Global commodity markets were shaken by a significant drop in oil prices on March 9, the heaviest in 29 years. The situation was exacerbated by a general decline in the financial markets, which has been suffering for several weeks now, bringing trillions of dollars in losses to investors. The oil market news has already affected the Russian economy -- the ruble has fallen by almost 10%. We found out what is going on and what Ukrainians have to prepare for.
The fall in oil prices on March 9 came amid panic in the financial markets caused by the coronavirus.
The outbreak of the virus in China has affected the country's economy -- the world's second-largest by GDP -- far more than the forecasts suggested. Many Chinese companies have been forced to extend Christmas vacations for their employees, some factories have ceased production. This is even evidenced by NASA data: China's air pollution levels dropped significantly in late February.
In recent decades, leading corporations like Apple and Tesla have been building factories in China. Thus, vacations and production shutdowns affected the performance of most industrial corporations and the value of their shares. Investors expect that due to the production shutdown, companies will make less profit, which in turn leads to smaller dividends and lower the appeal of securities.
In addition to investor expectations of companies' profits, a decline in production in China also means a drop in demand for energy, primarily oil.
The oil crisis
According to commonly cited market principles, if demand for a product falls and its supply remains unchanged, it leads to a fall in price. This is exactly what happened on March 9.
Key oil producers in the world, OPEC+ (Organization of the Petroleum Exporting Countries and Russia), have been unable to agree on a reduction in oil production in order to ensure that its supply meets demand and does not lead to lower prices. This is firstly due to the position of the Russian Federation, which refused to gradually reduce oil exports. As a result, on March 9, oil prices fell by 30%.
The decline in prices has been made worse by Saudi Arabia's statements about ramping up the country's oil production following the failure of OPEC and Russia talks. According to Bloomberg, such actions mark the beginning of Saudi Arabia's "price war" with Russia for the European market. Thus the Arabian kingdom is trying to bring Russia back to the negotiating table to reduce oil production.
Black Monday for Russia
Oil and gas constitute more than 50% of Russia's exports. That is, half of Russia’s foreign exchange earnings from trade depends on prices for energy resources. If they fall, it causes the Russian ruble to fall. On the morning of March 9, the dollar in Russia reached its maximum level since 2016 -- 74 rubles per dollar (in total, falling by 10%). The euro also reach its 4-year high at 84 rubles.
Shares of the largest Russian companies traded on the global stock exchanges have reacted to the fall in oil prices (since March 9 was a public holiday in Russia). Thus, Gazprom and Rosneft's shares on the London Stock Exchange lost a quarter of their value and Novatek, Russia’s second-largest gas producer, lost over a third. Russia’s financial sector was also affected by the crisis: Sberbank and VTB banks’ shares fell by more than 20% in a single day.
The fall in shares of Russian companies continued on the morning of March 10, when Russian stock exchanges opened after a long weekend.
The electronic panel shows the exchange rates at the exchange office in Moscow, March 9, 2020. On the morning of March 9, the dollar in Russia reached its maximum since 2016 - 74 rubles for the dollar. Photo: EPA-EFE / MAXIM SHIPENKOV
Impact on Ukraine and what will happen to the hryvnia?
At first glance, the fall in oil prices for Ukraine is a positive signal, since oil and gas are mainly imported by Ukraine. The fall in prices means that government spending on imports will decrease and thus less foreign currency will leave the economy, which will, in turn, strengthen the hryvnia. However, this is perhaps where the positive news ends.
The fall in oil prices, as a rule, leads to a further fall in prices for other commodities. This is also contributing to the slowdown in China's economy. The prices for the raw materials that Ukraine specializes in -- metallurgy and agricultural products -- are also falling.
As a consequence, foreign exchange earnings can decline significantly, the volume of foreign currency in the market will decrease and its exchange rate will grow.
In 2019, China became Ukraine's largest trading partner. Exports of goods amounted to $ 3.59 billion -- 7.2% of total exports. China's economy slowing down will mean falling exports from Ukraine.
Imports from China in 2019 amounted to $ 9.2 billion, and due to the coronavirus, fewer goods will be imported into Ukraine (and thus customs revenues will fall).
However, it is on the financial front that Ukraine has more risks. The plummeting markets may signal the beginning of a new economic crisis that will hit the Ukrainian economy very hard, says Sergey Fursa, an investment banker from Kyiv-based Dragon Capital.
“The global crisis scenario is becoming realistic. And it would be very painful for us in any case. It is important to reduce the impact of the crisis on the Ukrainian economy, to have support. And at that moment, it is critical for Ukraine to have support from the IMF,” Fursa believes.
According to him, the decision to change the government may aggravate the crisis for Ukraine, since Denys Shmyhal’s new Cabinet will find it more difficult to negotiate with the IMF. Moreover, at the outbreak of a new economic crisis, the government has virtually no economic leadership.
It is unknown how much Ukraine will have financial sustainability in the economic crisis in the world without the support of its international partners. Photo: UNIAN
Due to the dire situation in the financial markets, for the first time in a long time, Ukraine has had to cancel its government bond auction (the interest rate on such bonds may be too high and the demand for bonds very low).
“The week that started promises to be extremely difficult and important in terms of the decisions to be made. Global markets have collapsed dramatically against the backdrop of the virus, the price wars surrounding oil and geopolitics. The dollar is now being sold at 25.0-25.1 at the moment, but the prices for Ukrainian bonds have fallen even lower," says ICU investment company analyst Mykhailo Demkiv.
He noted that in 2019 the National Bank of Ukraine managed to accumulate record gold and foreign exchange reserves. As of March 1, they totaled $26.6 billion.
This means that a sharp fall in hryvnia’s exchange rate should not be expected: the NBU is ready to step in to curb fluctuations in the hryvnia/dollar rate. Moreover, it has already begun to do so, having sold $307 million from reserves in the first week of March (whilst buying $150 million from the market).
However, the question of whether Ukraine will have sufficient financial firmness amid a global economic crisis without the support of its international partners remains an open one.