Our Opinion: 2016

Oil price plunge damaging government finances

The damage to government finances caused by the sharp slide in oil prices is spreading far beyond the Middle East. This week, Nigeria was reportedly in talks with the International Monetary Fund (IMF) and the World Bank for a joint $3.5bn loan. Oil revenues are expected to make up just 33% of income in Africa’s largest economy, down from 70% last year. The budget deficit forecast has climbed to 3.3% from 2.2% and it hardly helps that the government has pledged to increase public spending by 40% this year. Nigeria also has a current account, or external, deficit and needs foreign money to plug the gap.

The spotlight is also on Azerbaijan, whose currency, the Manat, has plunged to a record low against the dollar. Last year the government spent over 60% of its foreign-exchange reserves trying to keep the Manat pegged to the greenback. It’s said to be seeking $4bn from the IMF and WB. Meanwhile, Russia, which needs oil at $80 a barrel to balance its books, has announced a $13bn privatisation programme to plug a budget deficit that could reach 6% of GDP. So who will be next? Venezuela, “if it can… recognise the shambles it has made of its economy, looks like a prime candidate”, reckons the Financial Times.

Russia had a lousy 2015 and 2016 isn’t shaping up to be much better. The economy, dependent on oil and gas exports, shrank by almost 4% last year. Due to the oil price slide, the central bank has just downgraded growth forecasts and predicts that the economy will spend another year in recession and grow only marginally in 2017.

As oil has plunged, the currency has too, hitting record lows against the dollar. This has driven up inflation to around 10%, eroding the value of people’s pay packets: real wages fell by 9% last year. It also prevented interest-rate cuts by the central bank. As a result, rattled companies have stopped investing and consumers have stopped shopping. Retail sales fell by 15% year-on-year in December, a record slide. In addition, public spending has been squeezed because “the arithmetic of Russia’s public finances is unforgiving”, says The Economist. The budget deficit climbs by about 1% of GDP for every $5 drop in the oil price. It is set to hit 7% this year. With the $70bn “rainy day fund” dwindling, the government has cut spending, undermining economic momentum. Foreign investors are turning tail. The worst of the energy crunch may be over, as President Vladimir Putin insists. But for ordinary Russians, phase two will not seem much better.

The falling oil price has the potential to significantly improve global economic growth, but markets and companies will take time to adjust. Investors need to ensure their portfolios are positioned to help protect them in these turbulent times.