|Spending surplus oil revenues will boost regional economic growth
|Commentary by Henry t.azzam
The accumulated foreign reserves of the Gulf countries, due to the surplus oil revenues of the past three years, have reached high levels estimated at $500 billion.
The way that this oil bonanza is spent will help shape future economic growth, not only in the Gulf countries but also in the region as a whole. The realization that this boom could be a prolonged one would encourage the countries of the region to invest for future growth rather than save the huge surpluses. In fact Middle East oil exporters have a greater capacity now to spend at home than in the 1970s and 1980s.
It is very difficult to tell where the Gulf countries are spending the huge surpluses they have been accumulating due to the higher oil revenues. According to the IMF, governments of the region have so far spent less than 30 percent of the extra oil revenues generated since 2002, compared with 75 percent during the oil boom years of the 1970s and the 1980s. In previous oil booms, most of the surpluses were spent on large construction projects that required imported equipment and unskilled foreign workers. Today, there is a need to spend more on education and health care, repay public debt, raise salaries for government employees when needed, and boost oil production and refining capacity. Surplus revenues may also be invested in private equity abroad, including other countries of the region, especially those providing safe and hospitable investment environment and where profitable opportunities exist.
So far it seems most of the extra oil revenues generated have been saved rather than spent. While in the past most of the surpluses were deposited in U.S. and European banks, this time around the bulk seems to have been directed toward bonds and stocks in the major international markets that provide liquidity and anonymity. Figures from the Bank of International Settlements show that deposits of OPEC countries with Western banks dropped in 2003 but increased only modestly in 2004 and the first half of 2005. In the past, international banks lent most of these deposits to oil importing developing countries fueling inflation and sowing the seeds of the emerging market debt crisis.
Despite the lack of hard data, a big chunk of the surplus petrodollars seems to have gone into the U.S. bond market, especially U.S. treasuries. This explains at least partly, why dollar bond yields have declined at a time when inflationary pressures in the U.S. were rising and short term dollar interest rates edging higher. The recycling of the surpluses via the bond market would have different effects on the world economy from bank intermediation of previous oil booms. The lower bond yields generated by the higher demand for bonds helped support additional borrowing and higher consumer spending and investment, not only in the U.S. and Europe but also in the region as well.
A flood of funds also went into private equity deals abroad and into hedge funds domiciled with offshore financial institution. As most of these investments are in dollars, this helped support the American currency's exchange rate despite such negative fundamentals as rising U.S. current account and budget deficits.
The average price for the OPEC basket of crude oil is likely to be above $50 a barrel this year, compared with just $36 a barrel in 2004, an increase of 31 percent. Gulf national oil companies are pushing production and exports to the limit. Their output will this year hit an average of 16 million barrels per day, an increase of 7 percent on the 2004 average. The region's oil revenues are likely to reach a record high this year, allowing budgetary surpluses for the six Gulf States to exceed $50 billion and their current account surpluses to reach $100 billion. As a percentage of GDP, the region's current account surplus could exceed 25 percent this year which is way above china's surplus of about 6 percent of GDP.
While previous oil booms where characterized by spectacular price upswings followed by sharp declines, oil prices are expected to stay stronger for a longer period this time around. Rapid demand growth in Asia and a pick up of economic pace in the U.S. and Japan are likely to coincide with production and refining constraints, as well as, supply uncertainty in certain oil producing countries. As the region's oil revenues stabilize at their current high level, the oil producing countries will be more confident to spend more of their oil surpluses rather than save them as they have done during the period 2003-2005.
We expect government budgets in various countries of the region to be much higher in 2006, with both current and capital expenditures surging. The region's infrastructure such as roads, sewage and water networks had suffered in the past decade and badly needed overhauling. There is also social pressure for more spending on education and health care and for schemes to encourage private sector employment. The oil producing countries of the region also need to spend on boosting oil production and refining capacity to ease future supply shortages and to stabilize oil prices. Saudi Arabia is using some of the extra money generated to repay debt. The kingdom repaid over $10 billion last year and is expected to do the same this year, cutting its mostly domestic debt to SR595 billion ($163 billion), or 49 percent of Gross Domestic Product. The government had recently raised salaries of government employees by 15 percent, the first across the board increase in 20 years.
Spending more petrodollars at home would give a big boost to economic growth of the non-oil sectors of the Gulf countries adding to their overall GDP growth rates. As the oil countries spend more on infrastructure, health and education and as the non-oil sectors keep on surging, this will undoubtedly generate higher demand for imports of both goods and services from the surrounding Arab countries. Many private investors are keeping their money closer to home. The flood of investments to the region's stock and real estate markets, as well as, to certain selective private equity investments contributed to the boom conditions prevailing in these sectors.
The non-oil Arab countries will benefit both directly, from higher remittances, more regional tourism, greater exports to the Gulf markets and larger capital inflows and also indirectly as the "feel good effect" and a general sense of optimism continuing to prevail due the booming regional economic conditions. Another exceptionally good year is expected with double digit growth rates in the smaller Gulf Countries and with real GDP growth of 7 percent in Saudi Arabia, 6 percent in Jordan, and 5 percent in Egypt. Of course, these remarkable trends will not last for ever, the good times will eventually end and a down cycle will take hold. Nevertheless, the regional boom is likely to continue throughout 2006 and possibly beyond.
Henry T. Azzam is the founder and CEO of Amwal Invest.
Henri T. Azzam
The Daily Star