Tracking Petrodollars (page 1 of 3)

The doubling in oil prices from 2002 to 2006 has resulted in a strong growth in export earnings for the oil-producing countries of the Middle East and redistributed large sums of money from oil-consuming to oil-exporting countries. This in turn, has substantially increased the energy-exporters position in the balance of power in the global economy, with regards to reducing global imbalances.

The US Treasury's International Affairs division has highlighted that since 2002, Washington's oil import bill has risen by USD 148bn, equivalent to more that half the deterioration of its overall current account deficit over the period. Meanwhile, the IMF has estimated that in 2006 the current account surplus of the Middle Eastern oil exporters will be larger in dollar terms than that of China plus the rest of emerging Asia. In addition, they will account for a much larger proportion of their economies, averaging a surplus of 25% of GDP.

Such a marked increase in revenue has a number of domestic and global implications. For oil exporting countries, the main question is the best way to utilise the windfall to support the long-term development of their countries. Meanwhile, on a global level, there is the question of what the Middle Eastern countries can do to reduce global imbalances and recycle their export earnings. There are two main ways an oil-exporter can recycle petrodollars. First, by increasing domestic consumption and investment, thereby increasing the demand for imports of goods and services (hopefully from oil-importing countries). In the case of the Middle East, the main sources of imports are from Asia and Europe. Second, through capital account outflows, i.e. petrodollars being saved in foreign assets held abroad.

The oil windfall offers a great opportunity for the regional oil-exporting countries to address economic and social challenges. In the past, the poor utilisation of the windfall has resulted in wasteful expenditure blowouts and a stalling in the economic reform program. Spending was haphazard and not well thought out, resulting in infrastructure being inadequate despite substantially higher spending in this area. Moreover, the lavish projects did little to diversify the economy or create local jobs. However, in the case of many of the GCC countries, the economy or the work force could not provide the goods and services required at that time.

There are indications that regional oil exporters have taken some lessons from their past mistakes and have been prudent with their spending. Until 2005, the majority of Middle Eastern countries were slower to increase spending. This was partly due to concerns that the oil price would weaken, but also to the time needed to formulate investment projects. This is especially the case for GCC countries. Governments have assumed more conservative assumptions for oil prices in their budgets and spending has not kept up with oil price rises and, to a lesser degree, production increases.

The spending multiplier (i.e. the proportion of additional oil revenue being spent by governments) is now lower then during the boom of the 1970s. The IMF estimates that governments have on average spent 30% of their extra oil revenue from 2002 to 2005, compared with 75% in the 1970s and early 1980s. Instead, regional oil-exporting countries are running greater external surpluses, paying of debts and building up assets. Furthermore, a number of countries, such as Egypt and Saudi Arabia, have forged ahead with their economic reform programs.

The absorptive capacity of the regional economies has increased with the larger size of the economy, the strong population growth and a need for upgrading the infrastructure, after years of weak government revenue.