Stagflation

In 1973, following the oil embargo be OPEC, USA witnessed a what was till then considered counter-intuitive- a phase of rising inflation and unemployment, leading to a fall in national product. To put it simply, higher unemployment means lower effective demand and hence a contraction of output. This would exert a downward pressure on general level of prices, since it is only at reduced prices that producers would be able to sell their products. Adherents of different schools of thought have proposed their own logic to reconcile this. The broad consensus was that since oil forms an important input in all economic activities, its rise contributed to inflation and lowering employment as firms found it costly to retain them.

Without loss of generality then, we should be able to draw a hypothesis that oil prices and economic activity show reverse causation right? The answer is not so simple (if at all there is an answer).  Firstly, this question should be seen from the point of view of whether an economy is a net oil producer or consumer. In 1973, USA was a net consumer, whereas Saudi Arabia was a net producer. During the duration of embargo, Saudi made huge capital gains.

Since June 2014, the price of oil has fallen from its peak of over $100 per barrel to just about $30 in February 2016. Without discussing the impact of this on net consumers (they have been highly ambiguous), let us see the impact of this on producers, namely Russia, Venezuela and Nigeria.

The choice of countries is for a special reason. Although they have huge hydrocarbon reserves, they are always viewed as an alternative to their Gulf counterparts. While countries like Saudi and Iran would not incur a loss even if oil prices fall to $25, the cost of production in the above countries is much higher.

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Source: The Economist

Falling oil prices have put these countries on the brink of a major crisis. Let us take their case o

Source: The Economistne by one.

Even on the eve of oil price fall, Russia was facing major problems on its domestic front. It was facing sanctions by a few Western countries for its brinksmanship in Ukraine and Crimea. At that point of time, it was thought that the sanctions would have limited impact since it catered to very few individuals and that the vast resources of Russia would keep it afloat. Things have taken a tailspin ever since.

As per data by the Economist, in 2015 the Russian economy grew by -3.8% and inflation was at 15.4%. This in invariably a case of stagflation (I am not quite fond of this word as it equates falling employment and output

as stagnation).  There is hardly anything that Russia could do in response. Investors have been wary of investing here. They have already seen a massive capital flight, leading to a fall in the value of Rouble, making imports costly. The one thing last policy tool the Russian authorities had, viz, monetary policy has already been employed to the highest degree. Interest rate on 10-year Government bonds stands at 10.3%, which is very high. This hasn’t prevented any capital flight per se, but has made it more expensive for Government to finance its fiscal deficit. The monetary policy has been ineffective because the source of this crisis lies outside its realm. The only apparently visible action by Russia is to become more and more authoritarian to curb dissent in every form.

Hugo Chavez was not an ordinary leader. This larger than life figure had carved a niche in the imagination of most of its citizens. Even CIA failed to overthrow his regime, and he returned almost as soon as he was deposed. He instituted massive subsidies, building it up entirely on the oil money. Unfortunately, he failed to diversify the economy. If Russian state of affairs are dismal, wait till you see the Venezuelan counterparts: In the 12 months till September 2015, its economy had shrunk by 7.1% and inflation was 141.5%. The interest rates are well above 10% as well. The economic crisis has made the political situation vulnerable. So called chavistas who counted on a corrupt and authoritarian regime have been badly hit.  In January, it was for the first time that the Opposition was elected in 17 years in the Parliament. With the economy running short on necessities, it is uncertain on how much political changes could do.

flationNigeria was in the news a while ago when a local militia Boko Haram (now claiming allegiance to IS) abducted 200 schoolgirls. The government has been able to push the growing influence of this group to small pockets in the north east. That said, the ills of falling oil prices have plagued them as well.  Many domestic oil companies borrowed heavily due to availability of cheap credit, but are now struggling to pay back. Fearing high inflation, there has been a curb on imports and freezing of Naira, its official currency. A heavy black market has mushroomed which provides the necessary foreign reserves to import essential commodities. Although, the overall debt of Nigeria is low, the government finds it tough to push an expansionary stimulus owing to high interest rates.

High volatility has been a part and parcel of capitalism, and the genesis of present crisis lies in what Marx would call ‘realization crises, i.e. inability to recover cost which goes in the production process. If it is a firm that faces a realization crisis, it has long term option of going out of the market. Countries unfortunately have no such option. They have to continue operating, no matter how tough the going gets. At present, it remains unlikely that the crisis would subside soon; infact, there are chances of it exacerbating.  It’s not just three countries that are facing a major existential threat, but there are many others in line. It becomes doubly more difficult to diversify when faced by a crisis, but they also give a window of opportunity to do take all such big measures which cannot be done in peace time. It is for time to now decide what the future of these countries and its citizens is.

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