Petrodollar Recycling And Global Imbalances -- Presentation by Saleh M. Nsouli, Director, Offices in Europe, International Monetary Fund

IMF News, March 23, 2006

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Petrodollar Recycling And Global Imbalances -- Presentation by Saleh M. Nsouli, Director, Offices in Europe, International Monetary Fund

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• Published: March 23, 2006

I. Introduction

• Context: surge in oil prices (2002-05) amid rising global imbalances beginning around 1996, with a large U.S. current account deficit matched by surpluses in other advanced economies and emerging Asia.
• Oil exporters became a major player as oil prices doubled during 2002-05.
• Key questions addressed:
  • Definition of "recycling" in this context.
  • Order of magnitude of the oil shock.
  • Impact of the recent rise in oil prices on global imbalances.
  • Policy recommendations for oil-exporting countries to contribute to orderly reduction of global imbalances.

II. What is "Recycling"?

• Definition: Petrodollar "recycling" = reflows to the rest of the world resulting from how oil-exporting countries use their oil receipts (spending on foreign goods and services or saving in foreign assets).
• Two channels of recycling:
  • Absorption channel: petrodollars spent to finance domestic consumption and investment, increasing demand for imports.
  • Capital account channel: petrodollars saved in foreign assets held abroad (central bank reserves, institutional funds, foreign bonds, private equity), including lending to institutions like the IMF in past episodes.
• Analytical point: Both channels matter for global imbalances; absorption narrows imbalances directly, while capital outflows can ease liquidity conditions depending on destination.

III. How Big is the Increase in Oil Receipts?

• Oil price and revenue facts:
  • Energy prices reached an average US$53 per barrel in 2005.
  • For the group of oil-exporting countries, oil export revenue rose from US$262 billion in 2002 to an estimated US$614 billion in 2005.
  • Increase = US$352 billion, corresponding to an extra 40 percent of pre-boom GDP for oil exporters.
• Historical comparison (increase in oil exporters’ oil export revenue, percent of own GDP; percent of World GDP):
  • 1973-76: 48; 1.5
  • 1978-81: 31; 1.4
  • 2002-05: 40; 1.0
• Relative importance in global savings (2005):
  • Asia's current account surplus projected at US$341 billion (equivalent to 47 percent of the United States' current account deficit).
  • Oil exporters' current account surplus projected at US$296 billion (equivalent to 41 percent of the United States' current account deficit).
  • IMF projections for 2006: oil exporters' current account surplus would amount to 46 percent of the U.S. deficit; Asia would drop to 41 percent.
• Permanence assessment:
  • Assuming that two thirds of the oil price increase proves permanent (IMF April 2005 WEO scenario), rise in value of oil exporters' petroleum reserves since 1999 implies a US$850 billion increase in their permanent income, almost three times the observed increase in their total imports since 1999.
• Note on oil price in real terms: still significantly below late 1970s and early 1980s levels.

IV. What is The Impact on Global Imbalances?

• Primary drivers of U.S. deficit: growing net imports from Asia, particularly China; U.S. trade deficit rose from some 2 percent of GDP in 1996 to over 7 percent in 2005.
• Effect of oil price rise to date:
  • Asia strengthened its current account since 2002 despite larger oil trade deficits.
  • U.S. current account deficit continued to widen; oil exporters became increasingly significant counterparts.
• Theoretical implications of oil exporters' choices:
  • If energy exporters spend oil revenue: petrodollars financing imports would reduce or limit increase in global imbalances.
  • If oil exporters save revenue: may drain financial resources away from investment/consumption in oil-importing world, reducing growth and employment prospects unless savings are reinvested so as to reflow dollars (e.g., into U.S. assets).
• Observed behavior and composition:
  • Many oil-exporting governments have conservatively budgeted lower oil prices and have been cautious in spending; some invest in social and infrastructure projects and debt repayment.
  • Oil exporters import less from the United States compared with other regions (imports from the United States, 2004, in percent of group’s total imports):
  • Fuel exporters: 8.4
  • Advanced economies: 25.8
  • Other developing countries: 19.5
  • Oil exporters became large buyers of goods from Asia, and sell the bulk of their oil to Asia—mitigating improvements in oil exporters' trade surplus vis-à-vis Asia.
• Historical lag in absorption:
  • Past episodes show imports continued to rise years after oil prices stopped increasing.
  • Between 2002 and 2005, of the US$352 billion increase in oil export receipts, about 52 percent was spent on additional imports of goods and services.
  • Contrast with previous high oil price episodes (1974-76 and 1979-81), where an average of 90 percent of additional oil export receipts was spent on imports.
  • In 2004, oil exporters' annual imports represented 91 percent of that year's oil revenue.
• Where savings are held:
  • Central bank reserves in oil-exporting countries increased some US$90 billion in 2005 (< one third of combined current account surplus).
  • Deposits in BIS-reporting banks amount to less than a third of cumulative current account surpluses.
  • Growth of sovereign investment agencies and stabilization funds; investments harder to track and often booked through intermediaries or offshore centers.
  • Evidence of diversification away from U.S. Treasury bonds in 2005 for OPEC, though dollar holdings remain important (GCC pegged to dollar since 2003; Russia managed float vis-à-vis dollar-weighted basket; oil sales invoiced in dollars).
• Macro effects:
  • Petrodollar recycling into U.S. assets likely helped alleviate upward pressure on U.S. long-term interest rates, possibly keeping U.S. long-term rates low despite Fed hikes in short-term rates.
  • IMF projection: global growth should drop to 4.8 percent in 2006, from 5.1 percent in 2005, with more expensive energy having only a modest impact on global growth.
• Medium-term risks of disorderly adjustment:
  • Dependence of the United States on potentially volatile source of savings (oil exporters’ investment agencies may be more opportunistic).
  • Gradual increase in oil exporters' domestic spending could raise long-term U.S. interest rates if funds shift to countries with lower propensity to save.

V. What Needs to be Done? (Policy Recommendations)

• Existing global policy axes (pre-oil shock):
  • Spur savings in the United States.
  • Promote higher exchange rate flexibility in emerging Asia.
  • Take measures to boost domestic demand in emerging Asia.
  • Implement structural reforms to boost domestic demand and growth in Europe and Japan.
• Recommendations addressed to oil-exporting countries:
  • Use the opportunity from higher oil revenue to address domestic economic needs within a sustainable fiscal framework.
  • Higher government spending, including through imports, can respond to domestic needs and help reduce global current account imbalances.
  • Prioritize higher investment according to country-specific needs to promote long-run growth and contribute to narrowing global imbalances.
• Caveat on speed and absorption capacity:
  • Oil exporters with high absorption capacity can rapidly recycle petrodollars through domestic investment, benefiting domestic development and trading partners.
  • Oil exporters with low absorption capacity should increase spending gradually as local absorption develops; they will likely recycle petrodollars via capital outflows, helping to dampen interest rates in oil-importing countries.
• Bottom line:
  • Adjustment is needed in current account-deficit and current account-surplus countries, including oil-exporting countries, to reduce global imbalances.
  • Steps taken thus far are insufficient and the world economy remains subject to serious risks of a disorderly adjustment.

Presentation by Saleh M. Nsouli, March 23, 2006; views expressed are those of the author and should not be attributed to the International Monetary Fund, its Executive Board, or its management.

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