Article

Adjustment in Major Oil Exporting Countries

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1990
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The sharp oil price increases in the 1970s appeared to free the major oil exporting countries (MOECs) from the familiar development dilemma posed by the need to choose between immediate consumption and mobilizing savings to foster economic growth. Given the ample wealth that they were able to accumulate rapidly as a result of the more than threefold rise in oil prices in 1973-74, both consumption and investment could be increased at the same time. But as oil revenues and sales volumes began to decline in the 1980s—first gradually, then sharply in 1986—with only a partial recovery in subsequent years, these countries had to implement major policy adjustments in an effort to sustain real economic growth.

In all of these countries—Algeria, Indonesia, Iraq, the Islamic Republic of Iran, Kuwait, the Socialist People’s Libyan Arab Jamahiriya, Nigeria, Oman, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela—oil exports play a dominant role, and in most cases, account for over 80 percent of total exports. Since oil is an exhaustible resource, they must either hold the oil in the ground or sell it and acquire other real or financial assets. Moreover, in view of the volatility of the international oil market and the limited diversification of their economies, prudence dictates that they maintain a relatively high level of foreign exchange reserves.

For them, the policy challenge is quite clear. During times of rising oil export receipts, they must take steps to ensure sustainable real economic growth, rather than a mere rise in current consumption. In addition, an enduring—as against an episodic—increase in real income requires a reduction in the economy’s dependence on the volatile world demand for oil. In assessing how well the MOECs have adjusted to their shifting financial situation over the past two decades (and what remains to be done), therefore, we should evaluate whether changes in real output have been accompanied by progress toward economic diversification, a reasonable stability in domestic prices, and a viable external payments position. While data limitations preclude a detailed analysis, indications so far point to a qualified success for the group as a whole, with some having performed better than others, because of considerable variations structurally as well as geographically.

Financial environment

Producer restraints on output have at times played a major role in both spurring a rise and in stemming a decline in world oil prices. However, the nominal export price, the import purchasing power, and the export volume of oil have been influenced primarily by outside forces, both economic and noneconomic. In general, oil prices have risen during extraordinary times of wars and political disruptions, and fallen as the higher prices have stimulated new oil discoveries and promoted conservation.

The nominal price of oil in US dollars fluctuated narrowly around a relatively low level during the century prior to the sharp rises and subsequent falls that began in October 1973. In the wake of disruptions in the Middle East and subsequent restraints on supply by producers, the average oil export price for the MOECs jumped from about $3.20 per barrel in 1972 to $10.50 in 1974, followed by an average annual increase of about 5 percent during 1975-78 (see Chart 1). Then in 1979-80, following the panic buying surrounding the Iranian revolution, oil prices surged once again, reaching an unprecedented $33.70 in 1981.

Chart 1Fluctuations in oil prices Since 1973

Sources: Official sources, and IMF staff estimates.

On the demand side, these price increases stimulated substitutions of non-oil fuels and adoption of energy-saving devices in industry, along with improvements in home insulation and a switch to more energy-efficient automobiles, particularly in the major industrial economies that are the main importers. On the supply side, they also facilitated exploitation of the higher cost oil fields in the North Sea and Alaska North Slope, as well as in Mexico and other developing countries. These developments gradually brought oil prices down by about 6 percent per year during 1982-85, before the plunge of over 50 percent in 1986. A subsequent marked recovery in 1987 was rolled back partially in 1988, although by the end of 1989, prices were again above the 1987 level. In general, inflation abroad substantially eroded the real price, or the import purchasing power, of oil for the MOECs. Indeed, 1973-74 and 1979-80 were the only years when the nominal price surged sharply ahead of inflation.

Oil revenues for the MOECs were also adversely affected by production developments. While world oil output increased from about 56 million barrels per day (b/d) during 1973-75 to a record 66 million b/d in 1979, oil production of the MOECs declined marginally during the period as they kept more of the oil in the ground in an effort to support prices. This falloff in output intensified during the 1980-87 period. World oil consumption was on the decline, and the MOECs wanted to continue to support prices by maintaining production restraint as an offset to the substantial increase in production that was taking place in other oil producing countries. As a result, their combined current account—which had been in surplus virtually throughout the 1970s, topping $110 billion in 1980—swung into a deficit in 1982, where it remained, with one exception, through 1988 (see Chart 2). The financial latitude of the 1970s was gone, succeeded by a re-emergence of foreign exchange as a constraint on development.

Chart 2MOEC balance of payments in a shifting financial environment

Sources: Official sources, and IMF staff estimates.

Adjustment efforts

Throughout these turbulent years, the MOECs turned to fiscal policy as the main instrument of adjustment, a reflection of the fact that their governments (not the private sector) are both the recipients and disbursers of oil export receipts, the economic mainstay. During the 1970s, the sharp rise in oil revenues enabled them to substantially boost expenditures, although the shift to fiscal expansion in 1979-81 was less pronounced than that following the 1973-74 oil price increases. The expansionary policies brought about a rapid development of the economic infrastructure, as well as a more diversified production structure and improvements in the welfare of their populations. Newly built port, road, and airport facilities eliminated physical bottlenecks that had been inhibiting growth in both imports and domestic output. Public investments in oil-and gas-based industries, such as fertilizers and petrochemicals, were increased. Subsidies were extended to encourage private investments in agriculture and a wide range of industries—notably food processing, building materials, and downstream products such as plastics. Moreover, a rapid expansion of schools, hospitals, and utilities improved services for the population (including the growing expatriate labor force), effectively redistributing income toward the lower-income groups. In addition, a number of these countries shifted some of the oil income to other developing countries through a liberal employment of expatriates and substantial foreign aid.

This rapid buildup of economic and social infrastructure was seen in all of the MOECs, although the impact on fiscal positions varied widely. The countries in what we will call Group I—Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates—were able to substantially improve their infrastructure, as well as maintain a budgetary surplus and increase reserves. This was in large part thanks to relatively small populations and the sharp rise in oil revenues. By contrast, the more densely populated Group II countries—Algeria, Indonesia, Iran, Iraq, Nigeria, and Venezuela—found their budgetary positions turn into deficits after 1975 (see Chart 3). The perception that oil price increases were permanent also led to borrowings against anticipated future earnings, thus in many cases leading to a buildup in debt.

Chart 3Changing fiscal balances in the MOECs

Sources: Official sources, and IMF staff estimates.

1 Includes Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.

2 Includes Algeria, Indonesia, Iran, Iraq, Nigeria, and Venezuela.

With the fall in oil income in the 1980s, however, fiscal restraint became essential for all MOECs. In most cases, the adjustment effort was far-reaching, although only a few adopted deliberate financial programs within an explicit macroeconomic framework. The initial spending cuts involved mainly a stretching out of the development effort through cancellation of low priority schemes, postponement of completion targets, and limits on new undertakings. This slowdown was in part a natural sequel to the preceding rapid expansion, as the bulk of the large infrastructural projects had been already completed. In addition, all MOECs introduced stricter controls on current expenditures. A number of countries moved forcefully to reduce budgetary transfers and cut subsidies through increased prices of controlled commodities, including basic consumer goods; employment and wage policies were also revised. Saudi Arabia’s total budgetary spending, for instance, was reduced substantially between 1981 and 1988. On the revenue side, discretionary increases in non-oil taxes, energy prices, and administrative fees were generally implemented, but these measures played a relatively small role, especially in the Group I countries, given the dominance of oil receipts.

Once again, the impact on fiscal positions varied from country to country, but in general, the less populated and wealthier countries in Group I managed larger and speedier reductions. Oil being their only significant source of income, they had to act quickly as revenues fell off sharply. Saudi Arabia, for instance, took a relatively large cut in oil production in an effort to support prices. Then, too, for some, fiscal restraint was made easier by an ability to shift at least a part of the adjustment onto the expatriate labor force. The countries in Group II, however, had relatively less room to maneuver, especially as they were now faced with heavy debt burdens to service. In the case of Iran and Iraq, there was the overriding consideration of a costly war.

What did these measures mean, however, for the efforts begun in the 1970s in these countries to ensure real economic growth?

Diversification. The generally restrictive fiscal stance of the 1980s notwithstanding, the MOECs remained committed to diversifying the domestic production base. Financial incentives (such as direct subsidies) were decreased, but indirect subsidization continued. Besides infrastructural support, domestic non-oil production received such encouragements as preferred treatment for local enterprises in awarding government contracts, selective bans on participation by foreign contractors, and meeting the private sector’s credit needs on concessional terms through specialized banks. In addition, exchange rate policy—notably, depreciation in such countries as Venezuela, Indonesia, and Nigeria—has been used to curb imports and encourage non-oil production.

As a result, the real non-oil output of MOECs has managed to register increases during most of the decade and a half since October 1973, although the rate of increase has fallen back sharply in line with the more restrictive fiscal stances. Over 1974-80, the average annual growth rate of non-oil output was around 13 percent, but this dropped to only 2 percent during 1981-88, reflecting mainly the falloff in budgetary spending and the effects of the Iran-Iraq war. The slowdown was most pronounced in construction, which diminished in importance following completion of most major infrastructural projects. Growth also slowed in the non-oil industrial sector, which was dominated in several cases by production of building materials.

Thanks to the diversification efforts, non-oil exports—including oil- and gas-based products—rose sharply in US dollar terms from a relatively low level, by an annual average of 21 percent over 1974-80. This rate then decelerated to some 6 percent for most of the 1980s—reflecting in part the effects of the Iran-Iraq war and a reduction of subsidy-dependent exports. However, the importance of non-oil exports for various countries has also varied greatly. In Group II countries, with their large non-oil resources, non-oil exports have accounted for as much as 25 percent of total exports. This contrasts with the thinly populated Group I countries, where the figure has at times been less than 15 percent. The latter group has relatively few non-oil resources, and has pursued international portfolio and equity investments. In Kuwait, for example, investment income from abroad has exceeded oil as the most important source of foreign exchange earnings in recent years.

Price stability. Concern about a flare-up of inflationary pressures has abated, as most MOECs have made a smooth transition from the high growth rates of the mid-1970s to the lower growth rates of the 1980s. Inflation, once running at an estimated annual average of some 13 percent (1974-80) has gradually subsided to around half that rate since 1981. This has occurred in large part due to the elimination of most of the physical bottlenecks that were holding up imports in the early 1970s, a general avoidance of administrative limitations on trade and current payments, and the global slowdown of inflation during most of the past decade and a half. Moreover, fiscal, credit, and exchange rate policies have helped keep domestic demand under restraint in most MOECs.

External payments developments. Faced with falling oil receipts, the MOECs sharply cut back imports through fiscal restraint, occasional exchange rate depreciation, and in a few cases, quantitative restrictions. As a result, average annual import payments declined during most of the 1980s, after growing by 30 percent in 1974-80. The lower level of economic activity also reversed the upward trend in payments abroad for services and led to a drop in workers’ remittances from these economies. The overall balance in the current account was further aided by the emergence of investment income as a major positive element, particularly for the countries in Group I. Thus, although the surpluses of the 1970s turned into deficits in the 1980s, the MOECs succeeded in limiting the deterioration.

Where the MOECs stand

While the timing and details of policy responses have varied widely, the MOECs as a group have managed to exercise fiscal restraint—doing so in a selective manner that has enabled non-oil output to continue to grow, albeit at a considerably slower pace. Inflationary pressures have abated, a deterioration in the balance of payments has been contained, and the economies have been further diversified, although they are still heavily dependent on oil. Besides large untapped reserves of oil and gas, most of these countries now have a modern economic infrastructure as well as a sizable industrial base. While the financial difficulties confronting a number of these countries, particularly in Group II, have been severe at times, the MOECs on the whole have remained stronger than most other developing countries.

All the same, the adjustment effort is still far from complete, and perseverance is imperative, despite the recently improved outlook for oil prices. Reductions in fiscal outlays have generally failed to keep pace with revenue declines, and while subsidies have been cut, they still weigh heavily—directly and indirectly—by way of, for instance, low energy prices and public utility rates. Moreover, much remains to be done to improve the efficiency of the public enterprises, which are frequently dependent on budgetary subsidies. Also, a greater effort is called for in all of these countries to expand and diversify the tax base so as to lower dependence on the volatile receipts from oil.

The need to continue with the diversification effort under a more restrained fiscal stance underscores the importance of mobilizing domestic savings and channeling these into productive investments. The widespread practice of maintaining interest rates at levels below those prevailing abroad, in particular, must be reviewed, if savings are to be stimulated, and capital flight, discouraged. Then, too, the persistence in some cases with price controls, as well as substantially overvalued exchange rates, has impeded the growth of efficient and competitive industries under private initiative. Finally, the adjustment effort needs to phase out the instances of tariffs, subsidies, and other more indirect shelters that have encouraged the emergence of uncompetitive industries.

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