How the volatile crude oil price has affected key global currencies
Crude oil has been in the news a lot of late. The price is down by more than 40 per cent this year, and a few weeks ago, the drillers were paying customers to take their oil. As a result, oil-dependent economies have been devastated at a time when they are also battling the coronavirus pandemic. So, let us look at how crude oil price impacts the foreign exchange market and the most vulnerable currencies.
Why did crude oil price drop this year?
This year, the crude oil industry has gone through its biggest challenge ever. The price started well in January as the market reacted to the first phase of the trade agreement between the United States and China. Also, the market was reacting to a supply cut deal that was reached by Organisation of Petroleum Exporting Countries (OPEC) in December.
Things started to change in March, when coronavirus was declared a global pandemic by the World Health Organisation (WHO). At the time, the market started to worry about demand of the commodity.
This was worsened by another meeting between OPEC and its allies. In this meeting, the two sides disagreed on the need for more supply cuts. As a result, Saudi Arabia decided to show its might, by opening its taps and reducing the price. Subsequently, the price dropped by more than 30 per cent in a single day.
Therefore, the crisis can be summed up as follows. Demand sunk because of the coronavirus-related lockdowns at a time when oil producers were increasing their supplies.
Most vulnerable currencies
There are two sides of low oil prices. On the one hand, there are the producers, who derive most of their foreign exchange by selling oil. Obviously, these producers suffer when the prices drop sharply. Worse, at a time of a global pandemic. On the other hand, there are consumers, who spend less amount of money buying the same amount of oil.
While many currencies are affected by these dynamics, the most vulnerable ones are the Canadian dollar, Mexican peso, and the Norwegian krone. As you can see below, the three currencies have declined sharply this year against the US dollar.
The Mexican peso, which has lost more than 20 per cent has been the worst-affected oil currencies. There are two reasons for that. First, Mexico’s economy is relatively vulnerable because of its dependence of the United States. Second, the country’s economy was also contracting before the coronavirus pandemic. Lastly, Mexico does not have the resources that Canada and Norway have to provide a buffer to low oil prices.
The Norwegian krone has been less affected because of Norway’s financial might, particularly, its $1 trillion sovereign wealth fund. Meanwhile, the Canadian dollar has been relatively stable because of Canada’s diversified economy.
Apart from these three, other currencies that are vulnerable to crude oil price are the Nigerian naira, Russian ruble, and Iraqi dinar.
Looking ahead
The chart above shows that these oil currencies have been gaining against the US dollar. That is because the price of crude oil too has been on an upward trend as you can see in the first chart. Looking ahead, we expect the crude oil price to be relatively stable as producers slash prices and as countries start to reopen. A coronavirus drug or vaccine will also help. Barring a second infection, we expect these oil currencies to be relatively strong in the near term.
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