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Finance & Development, December 1974
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The Payments impact of the oil crisis: the case of Latin America: Assessing the impact of the oil price increases on 19 importing countries in Latin America and the Caribbean

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1974
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E. Walter Robicheck

International payments relations have been altered dramatically by the surge of petroleum prices toward the end of last year. This article deals primarily with this aspect of the energy crisis in the oil importing countries of Latin America and the Caribbean.

It is clear that all countries will have to make radical adjustments to the new shape of the oil market. If we rule out a reversal of the recent gains in the terms of trade of petroleum exporting countries, which would obviate the need of petroleum importing countries to adjust, the requisite adjustments will almost certainly come on the supply as well as on the demand side. Among changes in the supply of energy, we can expect a concerted effort in oil importing countries to explore for oil within their own boundaries and to step up production of alternative sources of energy—hydroelectric, geo-thermal, solar, atomic, coal, gas, etc.

Changes in demand

The changes on the demand side can take various forms. The most obvious change is a reduction of the use of energy for consumption or as an input in the process of producing a great variety of goods and services for domestic use and for export. A more circuitous adjustment on the demand side that will also come into play is a general belt tightening of households in oil importing countries that will involve a reduction of their consumption of goods and services other than energy and not necessarily having a high energy component, an adjustment which would release factors of production for additional exports or for import substitution. The mix of possible forms of adjustment will differ from country to country, but time is needed everywhere to carry the adjustment process to its completion. In the meantime, the part of the increased energy costs which is being absorbed without any compensatory reduction in aggregate demand must be financed out of potential savings of households, out of potential profits of businesses and state enterprises, and out of government budgets. These changes will be reflected in a deterioration of the balances of payments of oil importing countries on current account.

The substitution of domestic for imported energy is subject to major constraints of a technological nature, and is to some extent ruled by an element of chance. We face, therefore, at this juncture the critically important but very difficult judgment of how fast it is safe to proceed with adjustments of aggregate demand, and how safe it is to delay such adjustments. If the countries affected were to try to make this judgment and act on it independently, their unilateral decisions would be self-defeating, given the degree of their interdependence. But if a rational solution lies along multilateral lines, then the world community must assume full responsibility for such a solution.

It is in this spirit that Mr. H. Johannes Witteveen, the Managing Director of the Fund, took certain important initiatives as far back as January of this year. At a meeting in Rome of the Committee of the Board of Governors of the Fund on Reform of the International Monetary System and Related Issues (the Committee of 20) he was instrumental in having the Governors assembled call on national authorities not to take unilateral actions that would have the effect of shifting to other countries the burden of adjusting to their increased oil import costs. The Governors were, thus, espousing a course of cautious demand adjustment for oil importing countries. Such a course naturally raises the question of how the oil deficits are to be financed, and this financing need has come to be referred to as the problem of recycling. Fully recognizing the implications of their stand, the Governors also called on competent international organizations to collaborate toward finding an early solution to the problem of recycling. They endorsed in principle Mr. Witteveen’s proposal to establish in the Fund a new oil facility to help oil importing countries, and particularly the developing countries in the Fund’s membership to finance their oil-related balance of payments deficits.

Magnitude of the 1974 recycling effort

Before proceeding to a description of the Fund’s new oil facility, it is worth contemplating the magnitude of the immediate recycling effort, with particular reference to the developing countries.

The estimates of the Fund staff indicate that this year’s oil-related balance of payments deficit of the group of oil importing countries among its membership will be about $65 billion. The lion’s share of this deficit will be borne by the developed countries. The group of oil importers among the developing member countries of the Fund (see box) will suffer this year a prospective oil-related deficit of some $7 billion, in addition to a projected deterioration of their balance of payments on non-oil current account of roughly equal magnitude. This group of countries gained some $5 billion in international reserves last year. This means that if they attracted the same amount of foreign capital, official and private, as they did last year, they would stand to lose $8 billion in reserves this year. They could probably withstand such a reserve loss, considering that their combined international reserve holdings exceeded $24 billion at the beginning of the year. However, the figure cited in all probability exaggerates the reserve loss they stand to suffer this year, because it does not take into account new facilities for receiving assistance with the financing of oil-related balance of payments deficits. Oil importing developing countries will receive this year perhaps $1 billion in special bilateral aid from oil exporting countries, and possibly some $1.5 billion from use of the Fund’s new oil facility. With an allowance for the use of these newly developed forms of financial assistance, the group of net oil importers among the developing member countries of the Fund stands to suffer this year a net international reserve loss of some $5.5 billion. The staggering problem of recycling the funds newly accruing to the oil exporting countries—as distinct from the even more vexing problem of the transfer of income and wealth—is, therefore, predominantly one between them and the oil importers among the developed rather than the developing countries.

These estimates are most emphatically not presented to invite complacency. The lumping together of 79 countries in all parts of the world inevitably involves a level of generalization that does not do justice to their individual situations. This article is mainly concerned with Latin America and the Caribbean, so let us look at the 19 oil importing member countries of the International Monetary Fund in this region, first as a group, and then identify those among them which are more severely affected than the rest.

The Latin American-Caribbean region will gain on balance from the surge of oil prices. The group of five net oil exporters of the region—Bolivia, Colombia, Ecuador, Trinidad and Tobago, and Venezuela—is likely to improve its combined current account balance of payments performance this year by more than $6.5 billion. This prospective gain is substantially larger than the losses that the group of 19 oil importing member countries of the Fund in this region will suffer this year—an estimated $3.8 billion increase in their oil import bill and an estimated $1.3 billion deterioration on their non-oil current balance of payments account, for an estimated overall current account deterioration of $5.2 billion. This year’s net capital inflow into these 19 countries is projected at $8.8 billion, about $1.8 billion larger than last year’s, not including in this projection their receipts of special bilateral assistance from two of the oil exporting countries of the region and their use of the Fund’s oil facility, which together could yield them another $0.5 billion. Since the 19 countries registered last year a net international reserve gain of $3.4 billion, their combined reserve holdings of close to $11.75 billion should remain substantially intact this year, as Table 1 shows.

Table 1.Summary balance of payments performance of group of 19 net oil importing member countries in Latin America and the Caribbean, 1973 and 1974(In billions of U.S. dollars)
Actual

1973
Projected

1974
Projected

change

1973 to 1974
Net oil imports−1.6−5.5−3.8
Non-oil current account transactions−2.1−3.4−1.3
Net ordinary capital movement+7.1+8.8+1.8
Net international reserve change+3.4+3.4

The country in this group that is by far the most severely affected by the oil price increase, as Table 2 shows, is Brazil, whose petroleum import bill is likely to increase by some $2.3 billion, which is 60 per cent of the increased petroleum import bill for the entire group of 19 countries. Far behind follow Chile with an estimated $335 million increase in its oil import costs, Argentina with $310 million, Uruguay with $120 million, Jamaica with $110 million, Peru with $105 million, Mexico with $100 million, and the Dominican Republic with more than $90 million. The five Central American Republics are likely to have to pay a combined $230 million more for their petroleum imports than last year.

Table 2.Summary balance of payments performance of 19 net oil importing member countries in Latin America and the Caribbean, 1973 and 1974(In millions of U.S. dollars)
Actual performance in 1973Projected performance in 1974
Net oil

imports
Non-oil

current

account
Total

current

account
Net

capital

movement
End-of-1973

gross official

International

reserve holdings
Net oil

Imports
Non-oil

current

account
Total

current

account
Net

capital

movement
Argentina−158+910+752−1041,468−467+889+422
Bahamas−16−6−23+3044−46+27−19+18
Barbados−7−43−50+5131−19−41−60+48
Brazil−709−1,018−1,727+4,1576,973−3,000−2,500−5,500+5,500
Chile−121−334−455+299258−455+37−417+228
Costa Rica−28−86−113+13151−84−76−160+140
Dominican
Republic−48−31−79+8275−140+24−116+128
El Salvador−19−20−39+1162−53−60−114+46
Guatemala−34+71+37+30210−122+78−43+19
Guyana−18−31−50+1620−53+25−28+42
Haiti−4−22−26+2117−13−13−26+22
Honduras−22−12−34+3737−41−29−70+57
Jamaica−65−185−249+207136−177−105−282+318
Mexico−235−1,047−1,282+1,4271,282−333−1,267−1,600+1,600
Nicaragua−23+6−16+96148−58−90−148+150
Panama−12−119−131+24532−33−213−246+217
Paraguay−7+2−5+2856−32+1−32+28
Peru−60−183−244+257568−164−109−273+224
Uruguay−55+92+38+60222−176+23−153+59
Total−1,641−2,057−3,698+7,08111,689−5,466−3,398−8,865+8,844

Nine countries in this group also stand to suffer this year a deterioration in their non-oil current account balance of payments performance—one of them only very marginally—which represents a prospective drain of more than $2 billion on top of the prospective increase of almost $3 billion in their combined petroleum import bill. The list of these nine countries is again led by Brazil with a projected deterioration of almost $1½ billion, which is larger than the total projected net deterioration on non-oil account for the entire group of 19 countries. It is followed by Mexico with a prospective deterioration of $220 million, and Nicaragua and Panama (about $95 million each). However, all of these most severely affected countries—with the possible exception of Honduras and Uruguay—either have an adequate international reserve cushion or should manage to attract sufficient foreign capital, or both, to withstand their current account deterioration this year. The other ten countries stand to be compensated for all but $200 million of the $900 million prospective increase in their petroleum import bill by gains on their non-oil current balance of payments account.

The oil facility of the Fund

On June 13, 1974, the Board of Executive Directors of the International Monetary Fund approved the establishment of an oil facility to help oil importing member countries, particularly the developing ones, finance the balance of payments impact of their sharply increased petroleum import costs. The life of this new facility is intended to be short, up to the end of 1975.

The Fund did not have to set up a new facility to assist with the recycling of oil funds; it could have accomplished the same results by engaging in conventional operations with net oil importing members. But the conditionality applying to the Fund’s conventional operations was not deemed suitable to the situation which the typical oil deficit country faces at present. Therefore, it was felt that oil deficit countries should be entitled to seek financial assistance from the Fund on conditions that are more appropriate to their prevailing circumstances. Moreover, the uncertainties inherent in the present state of the international monetary system call for a cautious husbanding of the Fund’s liquidity, and hence it was judged that the Fund could not afford to offer, from its own capital, assistance on a scale commensurate with the new oil-related balance of payments deficits.

These considerations were deemed to warrant the establishment of a special facility financed with funds borrowed for this purpose from oil exporting and, potentially, from industrialized member countries. The Fund has offered potential lenders an interest rate of 7 per cent per annum and a measure of exchange rate guarantee in the form of a denomination of such debt in special drawing rights (SDRs), the new international unit of account, which were endowed on that occasion with a stable value in relation to a basket of 16 major member currencies, weighted as shown:

Members Currencies in Basket
Weights

(per cent)
United States33
Germany12½
United Kingdom9
France
Japan
Canada6
Italy6
Netherlands
Belgium
Sweden
Australia
Denmark
Norway
Spain
Austria1
South Africa1
100 1

The value of the SDR at the start of its basket valuation was equal to 1.20635 U.S. dollars.

The value of the SDR at the start of its basket valuation was equal to 1.20635 U.S. dollars.

To data the Fund has secured for the oil facility about $3.4 billion from seven member countries:

To date the Fund has secured for the oil facility about $3.4 billion from seven member countries:

(In millions of U.S. dollars) 1

Abu Dhabi119.4
Canada305.4 2
Iran692.4
Kuwait477.5
Oman23.9
Saudi Arabia1,193.8
Venezuela537.2
3,349.6

At a rate of SDR 0.837671 per US$1, the basket rate for October 18, 1974.

At a representative rate of Can$ 0.9822 per US$1 on October 18, 1974.

At a rate of SDR 0.837671 per US$1, the basket rate for October 18, 1974.

At a representative rate of Can$ 0.9822 per US$1 on October 18, 1974.

The oil facility is available to member countries which are net oil importers and are running overall balance of payments deficits in 1974. Drawings on the oil facility are subject to special repayment terms. They are repayable within seven years in 16 equal quarterly installments after an initial three-year grace period, but repayment has to be accelerated if a country’s international reserve position improves. The cost of drawings from the oil facility is: an annual interest rate of 6⅞ per cent of the outstanding balance for the first three years such a drawing is outstanding, 7 per cent for the fourth year, and 7⅛ per cent a year for the remaining time to maturity. In addition, the transaction is subject to the Fund’s standard one-time service charge of ½ per cent payable at the time of the drawing. The combination of interest and service charge yields an effective annual borrowing cost of 6.9095 per cent for the first three years, of 7.0351 per cent in the fourth year, and 7.1608 per cent for the last three years.

The potential use of the oil facility in 1974 is limited to the smaller of the following two amounts: (a) 75 per cent of a member’s quota in the Fund; or (b) the calculated entitlement, which is a presumptive formula. The presumptive formula used for the time being is the amount yielded by multiplying a member’s net oil import volume in 1972 adjusted for part of the change in the volume of imports from 1972 to 1973, by $7.25 per barrel.

Having established, in this fashion, a member’s maximum potential entitlement to use the oil facility, the staff of the Fund then projects a member’s balance of payments performance in 1974, and the projected deficit qualifies for financing through the oil facility to the extent that it does not exceed a member’s maximum potential entitlement calculated as described above. In making its balance of payments projections, the Fund staff must take account of any special bilateral assistance a member is receiving this year from oil exporting countries, of its prospective net use of development loans and suppliers’ credits, and of its net borrowing operations in international money markets. A distinction is made, for the time being, between developed and developing countries for projecting their market borrowings in 1974. Developed countries are expected to utilize their capacity to borrow on international markets before seeking access to the oil facility, whereas this presumption is not applied with equal force to developing countries.

A further condition for access to the oil facility is a judgment by the Fund that a member is observing the spirit of the afore-mentioned Rome communiqué. This judgment revolves around a view of the scope of any new trade or payments restriction that a member may have imposed this year for balance of payments reasons—including, for example, a tariff increase or an advance import deposit requirement—and on the quality of official assurances that the new restriction is intended to be of a purely temporary nature.

The decision establishing the oil facility calls for a review of this facility by the Executive Directors of the Fund in mid-September and for another review around the end of the year. The first review has been completed, and among other results, produced the updated formula for calculating members’ maximum potential entitlement to use the oil facility in 1974 already described. The next review is likely to lead to a decision on whether and to what extent the oil facility will be continued into 1975, and if it is extended, to come up with revised rules for access to this facility in the coming year. The decision establishing the oil facility already sets the stage for making any use of this facility in 1975 subject to more conditionality than is required this year, in order to encourage oil importing member countries to pursue with enhanced vigor the needed adjustment of their balances of payments.

The Fund’s share of recycling operations

If the estimate of $65 billion for the oil exporting countries’ gain this year on current balance of payments account is accepted as the measure of the need for recycling oil funds in 1974, then the Fund’s oil facility with its present funding of $3.4 billion does not look particularly impressive. However, this facility is intended, and is likely to serve particularly the needs of developing member countries that are net oil importers, and as such it offers a certain compensation for the tendency of the international financial markets to lean in the opposite direction.

The Executive Directors of the Fund have stipulated that, until the next review of the oil facility, qualified member countries may draw on the oil facility amounts not exceeding 90 per cent of their 1974 calculated entitlement according to the formula, or 100 per cent of their assessed balance of payments need, whichever amount is smaller. Drawing requests totaling about $675 million from the following 27 member countries, and in the amounts shown, have been approved (or approval is pending) as of October 18, 1974:

(In millions of U.S. dollars) 1

LDCs in Latin America
and the Caribbean96.2
Chile49.5
Costa Rica6.4
El Salvador5.2
Haiti1.3
Nicaragua4.0
Panama8.8
Uruguay21.0
LDCs in other parts
of the world512.8
Bangladesh48.2
Cameroon5.5
Central African Republic0.8
Chad1.3
Fiji0.4
Guinea4.2 2
India239.0 2
Ivory Coast13.3
Kenya11.0
Korea25.1
Liberia
Malagasy Republic4.1
Pakistan116.9 2
Sierra Leone5.2
Sri Lanka13.1
Sudan11.2
Tanzania7.5
Uganda6.0
Developed countries404.4
Greece43.2
Italy313.4
Yugoslavia47.8
Total1,013.4

At the rate of SDR 0.837671 per US$1, the basket rate for October 18, 1974.

Approval pending.

At the rate of SDR 0.837671 per US$1, the basket rate for October 18, 1974.

Approval pending.

The drawings from the oil facility thus far are not overwhelming, but they are likely to accelerate during the remainder of the year. First of all, the facility became operational only in late August, when the pledges of the seven lenders to the facility were finalized. Some interested member countries have deferred their drawing requests because of difficulties of an operational nature on their side, others because they are still preparing information needed by the Fund’s staff for the assessment of their balance of payments need. Still others have held off because they are reluctant to sacrifice their gold tranche positions in the Fund—i.e., the part of their gold subscription equal to 25 per cent of their quota that is still intact—which under the Fund’s Articles of Agreement they are required to draw before using the oil facility, and the same holds true a fortiori of the few developing member countries that have a super gold tranche position—i.e., are net creditors of the Fund. Some of these inhibitions may well be cast aside later this year when balance of payments strains become more severe than they are now.

One may assume, therefore, that the $3.4 billion now available in the oil facility will have been substantially utilized by the end of this year, and from the partially completed exercise of projecting 1974 balance of payments results one may expect the amounts drawn this year from the oil facility to be about equally divided between developed and developing member countries. Using a round figure of $1.5 billion for each of these two groups, the role of the Fund in recycling oil funds is revealed in an entirely new light. Whereas the weight of a $3 billion contribution toward the prospective global recycling need of $65 billion is less than 5 per cent, a $1.5 billion share of the developing countries in the use of the oil facility would come close to 25 per cent of their prospective current account deterioration caused by their increased oil import costs, and the aggregate share of the developed member countries would come to only 2½ per cent of their increased oil import costs. Moreover, special bilateral assistance from oil exporting countries may finance as much as another 15 per cent of the oil related loss of the developing countries.

The intensity of the use in 1974 of the oil facility in relation to the balance of payments impact of higher oil import costs is likely to show marked regional differences. As against an estimated ratio of nearly 25 per cent for the Fund’s entire membership of oil importing developing countries, this ratio is not likely to exceed 10 per cent for such member countries in Latin America and the Caribbean. But then the 19 net oil importing countries in Latin America and the Caribbean entered 1974 with an overall balance of payments surplus position of some $3½ billion and with gross international reserves of close to $11¾ billion, a reserve cushion roughly equal to that of the 60 oil importing developing member countries of the Fund in all other parts of the world.

The future

Readers whose intuitive reaction to the conclusions drawn is that they portray too rosy a picture should bear in mind that the preceding analysis was conducted exclusively for the current calendar year. If the balance of payments strains inherent in the present situation may well be manageable this year for the oil importing developing countries as a group, they may not be so readily manageable next year, and almost certainly not the year after next, if these strains are allowed to persist.

“Recycling” is a fashionable shorthand term for generating the massive compensatory international capital flows needed in the present situation. Even when foreign capital goes to finance high priority investments in developing countries, it represents a strain on their future balance of payments position. The external debt service of many developing countries is already far too burdensome to allow them to use foreign capital for any length of time toward supporting a higher level of consumption than would otherwise be feasible. Certain developing countries have comfortable international reserve cushions which permit them to sustain consumption levels for a time without incurring additional international foreign indebtedness, but the magnitude of their increased oil import costs is such that this cushion could quickly vanish. The oil importing developing countries, therefore, have no alternative but to adjust without undue delay to their new balance of payments situations. It is the inevitability of this adjustment by developing countries that gives the problem of recycling, staggering as it may appear at the moment, its strictly temporary character.

The effort needed to adjust to the new situation looks perhaps more formidable than it is. Admittedly, the demand for energy is inelastic and, moreover, has been following a markedly ascending trend almost everywhere in the world. Until domestic sources of energy gradually displace imported petroleum, the volume of petroleum imports by oil deficit countries is, therefore, likely to be reduced only marginally by the sharp increase in petroleum prices. In this case, it is the consumption of nonenergy goods and services, be they locally produced or imported, that will have to be compressed. Leaving aside the problem that developing countries in other parts of the world may face, it would seem appropriate to quantify here the burden of the adjustment for the group of 19 net oil importing member countries of the Fund in Latin America and the Caribbean. The prospective increase from 1973 to 1974 in their oil import bill is, as already mentioned, $3.8 billion. Since their combined 1973 gross domestic product (GDP) is estimated at around $200 billion, the adjustment effort they need to make is equivalent to less than 2 per cent of GDP, by no means an impossible effort, if one considers changes in the tax burden and current account balance of payments performance of individual countries in this group in recent years.

The problem of adjustment would, of course, be aggravated if net oil importing developing countries simultaneously suffered a decline of their commodity export prices from the broadly satisfactory levels at present. It is, therefore, of critical importance to the developing countries that this does not happen, and this emphasizes the need to sustain and raise the level of economic activity in the industrialized countries. Recognizing the importance to the world at large of the economic performance of the industrialized countries, the Managing Director of the Fund has come out forcefully in favor of a gradual adjustment of global demand and against unilateral actions by individual countries, particularly against the resort to trade and exchange restrictions or to competitive exchange devaluations. Measures in restraint of international trade could well precipitate a contraction of world economic activity that snowballs with every new restriction that is imposed.

THE MEMBERSHIP OF THE INTERNATIONAL MONETARY FUND

Oil exporting countries

Western Hemisphere

Bolivia

Canada

Colombia Ecuador

Trinidad and Tobago

Venezuela

Europe

Romania

Middle East

Bahrain

Egypt

Iran

Iraq

Kuwait

Oman

Qatar

Saudi Arabia

Syrian Arab Republic

United Arab Emirates

Asia

Indonesia

Africa

Algeria

Libyan Arab Republic

Nigeria

Tunisia

Oil importing developed countries

Western Hemisphere

United States

Europe

Austria

Belgium

Denmark

Finland

France

Germany, Federal Republic of

Greece

Iceland

Ireland

Italy

Luxembourg

Malta

Netherlands

Norway

Portugal

Spain

Sweden

Turkey

United Kingdom

Yugoslavia

Asia

Japan

Africa

South Africa

Oceania

Australia

New Zealand

Oil importing developing countries

Western Hemisphere

Argentina

Bahamas

Barbados

Brazil

Chile

Costa Rica

Dominican Republic

El Salvador

Guatemala

Guyana

Haiti

Honduras

Jamaica

Mexico

Nicaragua

Panama

Paraguay

Peru

Uruguay

Middle East

Cyprus

Israel

Jordan

Lebanon

Yemen Arab Republic

Yemen, People’s Democratic Republic of

Asia

Afghanistan

Bangladesh

Burma

China, Republic of

India

Khmer Republic

Korea

Laos

Malaysia

Nepal

Pakistan

Philippines

Singapore

Sri Lanka

Thailand

Viet-Nam

Africa

Botswana

Burundi

Cameroon

Central African Republic Chad

Congo, People’s Republic of the

Dahomey

Equatorial Guinea

Ethiopia

Gabon

The Gambia

Ghana

Guinea

Ivory Coast

Kenya

Lesotho

Liberia

Malagasy Republic

Malawi

Mali

Mauritania

Mauritius

Morocco

Niger

Rwanda

Senegal

Sierra Leone

Somalia

Sudan

Swaziland

Tanzania

Togo

Uganda

Upper Volta

Zaïre

Zambia

Oceania

Fiji

Western Samoa

The point was made earlier that developing countries need to observe caution in their external debt management in order to protect their future balance of payments position. While they cannot afford to rely on increased inflows of foreign capital in misguided efforts to sustain for any length of time consumption levels jeopardized by the recent oil price increase, a developing country typically does and should run a current account balance of payments deficit, and hence does and should rely on capital inflows to finance a level of investment in excess of its capacity to save, as it climbs up the ladder of development. However, the suddenly changed pattern of international payments relations demands that the major oil exporting countries gradually replace the industrialized nations as prime source of the foreign capital on which the developing countries should be able to count.

This article is excerpted from a paper prepared by Mr. Robichek for the Energy Symposium of the Economic Commission for Latin America in Santiago, Chile, September 23-29, 1974.

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