What is Happening to the Petrodollars? A Commentary by Mohsin S. Khan, Director, Middle East and Central Asia Department, International Monetary Fund

November 27, 2005

A Commentary
By Mohsin S. Khan
Director, Middle East and Central Asia Department
International Monetary Fund
Gulf News
November 27, 2005

Sharply rising oil prices over the last three years have produced enormous increases in export earnings for oil-producing countries in the Middle East.

With these receipts running way above anyone's expectations, these countries now face a choice: to spend, both at home and on imports, or to save the petrodollars.

So far, countries have saved a large part of their oil earnings. In part, this reflects the prudence of governments wishing to insure against the future, when oil prices could fall to more "normal" levels. There also just has not been enough time yet to design investment projects requiring large-scale financing.

But the experts and futures markets both indicate that high oil prices seem set to stay, so Middle East oil exporters have a welcome opportunity to address their domestic economic needs by increasing their spending. In doing so, they will also help to sustain the growth momentum of the global economy.

The numbers are impressive. Oil exports of the ten major oil-exporting countries in the Middle East have increased from about $200 billion in 2003 to an estimated $450 billion this year. Oil receipts could exceed $500 billion in 2006 150 per cent higher than in 2003.

Middle Eastern oil producers' spending on imports has also risen, but more slowly. In 2004, imports grew at about half the pace of oil exports. In 2005, imports accelerated, but oil exports rose even faster.

All in all, imports are expected to rise by about $100 billion in the period 2003-2006. That leaves the Middle East oil-producing countries almost $200 billion to spend or save, about as much as the average level of imports during 2003-06.

The growing external current account surplus for the Middle East oil exporters now amounts to about a quarter of their GDP, larger in dollar terms than that of China plus the rest of emerging Asia.

It has been reflected in a hefty increase in official reserves and an even larger pickup in foreign investments by national oil companies, government oil and investment funds, and private companies and individuals seeking a diversified portfolio of assets.

While it is difficult to know precisely where these funds have been invested, a large chunk has likely gone into financial assets denominated in the US dollar. The rest is being invested in real assets and stock markets both in the West as well as in the region.

Decisions by Middle East oil exporters have important economic effects, some of which boost, and others restrain, global growth.

On the one hand, large flows of capital to global financial markets have helped keep world interest rates low. This has helped support global economic activity.

On the other hand, higher oil prices have, in effect, caused oil consumers mainly in the West and in Asia to transfer a larger part of their income to producers.

Thus far, producers have spent less of this income than consumers would have done. So less spending is taking place globally, imparting a restraining effect on global economic activity.

It is difficult to quantify these two effects with any precision, and therefore it is difficult to say whether Middle East oil producers' decisions on spending and saving have, on balance, boosted or restrained global growth. But global current account imbalances have widened, increasing the potential for disruptive adjustments an outcome that would obviously be undesirable for the global economy.

By increasing spending, Middle East oil producers will meet their own social and infrastructure needs and, at the same time, contribute to an orderly narrowing of global imbalances. Preserving stable global economic growth will also help ensure stable growth in demand for oil, which should keep oil markets steady.

How should the oil money be spent? Here, the lessons learned from the 1970s are important. The main challenge will be to achieve an orderly increase in spending, while avoiding wasteful expenditures.

The appropriate policies will vary across countries, but they should include the following elements:

• Boosting expenditures in areas that will permanently lift growth and reduce unemployment, thus spreading the benefits of the jump in oil receipts widely. Spending priorities should include infrastructure investment; higher health and education expenditures; and job creation programmes.

• Increasing demand for imports. Directing spending on goods and services produced by the rest of the world will make a significant contribution toward reducing global imbalances and also help reduce the risks of overheating of domestic economies unable to absorb large-scale domestic spending.

• Increasing investment in production and refining capacity to ease future supply shortages in the oil market. Oil market stability is clearly in the interest of oil producers as it will reduce the vulnerability of their economies to external shocks.

• Reducing government debt in countries where the debt is high.

• Extending financial assistance (directly or through international organisations) to low-income countries facing financial difficulties as a result of higher oil prices.

In an increasingly globalised world, countries have to address both domestic and international responsibilities. By following these policies, oil-exporting countries in the Middle East can play an important role in sustaining global prosperity, while at the same time developing their own economies.


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