BANGALORE - Disruptive as they might
have been, oil shocks of the past have all had a
silver lining for some: a significant portion of
the revenue windfall accruing to oil producers -
especially those in the Middle East - has been
recycled back into dollar-denominated assets.
In earlier oil shocks (or energy crisis:
any great shortfall or price rise in the supply of
energy to an economy), the flows associated with
these "petro-dollars" have been sizable enough to have
contained the damage to US
interest rates and to the interest-rate-sensitive
components of the US economy.
That was
then. The energy shock of 2005 is different. While
sharply higher oil prices may have generated close
to a US$300 billion revenue windfall for Middle
East oil producers, the reverse flow back into
dollars through the petro-dollar effect does not
seem to be happening on the magnitude of before.
This year, oil exporters could haul in
$700 billion from selling oil to foreigners. This
includes not only the Organization of Petroleum
Exporting Countries (OPEC) but also Russia and
Norway, the world's second- and third-biggest
earners. (OPEC this week raised its forecast for
growth in oil demand next year based on
predictions of stronger-than-expected expansion of
the world economy, news agencies reported. World
demand for oil will increase by 1.9% in 2006 to
84.9 million barrels per day, OPEC said in a
report released in Vienna, updating a previous
forecast of 84.8 million barrels per day. The
price of crude broke the $70 a barrel barrier in
wake of Hurricane Katrina.)
The
International Monetary Fund (IMF) estimates that
oil exporters' current-account surpluses could
reach $400 billion, more than four times as much
as in 2002. In real terms, this is almost double
their dollar surpluses in 1974 and 1980, after the
twin oil-price shocks of the 1970s - when Russia's
hard currency exports were tiny. The combined
current-account surplus of China and other Asian
emerging economies is put at only $188 billion
this year.
Relative to their economies,
the oil producers' current-account surpluses are
far bigger than China's. Whereas the IMF forecasts
China's surplus to be about 6% of gross domestic
product (GDP) this year, it predicts Saudi
Arabia's to be a whopping 32%. On average, Middle
East oil exporters are expected to have an average
surplus of 25% of GDP. Russia might record 13% and
Norway 18%.
What will happen to all these
petro dollars? In essence, they can either be
spent or saved. Either way, a lot of the money can
be recycled to oil-consuming economies and thus
soften the impact on them of higher oil prices.
If oil exporters spend their bonanza, they
import more from other countries and thus help to
maintain global demand. If they save their
windfalls, but invest in global capital markets,
they can finance oil importers' bigger
current-account deficits - in effect, lending the
increase in fuel bills back to consumers. And by
increasing the demand for foreign financial
assets, they can boost asset prices and push down
bond yields in oil-importing countries. This in
turn can help to support economic activity in
these economies.
Experience shows that oil
booms can be a blessing or a curse for producing
economies, depending on how wisely the extra
revenue is spent or saved. Too often, past
windfalls have been celebrated with budgetary
blow-outs, while the abundance of money has
encouraged the postponement of economic reforms.
This time, however, oil exporters seem to be
spending less, instead running larger external
surpluses, repaying debts and building up assets.
In 1973-76, 60% of the increase in OPEC's export
revenues was spent on imports of goods and
services. In 1978-81, the proportion rose to 75%.
But the IMF estimates that only 40% of the
windfall in the three years to 2005 will have been
spent.
In Russia, for example, the
government has taken the sensible step of setting
up an oil stabilization fund, which will be used
to reduce its large foreign debt.
In most
of the Middle East, governments are being more
cautious than usual with their extra revenue.
Mohsin Khan, the director of the IMF's Middle East
and Central Asia department, reckons that most
governments in the region are budgeting on an oil
price of only $30-40 a barrel for next year. He
estimates that governments have on average spent
only 30% of their extra oil revenue since 2002,
compared with 75% in the 1970s and early 1980s,
after previous steep climbs in the oil price.
Their average budget surplus has increased from 2%
of GDP in 2002 to nearly 15% this year.
Some evidence of why the recycling effect
of the oil shock is different this year is as
follows:
First, a significant portion of the oil
revenue windfall has been plowed back into surging
domestic equity markets. Coincident with the sharp
run-up in oil prices, year-to-date gains in stock
markets of major Middle East oil producers have
been nothing short of spectacular; that's
especially true in Dubai (+166%), Saudi Arabia
(+99%), Kuwait (+82%), Abu Dhabi (+80%), and Qatar
(+69%).
These markets have expanded so
much in recent years, they now have the capacity
to absorb large oil-related inflows; for example,
the capitalization of the Dubai and Abu Dhabi
equity markets, combined, is now about US$200
billion - up dramatically from less than $15
billion in 2000. While there are understandable
concerns that valuations in these markets have
reached bubble-like proportions, there seems to be
no rush to the exits. Awash in newfound revenues,
Middle East oil producers now feel strongly about
supporting their home markets.
Second, booming domestic real estate projects
have also absorbed a meaningful portion of the
windfall. Take Dubai for example. Reportedly, some
89 condominium towers with more than 300,000 units
are slated to go up within the next two years. And
plans for offshore development in Dubai are
staggering. Add in a comparable effort in Doha and
you have an entirely new option for petro
windfalls that did not exist in earlier oil
shocks. Seemingly, the Gulf countries are now
developing and funding their own investment
projects.
Third, post-September 11 security concerns are
seriously hampering Middle Eastern capital flows
into dollars. New regulatory requirements of the
US Patriot Act, which require extensive
documentation of Middle East portfolio flows into
US financial institutions, are proving to be
frustrating. At the same time, given the ongoing
political turmoil in the region, many Middle East
investors simply do not want to risk being exposed
as pro-American in their asset allocation
decisions.
Fourth, Saudi Arabia, the world's largest oil
producer, has a public sector debt problem that
could absorb a significant portion of the nation's
windfall from higher oil prices. Official
statistics put Saudi public sector debt at 92% of
GDP in 2004 (source: Economist Intelligence Unit)
- far below the outsize overhang in Japan (164%)
but well in excess of that in the United States
(65%).
This debt, which is an outgrowth of
the country's severe budget deficits of the 1980s
and 1990s, is held largely by Saudi national
pension and social security funds. While that
means the Saudi Arabian government effectively
owes most of its debt to itself, there is good
reason to believe that the Saudis will follow the
pattern of earlier oil shocks and attempt to use a
significant portion of the current revenue
windfall to put their fiscal house back in order.
Fifth, there is deepening concern over the
dollar outlook in the Middle East. Despite this
year's rally following nearly three years of
decline, the general consensus seems to be that
more downside is in the offing, the main concern
being an outgrowth of America's massive and
ever-widening external imbalance.
Seemingly, the oil-exporting governments
seem to have taken to heart the lessons of the
1970s and 1980s. First: don't assume that oil
prices will stay high forever: in real terms,
OPEC's annual average oil revenue in 1981-2000 was
only one-third of that in 1980. Second, don't
waste your windfall. In previous booms,
oil-producing countries gaily spent their petro
dollars on lavish construction projects that
required imported equipment and skilled foreign
workers, but did little to create local jobs or
diversify economies.
In its recently
published Regional Economic Outlook for the Middle
East and Central Asia, the IMF advises governments
to give priority to spending that will have a more
lasting impact on growth and living standards.
Indeed, the Middle East oil exporters now
have greater capacity to spend petro dollars at
home than in the 1970s and 1980s, because their
populations have been rising rapidly and because
their infrastructure needs upgrading after many
years of dwindling government revenues. High
unemployment means that there is social pressure
for more spending on education and health, and for
schemes to encourage private-sector employment.
Saudi Arabia, with one of the world's
fastest growing populations, has an unemployment
rate of perhaps 20%. After nearly two decades of
large budget deficits, the government's debt was
100% of GDP by 2000. Even this year, Saudi
Arabia's oil revenues per head will be about 70%
less in real terms than in 1980, owing in part to
a near tripling of its population. It is using
some of its extra money to repay debt, and the
government has recently raised civil servants' pay
by 15% - the first across-the-board increase in
more than 20 years.
As well as spending
more on health, education and infrastructure, the
Middle East also needs to invest in oil production
and refining capacity, to ease future supply
shortages and so stabilize prices. The
International Energy Agency gave warning recently
that oil prices would keep rising over the next
two decades unless the region's producers invested
substantially more than they currently intended.
Reason enough of flow reversal.
Swati Lodh Kundu has a Masters
in Economics from the University of Calcutta.
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