Oil market showdown: can Russia outlast the Saudis?

In both Russia and Saudi Arabia, the governments have attempted to shield their citizens from job cuts. In Russia, the government has discouraged businesses from shedding employees, while the Saudi government has maintained headcount in the government and government-related bodies, where most Saudis nationals are employed.

In terms of income, however, the situation is different. IMF WEO projections show per capita income in 2015 declining from 2014 levels in both Russia and Saudi Arabia, and only slowly recovering (the year exceeding 2014 levels in red font). (The increases in per capita income in the Russia current prices, national currency and in the Saudi constant prices, national currency series results from the same factors discussed in the section on GDP).

Impact on currencies

The steep decline in crude prices has pressured both currencies. The Ruble has suffered two curses. First, it has declined substantially relative to "hard" currencies, such as the US$, the Euro, British Pound, and the Swiss Franc. Against the U.S. dollar, it depreciated ~29 percent from November 27, 2014 to October 13, 2015 (48.58/US$, to 62.77). Second, it has been and continues to be highly volatile, its fate tied to moves in crude prices. The Ruble reached its post-November 27 low on June 27 (33.73/US$) and twice reached its high of ~70/US$ (January 30 69.47, August 24 70.89). A chart is available on Bloomberg.

The pressure on the Ruble forced the Russian Central Bank to take a series of emergency measures. At the end of last year, it spent ~$100 billion from its foreign currency reserves to defend the Ruble (it finally abandoned the defense when it proved futile and allowed the Ruble to float). In the same period, it extended emergency "hard" currency funding to major Russian banks and businesses with "hard" currency obligations that were coming due at the end of 2014. The Central Bank also sharply raised interest rates-to 17 percent at one point-and has kept the rates high to defend the Ruble (currently ~11 percent). Two examples illustrate the impact of Ruble devaluation:

- Transaero, until recently Russia's second largest passenger airline, attributed being forced into bankruptcy to high interest rates and a devalued Ruble-the former raised the cost of financing, the latter pushed up prices in Rubles and therefore reduced demand in Russia for international flights and increased the cost, in Rubles, of repaying foreign currency denominated loans and interest.

- The Association of European Businesses in Russia recently announced that sales of new cars and light commercial vehicles contracted 29 percent in August year-over-year and forecast a 37 percent decline for all of 2015. It cited price increases that the car manufactures were forced to take to cover the increased cost of foreign parts and systems used in domestic auto manufacturing.

Volatility is equally pernicious. As another Bloomberg article points out, Russian businesses, unsure of what the value of the Ruble will be long term or even day-to-day, are deferring investment despite generating substantial (Ruble) profits-the very investment which some believe the Russian economy needs to grow and which has been contracting for 20 months.

The Saudis have avoided both Riyal depreciation and volatility. The government has insisted it will keep the Riyal pegged at 3.75/US$ and financial markets thus far have taken comfort from Saudi reserves (estimated to exceed $660 billion). However, as deficits deplete reserves and events occur that threaten the peg and Saudi oil-related export revenues, this comfort quickly could dissipate. After the Chinese Central Bank unexpectedly devalued the Yuan by ~2 percent against the US$, bets that the Saudis would be forced to abandon the peg spiked.

Breaking the peg would devastate the Saudi economy. It would drive up the cost of imports-and Saudi Arabia depends substantially on imports for a wide variety and high percentage of necessary consumer, business, and government goods and services-from food to oil, petrochemical, and other industrial equipment and services to military equipment, supplies, and training. It would also harm the Saudis who recently have been increasing their exposure to "hard" currency denominated loans.

Sovereign wealth and foreign currency reserves