with heavy reliance on natural resource sectors.

The adjustment to permanently high oil prices presents new challenges for economic policy

• “Fiscal policy is the best tool for managing this adjustment…
• The authorities aim to reduce inflation to around 4.5–5.0% per annum bythe end of the decade. In present circumstances, however, the Bank ofRussia’s policy options are limited, given the weakness of both the interest-rate channel and exchange-rate pass-through. A relatively tight fiscal stance, on the other hand, can reduce both inflation and exchange-rate pressures, thereby mitigating the competitiveness–inflation trade-off facingthe Bank. Moreover, fiscal policy could play a critical role in sustaining notonly budgetary expenditure but also growth and exchange-rate stability in the event of a negative terms-of-trade shock. Over time, financial deepeningshould allow the Bank to pursue a more effective anti-inflation strategy,relying on a wider range of policy instruments than at present, but fiscalpolicy remains the best instrument for managing the adjustment to the newterms of trade while achieving substantially lower inflation”.

OECD assessment Nov, 2006