Henry E. Jakubiak and M. Taher Dajani
For most developing countries, a major consideration in economic planning has been the existence of revenue and foreign exchange constraints, limiting the ability to fund new investment and social projects and to purchase imported goods required for project implementation. Saudi Arabia and Iran, on the other hand, as the two largest oil exporters in the world, have had their fiscal and foreign exchange positions substantially enhanced by the recent sharp increases in crude petroleum prices.
Between October 1973 and January 1975, posted prices of crude petroleum increased nearly fourfold, and this factor, along with improved financial terms, raised government revenue per barrel of light crude oil from less than US$2 to over US$10. Although oil production and exports leveled off over the course of 1974 and declined in the first half of 1975—when world demand fell as a result of slowed economic activity in the industrialized countries as well as higher petroleum prices—net foreign exchange receipts and total government revenues from the oil sector grew dramatically over the two years ended 1974/75. (The Iranian fiscal year ends on March 20, and the Saudi Arabian fiscal year 1974/75 ended on July 9.)
In the wake of the rise in oil revenues, budgetary expenditures in the two countries were greatly expanded for both current and development purposes. In Iran, total central government spending increased to nearly US$19 billion in 1974/75 compared with about US$5 billion in 1972/73, the fiscal year before the increase in oil prices began. Employing this base, the increase in current government expenditures, including defense outlays, was equivalent to more than 325 per cent and that of fixed capital expenditures to almost 300 per cent. The Fifth Development Plan, covering 1973/74-1977/78, was completely revised in mid-1974/75, and a new target for public and private sector domestic capital formation was established at US$70 billion, 92 per cent above planned investment in the original version of the plan. As nearly two years of the plan period had elapsed, it was expected that about 80 per cent of this amount would be invested over the remaining three years with the bulk of investment outlays originating from the public sector. Priority in the allocation of investment funds was accorded to petroleum and petrochemicals, basic industries, such as steel and copper, and manufacturing lines employing these inputs. In addition, considerable investment in ports and inland transportation infrastructure was foreseen in order to overcome already evident supply constraints. Among current expenditures, allocations for manpower training were also expanded.
In the case of Saudi Arabia, budgetary outlays were also sharply increased, rising by 260 per cent to US$9 billion in the two-year period ended 1974/75. While current expenditures, including foreign aid, rose by nearly 200 per cent, project expenditures expanded fourfold, to almost US$5 billion, with much of the expansion recorded in outlays for communications, education and health, municipalities, and defense. As a result of this acceleration in government spending, the target expenditure level under the First Five-Year Development Plan (1970/71-1974/75) was exceeded by 67 per cent. In May 1975, Saudi Arabia launched its Second Five-Year Development Plan, covering the period through 1979/80. The plan called for total government expenditures of US$141 billion, more than seven times the amount spent under the first plan. About two thirds of plan allocations was to cover the cost of projects for the development of infrastructure, agriculture, industry, and education; the industrial program focused on hydrocarbon-based industries, including major plants for gas gathering and treatment, and production of petrochemicals.
The increase in public spending following the surge in oil revenues made a substantial contribution to economic growth in both countries and provided a strong stimulus to economic activity in the private sector. In 1974/75, the real growth rate of Iran’s non-oil gross domestic product (GDP) accelerated to 17 per cent and that of Saudi Arabia to 14 per cent. Although the gains in output were considerable, the domestic productive capacities of both economies were strained by the expansion in aggregate demand, and the acceleration in real growth was accompanied by inflationary pressures.
Money, constraints, and prices
In 1974/75 the supply of money and quasi-money increased by 57 per cent in Iran and by 61 per cent in Saudi Arabia compared with an annual average increase of 32 per cent and 40 per cent, respectively, over the preceding two years. The factors affecting the growth in domestic liquidity may be seen from two points of view. Employing the consolidated accounts of the banking system, the accumulation of net foreign assets by the banks appears as the primary expansionary determinant, offset by any buildup in net public sector deposits resulting from budgetary surpluses. However, since the main factor underlying the rise in net foreign assets—the receipt of oil revenues by the government—has no immediate monetary effect (being directly counterbalanced by an equivalent rise in government deposits), an alternate and analytically more meaningful approach to monetary analysis for the two oil exporting economies is to redefine the determinants of growth in domestic liquidity by employing the balance of payments and public sector budget identities. The advantage of this procedure is to isolate the effect of budget operations on changes in domestic liquidity, by defining the growth of money and quasi-money essentially as a function of public sector net domestic expenditures (public sector domestic spending less domestic revenues), the increase in private sector borrowing from the banking system, and the latter’s balance of payments position. This alternate approach identifies the rapid growth in public sector, and primarily central government, net domestic expenditures in Iran and Saudi Arabia as the main factor accounting for the acceleration in the rate of monetary expansion (see Tables 2 and 4). In fact, in both countries the monetary impact of private sector economic activity was contractionary on a net basis as the private sector balance of payments deficit exceeded the growth of credit to that sector. (Because of statistical difficulties, public sector net domestic expenditures are estimated by employing data from the monetary and balance of payments accounts, and are derived primarily as the difference between net external receipts of the public sector and the increase in net public sector deposits with the banking system. For this reason, the estimates of net domestic expenditures presented below are not strictly comparable with data in the central governments’ budgetary accounts.)
(In billions of U.S. dollars) 1
|Year ended March 20||1972/73||1973/74||1974/75||1975/76|
|A. Receipts from the oil sector||2.60||4.83||18.67||19.05|
|B. Other goods and services (net)||-2.70||-4.71||-10.06||-16.26|
|C. Total (A + B)||-0.10||0.12||8.61||2.79|
|D. Nonmonetary capital||0.59||0.93||-1.98||-3.13|
|Official loans and credits (net)||0.52||0.76||-2.20||-2.88|
|Private capital (net) 1,2||0.07||0.17||0.22||-0.25|
|E. Errors and omissions (net)||__||0.10||-0.47||-0.24|
|F. Total (C + D + E)||0.49||1.15||6.16||-0.58|
|G. Monetary movements2,3|
|(increase in assets—)||-0.49||-1.15||-6.16’||0.584|
The magnitude of public sector net domestic expenditures in 1974/75 in Iran and Saudi Arabia gave rise to levels of aggregate demand incommensurate with supply availabilities from domestic and external sources. Existing domestic production capacities were small relative to the growth in demand, and full capacity utilization in many areas of production was quickly approached. In addition, the expansion of domestic capacity in the short run was constrained by normal gestation lags and physical limitations—both countries, for example, were confronted with acute shortages of skilled manpower. Although interim measures were introduced to expand the supply of skilled labor, including the employment of foreign technicians and professionals and contracting out projects to foreign firms supplying their own labor, the demand for labor could only partly be met from these sources. The creation of the skilled cadres needed for the completion of the new expenditure plans called for extensive training programs for domestic labor or measures facilitating an expanded entry of foreign workers.
With regard to the external sector, public and private sector imports in both countries expanded rapidly in 1974/75 and alleviated the buildup in domestic demand pressures. Direct public sector foreign exchange outlays for imports, supplemented by official capital outflows, contributed to limiting public sector net domestic expenditures. In Iran, public sector payments abroad for imported goods and services rose from nearly US$3 billion in 1973/74 to about US$7 billion in 1974/75, while government foreign aid, loans, investments, and accelerated debt repayments yielded a net official capital outflow of more than US$2 billion. Similarly, in Saudi Arabia, public sector imports of goods and services approximately doubled to US$3 billion in 1974/75, and foreign aid rose steeply. However, despite the growth in import expenditures and budget surpluses, the magnitude of public sector net domestic spending was substantial in both countries, and the expansionary impact on domestic liquidity from this source was only partly offset by private sector external payments deficits adjusted for increased private sector borrowing.
Although the authorities in Iran and Saudi Arabia had attempted to realize higher levels of public and private sector imports, this was inhibited by bottlenecks in the ports. Despite an augmentation of effective port capacity, the number of ships waiting at the ports grew substantially, and the average period for offloading rose to between two to four months for goods not accorded special priority, resulting in mounting interest and demurrage costs. Similarly, the virtually fixed short-run supply of inland transportation and warehousing services also inhibited the absorption of imports into the economy. As a result of these factors, the leakage of demand pressures through the current account of the balance of payments was constrained below desired levels.
With physical limitations on supply, the growth of aggregate demand was reflected in rising price levels. In Iran the cost of living index increased by 14 per cent in 1974 and, during the first half of calendar 1975, prices rose at an annualized rate of 29 per cent. In Saudi Arabia the increase in the Riyadh cost of living index accelerated from 17 per cent in 1973 to 35 per cent in 1975. While some proportion of the rise in prices was attributable to higher costs of imported goods, most of the increase originated within the domestic economy. Measures were introduced by the authorities in both countries to reduce the impact of inflation on the domestic cost of living—including the reduction or abolition of import duties on a broad range of commodities and the introduction of subsidies for foodstuffs and other basic goods. In Iran quantitative restrictions on imports were also substantially eased.
Adjustment of financial policies
The sharp monetary expansion during 1974/75 resulted in a considerable liquidity carry-over into the following year in both economies, and as physical constraints remained largely unrelieved, aggregate supply and demand imbalances and upward trends in prices persisted. Under these circumstances, the authorities began to reassess existing policies.
In Iran, a surge in public sector expenditures during the last quarter of 1974/75, reflecting a drawdown of deposits with the banking system, resulted in a sharp buildup in domestic liquidity and the intensification of inflationary pressures. As an initial response, a severely administered price control program was introduced at midyear to stem the mounting inflationary thrust of the economy and alter inflationary expectations. With this program, the upward movement in prices was suppressed. However, the authorities were aware that these measures by themselves would not moderate the underlying excess demand pressures in the economy, and decisions were taken concomitantly to restrain the rate of increase in public sector expenditures. The decision to slow the growth in budget outlays was partly engendered by stagnating oil sector revenues; although oil prices increased by about US$1 per barrel during 1975, world demand for oil continued to slacken, and Iranian petroleum exports fell by over 10 per cent for the year as a whole. Central government budget outlays for 1975/76 were held close to original estimates and rose by about 20 per cent, considerably below the extraordinary rate of increase in the previous year. The absolute increase still amounted to over US$4 billion; however, a sharper deceleration in expenditure growth was considered undesirable due to the possible adverse consequences for economic growth.
With altered fiscal policies, Iran’s public sector net domestic expenditures in 1975/76 are estimated to have been held at approximately the level prevailing in the previous year, declining, however, as a proportion of the domestic money stock. The containment of net domestic expenditures largely reflected a shift in the distribution of government outlays away from domestic and toward external supply sources, as public sector imports increased by 50 per cent. The estimated private sector balance of payments deficit widened considerably, and although the rate of growth of private sector borrowing increased, on a net basis private sector economic activity exercised a stronger contractionary influence on the growth of domestic liquidity than in the previous year. Reflecting the policy of demand restraint, the rate of monetary expansion was reduced to 41 per cent. On the supply side, some progress was made in facilitating imports. However, limitations imposed by full capacity utilization as well as other physical bottlenecks began to constrain increases in non-oil GDP and were particularly reflected in a diminishing rate of expansion in the industrial sector. Although an aggregate demand and supply imbalance persisted and the economy continued to experience excess demand pressures, the increase in the cost of living index was held to 5 per cent, primarily through reliance on administered prices. The Iranian authorities have maintained a policy of fiscal restraint into 1976/77, and guidelines were established with the intention of again holding the annual growth in central government expenditures to about 20 per cent. However, as oil revenues were not anticipated to increase notably, a central government budget deficit was projected, to be financed through a drawdown of government deposits with the banking system and reliance on bank credits. Despite this turnaround in the fiscal position, financial restraint, including a reduced growth in private sector credit, was anticipated to yield a further slowing in monetary expansion to about 30 per cent and a continued easing of pressures on domestic resources and prices.
(In billions of U.S. dollars) 1/
|Year ended March 20||1972/73||1973/74||1974/75||1975/76|
|A. Changes in money and quasi-money||1.36||1.71||4.36||4.92|
|B. Public sector net domestic expenditures 2/||1.61||2.74||8.70||8.88|
|C. Monetary impact of private sector||0.17||0.01||-1.13||-2.03|
|Changes in claims on private sector (increase +)||1.12||1.86||3.10||5.53|
|Private sector lending to Central Government (increases -) 3||-0.07||-0.11||-0.02||…|
|Private sector balance of payments (deficit—)||-0.88||-1.74||-4.21||-7.56|
|D. Changes in net unclassified bank|
(In billions of U.S. dollars) 1
|A. Receipts from the oil sector (net)||3.63||11.49||27.80||28.18|
|B. Other goods, services, and private transfers||-2.09||-3.92||-5.50||-9.22|
|Services and private transfers (net)||-0.53||-0.57||-0.68||-1.24|
|C. Total (A + B)||1.54||8.20||22.30||18.96|
|D. Official transfers and miscellaneous capital||0.03||-1.49||-2.31||-4.12|
|Official transfer payments||-0.35||-0.77||-1.29||-1.99|
|Private capital (net) 2||0.38||-0.72||-1.02||-2.13|
|E. Total (C + D)||1.57||6.71||19.99||14.84|
|F. Change in net foreign assets of SAM A 3/ and commercial banks|
|(increase in assets -)||-1.57||-6.71||-19.99||-14.84|
In the case of Saudi Arabia, the government budget for 1975/76 called for more than a threefold increase in expenditures over those for 1974/75, with the largest part of the increase appropriated for development projects. Actual fiscal and monetary data are not yet available for 1975/76; however, government expenditures are believed to have fallen short of the budget estimates mainly because of the existing physical bottlenecks. While a large proportion of expenditures were accounted for by direct payments abroad, public sector net domestic spending increased considerably, thereby exerting a further expansionary impact on domestic liquidity which continued to grow at a rapid rate in the early part of the year despite an increase in the private sector balance of payments deficit. Prices continued to rise sharply in late 1975 and early 1976. Saudi Arabia’s financial policies for 1976/77 seek to moderate the rate of price increase mainly through restraining the growth in public sector net domestic expenditures. The government budget provides for an unchanged level of total allocations, despite anticipated higher oil revenues, and a larger proportion of expenditure is expected to be disbursed abroad, including advance payments to contractors for several priority projects, particularly in the areas of housing, ports, and roads. Moreover, in May 1976 the Saudi Arabian Monetary Agency raised the minimum reserve requirements of commercial banks. While the increase in reserve requirements was moderate and will absorb only small proportion of excess reserves held by banks, this action has signaled the need for banks to tighten credit.
(In billions of U.S. dollars) 1
|Changes in money and quasi-money||0.43||0.70||1.50|
|Government net domestic expenditures 2/||1.70||2.95||5.81|
|Monetary impact of private sector||-1.07||-2.11||-4.00|
|Bank claims on private sector (increase +)||0.03||0.39||0.62|
|Private sector balance of payments (deficit -) 3||-1.10||-2.50||-4.62|
|Changes in net unclassified bank liabilities||-0.20||-0.14||-0.31|
In summary, the recent increases in petroleum prices have considerably enhanced the financial and foreign exchange positions of Saudi Arabia and Iran. However, the rapid expansion of government expenditures for the purpose of improving living standards, accelerating economic growth, and diversifying the productive base of the economy was confronted with serious physical bottlenecks—particularly manpower shortages and capacity limitations in the ports, inland transportation, and construction sectors. As a result, the ability to utilize oil revenues in a fully efficient manner was constrained, and both countries experienced imbalances in aggregate supply and demand and increased inflationary pressures. As the substantial alleviation of supply constraints was not feasible over the short run, the authorities in both countries have adjusted their financial policies and limited the growth of public sector net domestic expenditures in order to bring aggregate demand into line with resource availabilities and facilitate a more sustainable pattern of economic growth.