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Economic Prognosis for July, 2008
The first half of the year 2008 is over, and Vlast economic weekly, as usual, offers its economic prognosis for the second half of the year. Experts will answer the following questions: what will happen to the dollar exchange rate, how high the inflation in the Russian consumer market will be, how the world oil prices will change, how the dollar and the euro will behave in the world currency market? But to begin with, we’ll touch upon the key economic event of the first half of the year.
The falling of the dollar in the world as well as Russia can be regarded the major economic news of the first half of the year. Late December, 2007 you could have $1.45 for ˆ1, and in July, 2008 – $1.57. The exchange rate of the Russian Central Bank on December 28, 2008 was 24.63 rbl. per $1, and in July 1, 2008 – only 23.40 rbl.
In the first half of the year the American currency hit the historical barrier of $1.5 for ˆ1, it happened on February 27. You can recollect that many experts predicted $1.5 for ˆ1 as far back as the end of 2004. Then it came to $1.36 for ˆ1, and it seemed that the magic boundary would be will crossed very quickly. However, in 2005 the dollar began going up, and the year ended with the result of $1,18 for ˆ1. Only in 2006 the dollar dropped again, and at the end of the year the exchange rate of $1.31 for ˆ1 was registered. In 2007 the weakening of the dollar continued, and it became obvious by the end of the year that the $1.5 for ˆ1 will be reached all the same. In January, 2008 the euro managed to get more expensive than $1.49 several times, though to hit the $1.5 target, it would always lack a scintilla. And in February the European currency already cost more than $1.51. Moreover, in April the dollar became so weak that you could get more than $1.6 for ˆ1. The first half of the year ended closely to the record-breaking cheapest dollar and the most expensive euro.
On the last day of February in Russia the dollar passed the psychologically important mark of 24 rbl./$ in its movement downwards, and it hasn’t risen above this mark so far. It looked natural: why should the dollar go up in Russia whereas in the world it becomes cheaper breaking new records?
Experts would suggest different reasons for the weakness of the dollar in the world in the second half of 2007 and the first half of 2008. In particular, the IMF, as usual, explained the plunge of the American currency with the deficiency of the balance of payments in the USA. “Just like the decrease in the dollar exchange rate in 1985-1991, the present fall of the American currency was accompanied by an enormous deficiency of the American balance of payments. Nevertheless, at that time the deficiency decreased at once as a result of a slump in the dollar exchange rate; under the present circumstances, since 2002, as the falling of the dollar started, the deficiency has even grown reaching a record of 7% of the GDP in 2005. Only some time later it began to go down gradually, but all the same it remained at 5.5% of the GDP in 2007.” According to the experts of the IMF, the following factors fostered the deficiency (hence, the weakness of the dollar). First, the LDC’s more important role in the world’s trade; they supply America and the world with relatively cheap goods, and it is difficult for American manufacturers to compete with these goods whatever the dollar exchange rate. Second, the peculiarities of the business cycle in the USA: up to the year 2006 the country showed a much more rapid economic growth at the expense of a boost in consumption and an increase in housing prices. Under such conditions the American consumers showed considerable demand for imports. Third, the record growth of the world oil prices, which spoiled the balance of payments of all countries importing oil, the USA in the first place. Fourth, the circumstances connected with the financial markets dynamics played quite a role. However big the deficiency was, the USA was able to finance it by means of selling securities to foreigners – not only short-term bonds of the American exchequer, but also private bonds, including those secured with the real estate. “But starting from the middle of 2007,” the IMF experts opine, “The cyclic and financial circumstances accelerated the falling of the dollar. The crisis phenomena in the world financial markets made the price and the liquidity of the American securities unclear, considerably lowering the demand for corporate and state bonds. They also reduced the inflow of the foreign capital to the USA and negatively affected the price of the American currency."
Alan Greenspan, the Federal Reserve former head, also linked the falling of the dollar with the deficiency of the balance of payments, however, he expressed his particular point of view, "Accumulation of dollar demands to American residents as a result of the growth of the deficiency has already caused concerns with a risk of concentration – a situation when all eggs are put in one basket. It could make foreign holders of dollar assets exchange dollars for other currencies, regardless of the fact that dollar assets brought bigger incomes. That’s why since 2002 the dollar exchange rate has plummeted, just like role of the dollar as a means of portfolio investments.”
However, the speculators in the world currency market explained their activities against the American currency with the constant decrease in the American interest rate, rather than the problems of the American balance of payments: say, having assets in a currency of a country with a permanently cheapening credit doesn’t pay.
In Russia the exchange rate is regulated, and the cheapening of the dollar was ensued not only by the objective reality of the world market, but also other reasons, first of all the theory that strengthening the national currency is an anti-inflationary tool. However, the expensive rouble didn’t appear to play any anti-inflationary role – the anti-inflationary plan failed at the beginning of the year already. Anyway, imports soared, and the Central Bank had to respond to those manufacturers who reproached it with impeding the national competition pursuing its exchange rate policy.
1. What will happen to the rouble exchange rate?
In our prognosis for June we assumed that the government is still interested in combating inflation, and so, the dollar in June will not cost more than 23.8 rbl. The assumption turned out correct: the month ended with the rate of 23.4 rbl./$.
In the second half of the year the Central Bank is likely to keep on with its policy of the strong rouble: it wants to show it does its best to scotch the inflation. Here, two theories are implied. According to the first one, without keeping a check on the rouble, the Central Bank doesn’t buy many of the dollars going to the country and, consequently, doesn’t print too many roubles. According to the second theory, the strong national currency encourages imports, and an inflow of foreign goods contributes to the satiation of the consumer market. Due to severe competition, sellers avoid a fast increase in prices. More to the point, with the present extremely high world oil prices and the weak dollar in the world currency market a sudden weakening of the rouble would look odd.
To the reproaches that the strong rouble tells negatively on the national competition and the economic growth, the Central Bank replies that the Russian manufacturers had better turned to advantage the current state of affairs, rather than complain constantly. First of all, it is necessary to import as much as modern equipment as possible, using the benefits of a high rate of the national currency, and to carry out technological modernizing of enterprises. It’s high technology that is now a basis of international competitiveness.
It is necessary to keep in mind that now the Russian government officially predicts a fall in the rouble exchange rate in the short run. Allegedly, imports are on the rise now, and the Russian balance of payments gets worse, which will affect the rate. In other words, the government suggests that you shouldn’t complain about the strengthening of the rouble because it is going to get weaker.
Our prognosis: In the second half of the year the dollar will cost less than 24 roubles because of the policy of the strong rouble.
2. What will happen to the Russian prices?
In our prognosis for June we pointed to the fact that dealers will continue to boost prices and inflation will exceed 0.8%. The forecast was correct: according to the Rosstat data, in June consumer prices grew by 1%.
This said, since the beginning of the year inflation has already reached 8.7%. The failure of the anti-inflationary plan this year is even more stunning than in the past. Within the first half of the year the marks of 8 and 8.5% were passed (whereas these were considered anti-inflationary tasks for the entire year). In the first half of the year the Russian government was so much impressed with its inflationary failures that it would not make any anti-inflationary plans and tasks at all. And now you can speak about some vague inflation prognoses, which won’t necessarily come true. Now another official forecast is 10.5%. In informal conversations, officials with the Central Bank say that, of course, the bank does its best to combat the rise in prices but no one can guarantee anything – you can do nothing but sit and wait till the inflation drops itself. After all, it is to drop some day!
The government, as it always does, expects the inflation to ease somewhat in the second half of the year. It believes that the cheapening of fruit and vegetables will reverse the trend. The world food crisis seems to be calming down. On the other hand, the government has argued that the salaries of state employees and social expenses should be made higher to compensate for the losses caused by the inflation. It makes consumers and manufacturers think that the inflation will remain high and nothing will be done about it.
Our prognosis: In the second half of the year the inflation won’t go down drastically, and the growth in consumer prices won’t exceed 13%.
3. What will happen to the world oil prices?
In our prognosis for June we underscored that in the present oil game any drop in prices is only a temporary phenomenon and in June oil won’t be cheaper than $120 per barrel. The forecast was correct: Oil rose in price and on the last day of June it set an absolute record – $143.67.
It need be said that the present oil crisis has been marked with a complete lack of understanding between producers and consumers of oil. After the world oil prices rocketed on June 6 by the unbelievable $11 per barrel, the exporters and importers of oil, as well as the largest oil companies decided to hold a conference in Saudi Arabia to figure out what to do with such price miracles. However, they didn’t manage to agree upon anything. The OPEC countries continued to assert that they could do nothing about the prices, as the problem lay not in the shortage of oil, but in the relentless speculation with oil futures. The western countries (mainly, the USA) emphasized that the international financial speculation is obvious, however, speculators are not to be blamed for the increase in prices: unless the prices grew by themselves, nobody would stake on their growth. So, the oil-producing countries could cool the speculative heat, boosting production.
Oil-producing countries continue to adhere to the theory that the falling dollar is the major factor stipulating the growth of oil prices: exporters need to compensate for their losses since oil is sold only for dollars in the world. They have advanced this theory for a long time, and the USA has already responded to them that it didn’t notice any decrease in oil prices when the dollar used to grow rapidly.
Our prognosis: The rows between producers and consumers will continue despite the crisis, and oil will cost more than $110 a barrel.
4. How will the dollar fare against the euro?
In our prognosis for June we predicted that the euro won’t be cheaper than $1.52 as currency speculators are confused and oil prices are high. We were right: The month finished with the euro exchange rate exceeding $1.57.
In the second half of the year currency speculators will pay less attention to the prospects of an increase in the American interest rates. To foster the economic growth of the USA in the first half of the year, these rates were lowered to 2% – and it’s risky to keep on with it. However, they’ll pay much more attention to the level of the world oil prices, according to the theory which argues that exporters of oil get such dollar revenues (Morgan Stanley estimates them at $200 bln a month) that they will inevitably want to convert a certain share into the euro in order to avoid concentrating their assets in the same currency. Then the euro exchange rate will rise, hence, it is necessary to buy up the European currency now.
It need be stressed that not all researchers consider the dollar a “bad” currency. British economist Anatole Kaletski says, “I believe that the prime motivator of fluctuations in exchange rates is the optimism concerning the countries of the Eurozone, rather than the pessimism concerning the prospects of the USA. It is not the dollar that is weak, it is the euro (and the English pound) that are strong. And the key question for the currency market, hence, is not whether the crisis in the housing market will aggravate, but whether something will happen that will dispel the euphoria concerning the European economic growth. The answer is, certainly, yes, but not in the near future.” The expert explains that under the present circumstances it is just a question of a choice between the dollar and the euro because these currencies are considered to be reserve. If investors opt for the euro, they try to get rid of dollars (the British pound traditionally grows together with the euro). And its faring well against the yen proves that the dollar is not a weak currency.
Our prognosis: In the second half of the year speculators won’t get that disappointed about the euro to let this currency cost less than $1.50.
Sergey Minaev
All the Article in Russian as of July 07, 2008
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