“The paradox of Norway’s oil exports is that lower foreign earnings translate into more, not less, demand for NOK.”
That’s from Deutsche Bank and it sums up the conundrum facing Norwegian officials as they attempt to cope with the sharp decline in crude prices that threatens to cripple the country’s economy.
Norway’s prime minister, finance minister and central bank governor held an extraordinary meeting last week to discuss the possibility of implementing emergency measures to shore up the economy in addition to record fiscal stimulus.
It’s “not a crisis,” they concluded, an assessment that’s sharply at odds with comments made by Bente Nyland, director general of the Norwegian Petroleum Directorate earlier this month and sharply at odds with reality.
“Right now the economic policies that we presented in our October budget are working,” Finance Minister Siv Jensen said. “What we have said today is that we are prepared to act if needed.”
Compounding the problem for Norway is that while the country’s officials remain “ready to act”, central bankers the world over are already acting and that’s inhibiting the NOK’s ability to function as a counter cyclical buffer for the country’s economy.
Even as the ECB, the SNB, the Nationalbank, and the Riksbank all stuck in NIRP, the Norges Bank is at 75 bps. Positive 75 bps.
That means the NOK can’t fall as much as it needs to to help the economy absorb the blow from lower crude. As Bloomberg put it last year, the krone “just can’t get weak enough.”
Here's the rub. In order to fund the fiscal stimulus the economy needs to stay on its feet, Norway is tapping into its sovereign wealth fund. In short, expenditures are set to exceed revenues and so, it's time to tap the piggy bank which, at $830 billion, is the largest rainy day fund on the planet. The problem here is that oil proceeds must be converted to kroner before they can be used to cover budget needs. That means the Norges bank is a buyer of NOK. Here's how it works, via Deutsche:
The amount of state petroleum revenues converted into NOK is a function of the non-oil budget deficit. Revenues in foreign currency from the SDFI are transferred daily to the Norges Bank’s petroleum buffer, before being distributed to the GPFG. By contrast, revenues from the Statoil dividend and oil tax are transferred to the government directly in krone, after companies have sold their foreign exchange revenues to pay the dividend and the tax.
When krone revenues from the Statoil dividend and oil tax exceeds the non-oil budget deficit, the Norges Bank converts this surplus on behalf of the government into foreign exchange, depositing it in the petroleum buffer before transfer to the GPFG. The Norges Bank thus buys foreign exchange and sells krone on behalf of the government. Where krone revenues from the Statoil dividend and oil tax are insufficient to cover the non-oil budget deficit, no krone is converted back into FX by Norges Bank. Instead, SDFI revenues in the petroleum buffer are converted into krone. As a result the Norges bank sells FX and buys krone on behalf of the government.
Simple enough. Here it is visually:
Here's a look at the history as well as a chart which depicts the convergence of oil revenues and the deficit:
So as you can see from the left pane above, the Norges Bank announced it was set to become a buyer of NOK at a clip of 250 million per day starting in October of 2014.
“The amount that they will buy is even bigger than we expected,” Kjersti Haugland, an analyst at DNB ASA, remarked at the time.
That total was up to 500 million per day by the end of 2015 and today we learn that it's about to get a whole lot bigger.
"The Nordic country will buy 900 million kroner ($104 million) a day next month as it converts its oil income into local currency to cover budget needs, " Bloomberg reports.
“This is a substantial change,” DNB ASA's Magne Oestnor remarked. “This will add pressure to the appreciation of the krone. Suddenly Norges Bank goes from being just a medium size flow everyday to starting to be a flow to reckon with.”
Yes a "flow to be reckoned with," and the problem with that should be immediately apparent. Norway needs to buy NOK in order to fund the stimulus the country hopes will support the economy. But by doing so, the Norges Bank is putting upward pressure on the currency at a time when it really needs to depreciate. In other words, what Norway must do to pay for stimulus (buy kroner) is indirectly hurting the economy by keeping the NOK from depreciating as much as it otherwise would. This is complicated by the fact that the country's largest export destinations are still in easing mode.
(Norway's export destinations)
On Friday, data showed unemployment soaring to its highest level in more than a decade and retail sales falling. "The poor economic data offset the effect of rising krone purchases," Bloomberg notes.
Maybe. But the upward pressure on the currency is going to intensify in February and besides, were it not for Norges Bank buying, the currency might have fallen further on the bad data.
It will be interesting to see how this "paradox" resolves itself going forward and whether the Norges Bank will end up fighting itself à la Fight Club by cutting rates to drive down the NOK even as they buy the currency hand over fist.