During 2014, the price of oil has fallen over 40%. Both Russia and Saudi Arabia’s economies are very dependent on oil exports.
- What has happened to the value of the Russian Ruble? What are the economic and political reasons? Explain.
- What has happened to the value of the Saudi Arabian Riyal? What are the economic and political reasons? Explain.
- What recommendations do you have for the Russians regarding their currency exchange issues? Do you recommend a fixed, flexible, or crawling peg currency exchange policy? Explain.
As the price of oil has fallen in 2014, the currencies of Saudi Arabia and Russia have been affected in very different ways. This is due mainly to the differences in their political and economic systems.
As the price of oil has fallen, the Russian ruble has lost a tremendous amount of its strength relative to the dollar. On January 1, 2014, the 32.9 rubles equaled one dollar. As of today (12/27/2014), it takes approximately 51 rubles to buy one dollar. This is a tremendous decline in the power of the ruble. By contrast, the strength of the Saudi riyal has not really changed. In fact, it takes the same number of riyals (3.75) to buy a dollar today as it did on January 1, 2014.
One major reason for these different outcomes is the difference in the economic situations of Saudi Arabia and Russia. Saudi Arabia has a much larger monetary reserve than Russia does. This allows the Saudis to continue to use their savings to keep their government deficit from getting too high. Russia does not have such large reserves and its deficit is rising. This helps push the Russian currency down because it reduces people’s confidence in the Russian economy. The Saudi currency does not suffer this fate because there is much less worry about the overall strength of the Saudi economy.
Just as important is the difference in the two countries’ political situations. Russia’s economy is hurting to some degree because of the sanctions that have been imposed on the country because of its actions in Ukraine and the Crimea. As the sanctions cut into the strength of the Russian economy, the value of the Russian currency declines. By contrast, Saudi Arabia is not under any sanctions and is a fairly close ally of the West. This means that there is much less political risk connected to the Saudi economy than to the Russian economy and people are more willing to do business with and in Saudi Arabia.
As for what the Russians should do about their currency, I agree with their decision to let the currency float. The falling strength of the ruble is bad in some ways, but it does help Russian exports because the price of those exports will fall in real terms for people in other countries. In addition, trying to maintain a peg would force the Russian government to expend tremendous amounts of foreign currency reserves trying to prop up the ruble. This would not be good for Russia either. Thus, while letting the ruble float is painful, it is less painful than trying to maintain a peg. I would recommend a flexible policy, letting the ruble’s value be set by forces of supply and demand. For more discussion of this topic, please follow this link.