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 | News | |
 Middle East and North Africa: "the petrodollar mint"
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Koceila Maames, Senior Economist Middle East & Africa, Calyon CMR |
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Since 2000 when oil prices rose from their historical lows reached in 1998, Middle Eastern and North African countries have built up surpluses of around USD 900 billion, substantially more than during previous oil shocks. |
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- A financial windfall even larger than during the oil shocks of 1973 and 1979-1980
In recent years Middle Eastern and North African countries have had unprecedented surpluses. There are three main reasons for this:
- first, over the past four or five years, for the first time ever, prices not only shot up suddenly but have also remained at high levels,
- second, unlike previous oil crises, the current shock originated on the supply side as opposed to the demand side. Since 2000, prices have risen in particular because of weak surplus production capacity. In fact, surplus production capacity has dropped to a historical low of around 2 million barrels a day currently, from more than 10 million barrels a day in 1985. This means that oil-producing countries have been producing at levels very close to full capacity,
- third, having been slightly burned by the drop in oil prices in 1998, Middle Eastern and North African countries adopted very conservative pricing assumptions to build their budget: USD 20 to USD 25 a barrel, whereas prices have constantly stayed above USD 40 a barrel on average. This prudent budgetary approach has worked as an incentive not to overspend. Over the past few years oil-producing countries have recorded budget surpluses well above what they expected.
- What are petrodollars used for?
The way petrodollars are recycled has changed considerably since previous oil shocks and is now very different.
- Countries in the Middle East face high levels of demographic pressure. Populations in the Gulf countries have doubled since the first oil shock, and are expected to double again over the next 20 years, forcing the governments to invest in public infrastructure (hospitals, schools, housing, etc.).
- With larger populations, the oil price needed to balance budgets has automatically risen. Aware of this weakness, these countries have allocated a non-negligible portion of their oil revenue to paying down their debt, something they did not do in 1973 or 1979. From 1998 to 2006, Saudi Arabia's debt has been reduced from more than 100% of GDP to less than 29%, while Algeria has reduced its debt from 90% of GDP to 31%.
- We are seeing entirely new situations in these countries' financial markets. New investment alternatives are developing in the Middle East as stock exchanges and real estate markets become increasingly active. Previously, petrodollars left the Middle East to be almost entirely invested abroad. Now, a substantial portion of petrodollars are invested within the region.
- Lastly, the structural decline of the US dollar, the currency to which most of the region's currencies are tied, has led them to diversify their assets, in particular in the Euro zone.
Risks and challenges | |
A significant part of the oil windfall has been recycled through Middle Eastern stock markets. Local governments have used the markets as a mechanism for redistributing oil revenues to their populations. A large number of public-sector companies have been listed on the stock market in offerings restricted to nationals at "under-valued" prices.
In the Gulf countries, the recycling of petrodollars has sustained a kind of exuberance on local financial markets (with average annual gains of up to 100% before the bubble burst in 2006). This situation was further exacerbated by households borrowing money to invest in local markets.
The new infrastructure needed to meet the needs of growing populations constitutes a second challenge. Gulf countries have plans to spend USD 1,500 billion on infrastructure over the next five years. However, it is not certain that all of the countries concerned will choose relevant development strategies and invest in areas of activity where they enjoy comparative advantages. For example, the six Gulf countries have all decided to invest in the development of financial districts but only one or two of them will succeed in becoming regional financial centres.
A third challenge involves not succumbing to the temptation to maintain the status quo, which is often difficult for countries that suddenly find themselves with such vast surpluses. Depending on oil export revenues for 95% of national income is a highly risky proposition. Reforms come at a high social cost and these countries may be inclined to buy social peace by redistributing income rather than undertake the reforms needed to diversify their economies.
Inflation is the final challenge they face. Substantial capital inflows linked to the oil-engendered trade surpluses have resulted in very substantial increases in foreign exchanges reserves in Middle Eastern and North African countries. With fixed exchange-rate systems and the absence of so-called sterilisation policies, domestic liquidity tends to increase and feed inflation. In Iran, for example, inflation is running at between 15% and 20% a year.
Moreover, in countries whose currencies are tied to the dollar, the dollar's decline has generated imported inflation.
What is at stake for the world economy? | |
- Impact of petrodollars on the global economy
Oil-producing countries account for less than 2% of world GDP. However, as the main suppliers of this strategic resource, they have a disproportionate impact on the global economy relative to their weight in terms of GDP.
Whether petrodollars are spent or saved, Europe and the United States benefit from the recycling of oil revenues.
- As the Middle East's main source of imported goods and services, the Euro zone's exports increased. The rising demand from Middle Eastern countries limits the impact of rising oil prices on world economic growth.
- For the United States, abundant petrodollars help finance the country's deficits (and in particular its current account deficit) at relatively low cost.
Since 2005 and 2006, there has been a definite trend for Middle Eastern and North African countries to spend rather than save, as all of the region's countries have embarked on ambitious spending programmes to meet demand from their ever-growing populations. European growth has been the leading beneficiary of this spending. The effect of higher oil prices on the Euro zone's trade balance has been more than offset by the growth in its exports to these countries.
- Implications for the oil market
A report issued by the International Energy Agency (IEA) states that by 2010 Middle Eastern and North African countries will need to invest around USD 130 billion to increase their production capacity to meet growing global demand for oil. Currently, however, the total spending planned in the region amounts to just USD 80 billion.
Because the region's countries want to maintain high levels of social welfare, they give the priority to building infrastructure facilities rather than to increasing production capacity (and in particular surplus capacity).
The countries of the Middle East and North Africa have learned an important new lesson from the way the global economy has reacted to higher oil prices. Over the past five years, they have seen that high oil prices, even though they naturally have an impact on the global economy, do not result only in disadvantages for Europe and the United States. As a result, they do not believe that they need to over-invest in additional capacity and prefer to spend their money on social programmes. With only rare exceptions, national oil companies own almost all the oil reserves. Foreign operators are not allowed to invest in "upstream" activities (exploration and extraction) and are therefore not in a position to make up for the national oil companies' spending shortfall.
From the viewpoint of the producing countries, oil prices appear to have stabilised within the range of USD 50 to USD 60 a barrel.
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