Fiscal Policy in Oil Exporting Countries, 1972–78

Following the oil price rises of late 1973 and early 1974, several organizations predicted massive accumulations of international reserves by the major oil exporting countries by the end of 1980. 1 In the event, their balance of payments surpluses on current account and their reserve accumulations have been substantially lower than expected. 2 One reason is that world economic growth has been slower than assumed. But almost certainly the major source of error concerned the absorptive capacity of the oil exporting nations. The speed with which highly ambitious development strategies could be formulated and implemented in the oil exporting countries during the period after 1973 was not anticipated by many commentators in the early days of the oil crisis. Largely as a result of these factors, the balance of payments surplus on current account of the major oil exporting countries 3 declined from $68 billion in 1974 to $35 billion in 1977; and it has been projected to decline further, to around $10 billion in 1978.4 Further, this surplus is now concentrated among five countries of relatively low absorptive capacity—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Socialist People’s Libyan Arab Jamahiriya. The current account position of the other seven oil exporting countries as a group was expected to move into deficit in 1978.

Abstract

Following the oil price rises of late 1973 and early 1974, several organizations predicted massive accumulations of international reserves by the major oil exporting countries by the end of 1980. 1 In the event, their balance of payments surpluses on current account and their reserve accumulations have been substantially lower than expected. 2 One reason is that world economic growth has been slower than assumed. But almost certainly the major source of error concerned the absorptive capacity of the oil exporting nations. The speed with which highly ambitious development strategies could be formulated and implemented in the oil exporting countries during the period after 1973 was not anticipated by many commentators in the early days of the oil crisis. Largely as a result of these factors, the balance of payments surplus on current account of the major oil exporting countries 3 declined from $68 billion in 1974 to $35 billion in 1977; and it has been projected to decline further, to around $10 billion in 1978.4 Further, this surplus is now concentrated among five countries of relatively low absorptive capacity—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Socialist People’s Libyan Arab Jamahiriya. The current account position of the other seven oil exporting countries as a group was expected to move into deficit in 1978.

Following the oil price rises of late 1973 and early 1974, several organizations predicted massive accumulations of international reserves by the major oil exporting countries by the end of 1980. 1 In the event, their balance of payments surpluses on current account and their reserve accumulations have been substantially lower than expected. 2 One reason is that world economic growth has been slower than assumed. But almost certainly the major source of error concerned the absorptive capacity of the oil exporting nations. The speed with which highly ambitious development strategies could be formulated and implemented in the oil exporting countries during the period after 1973 was not anticipated by many commentators in the early days of the oil crisis. Largely as a result of these factors, the balance of payments surplus on current account of the major oil exporting countries 3 declined from $68 billion in 1974 to $35 billion in 1977; and it has been projected to decline further, to around $10 billion in 1978.4 Further, this surplus is now concentrated among five countries of relatively low absorptive capacity—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Socialist People’s Libyan Arab Jamahiriya. The current account position of the other seven oil exporting countries as a group was expected to move into deficit in 1978.

The major purpose of this paper is to begin analyzing the fiscal policy experience of the major oil exporting countries during the period 1972–78. Data are assembled on the major fiscal aggregates, distinguishing high- and low-absorption countries. 5 Where the data permit, attention is focused on the domestic, rather than the overall, budget balance in order to evaluate the impact of fiscal policy on domestic liquidity and prices.

The major findings of the paper can be summarized briefly:

(1) The growth of government expenditures in the major oil exporting countries over the period 1972–78 has, by any standards, been spectacular; in both absolute and percentage terms, it has been more rapid than the growth in their revenues.

(2) The rate of growth of government expenditures has been no less rapid in the low-absorption countries than in the high-absorption countries.

(3) The ratio of government expenditure to gross domestic product (GDP) in the major oil exporting countries jumped from 27 per cent in 1972–73 to 40 per cent in 1975, and it has continued to rise. The ratio of government revenue to GDP, however, has been on a declining trend since 1975, reflecting the changing composition of GDP, with an increase in the share of the comparatively lightly taxed non-oil sector in total GDP. As a result, the overall budget surplus was reduced to less than 1 per cent of combined GDP in 1977; and a substantial budget deficit (equal to $14.5 billion, or 4 per cent of forecast GDP) was projected for 1978.

(4) The high-absorption countries as a group have been incurring overall budget deficits since 1975; the low-absorption countries as a group continue to run overall budget surpluses, although the magnitude of these surpluses has been sharply reduced.

(5) During the period since 1972, there has been a close relationship, for the oil exporting countries taken together, between the overall budget surplus/deficit and the overall balance of payments surplus/deficit.

(6) In the oil exporting countries, fiscal policy is the primary determinant of domestic liquidity and aggregate domestic demand. It must be the primary instrument of demand management. For the six oil exporting countries for which data are available, there exists a close relationship between domestic budget deficits, domestic liquidity expansion, and inflation. For the same six countries, it appears that sharp reductions in the rate of growth of the domestic budget deficit have been closely associated with the restoration of domestic financial stability; earlier attempts to control inflationary pressures through subsidies and price controls, while highly expansionary fiscal policies were pursued at the same time, do not appear to have been successful.

(7) For the five oil exporting countries for which adequate data are readily available, preliminary tests indicate a stable relationship between the demand for real liquid balances and real non-oil GDP.

The plan of the paper is as follows. Section I outlines a framework for considering the impact of fiscal policy on monetary expansion in an oil exporting country. Section II provides a profile of fiscal policy in the oil exporting countries over the period 1972–78 and relates fiscal policy to domestic liquidity, price, and balance of payments developments. Section III discusses briefly policy approaches adopted by the oil exporting countries to achieve rapid growth within a framework of domestic financial stability and considers some of the major issues involved in the formulation and implementation of appropriate fiscal and monetary policies. An agenda for further research is provided in Section IV.

I. Monetary Implications of the Budget in Oil Exporting Countries

In order to examine the impact of fiscal policy on the domestic economy of a country in which a substantial volume of external receipts and payments passes directly through the government’s budget, the domestic budget balance provides a better first approximation than the overall budget balance. The separation of government transactions into foreign and domestic transactions represents an attempt to estimate the direct impact of the budget on domestic, rather than total, demand. Government expenditure abroad does not add directly to domestic demand and therefore does not increase domestic employment and output; 6 similarly, government receipts from abroad do not directly reduce private domestic resources. An analytically useful separation of domestic transactions involves more than a straightforward accounting exercise; it requires the making of behavioral assumptions and, to the extent that it does, a degree of arbitrariness is unavoidable. In the case of government revenue, for example, the central issue is whether the revenue represents a withdrawal from the income stream in the domestic private sector. The exclusion of government tax revenues from domestically based, foreign-owned oil companies from the domestic balance implies that these revenues would otherwise have been repatriated abroad. Clearly, the validity of this assumption needs to be examined on a case-by-case basis. On the expenditure side, it is not sufficient to exclude all government expenditure directly incurred abroad; account needs to be taken of government domestic purchases from importers. 7

The domestic budget balance concept, which emphasizes the first-round effects of budgetary operations on the generation of income and purchasing power, is closely related to liquidity budget balance analysis, which focuses on the liquidity implications of government operations. The liquidity balance differs from the domestic balance, in that it excludes domestic nonbank borrowing by the government but takes account of the receipt of central bank profits by the government, as well as interest payments by the government to the domestic banking system. 8

Placing emphasis on the domestic, rather than the overall, budget balance has direct implications for the analysis of monetary policy. It is easily demonstrated that the direct effect of the government budget on money creation is determined by the domestic budget balance. 9 Hence, the money supply identity may be depicted as follows: 10

ΔM =(ΔCp+BPp) +(GdRdLd) +ΔNUA(1)

where ΔM = change in domestic liquidity (money plus quasi money)

ΔCP = change in the claims of banking system on private sector

BPP = balance of payments of private sector

Gd = government domestic expenditures

Rd = government domestic revenues

Ld = government borrowing from domestic nonbank sector

ΔNUA = change in net unclassified assets of banking system

This formulation emphasizes that the main determinants of the money supply are the domestic budget deficit, the balance of payments deficit of the private sector, and the change in domestic bank credit to the private sector. Note that government external transactions do not appear in the identity, reflecting the fact that they do not contribute directly to the monetary creation process.

The alternative presentation is illuminating for analytical purposes. Consider the following hypothetical example for an oil exporting country in 1973 and 1974. The fiscal account shows a very substantial move from a deficit to a large surplus in 1974 as a result of the sharp jump in oil revenues (See Table 1.). The surplus is reflected in increased government deposits with the domestic banking system.

Table 1.

Hypothetical Oil Exporting Country: Central Government Operations, 1973 and 1974

(In millions of hypothetical dinars)

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A minus sign represents a reduction in liabilities or an increase in assets.

The conventional presentation of the monetary survey portrays the rise in the net foreign assets of the banking system as the primary expansionary factor in the growth of liquidity in 1974 and the large increase in government deposits as the main offsetting factor (See Table 2.). Fiscal policy and, in particular, its monetary implications, appear contractionary. The conventional presentation conceals the fact that the government’s fiscal operations constitute the primary determinant of changes in money and quasi-money. The receipt of oil revenues by government (the main factor underlying the rise in foreign assets) has no immediate monetary impact, since it is directly offset by a rise in government deposits. Only to the extent that the government injects this revenue into the domestic income stream, through its domestic expenditures, is the inflow of foreign exchange translated into domestic liquidity. Hence, an analytically more meaningful presentation of the factors affecting changes in liquidity is presented in Table 3. This table portrays government sector activity as the major expansionary factor in the growth of liquidity. 11

Table 2.

Hypothetical Oil Exporting Country: Factors Affecting Changes in Domestic Liquidity, 1973 and 1974

(In millions of hypothetical dinars)

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Table 3.

Hypothetical Oil Exporting Country: Alternative Presentation of Factors Affecting Changes in Domestic Liquidity, 1973 and 19741

(In millions of hypothetical dinars)

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All entries in this table are taken from Tables 1 and 2 except for nongovernment sector external transactions, which enter as a residual.

One important policy implication highlighted by this alternative presentation is that the exogenous nature of oil revenues to any one oil exporting country per se does not give rise to the monetary stabilization problems that would confront, say, a coffee exporting nation where coffee production was in the hands of the private sector. Under existing institutional arrangements in almost all major oil exporting countries, oil revenues are automatically sterilized. The relevant transmission mechanism is not the balance of payments, but rather the government budget. Hence, the surge in oil revenues in 1974 did not, in itself, generate a rise in domestic liquidity. Similarly, the recent flattening in oil revenues will, in itself, do nothing directly to alleviate situations where excessive private sector liquidity has been allowed to develop. Such a result will follow only to the extent that the flattening induces moderation in net government domestic spending.

II. Fiscal Policy Experience, 1972–78

The 12 major oil exporting countries considered here are a heterogeneous group with differing political outlooks, cultural traditions, and economic capacities. While the discussion in this section does not and could not reflect differences in individual country experiences, there are notable similarities in broad macroeconomic developments in all 12 countries during the period 1972–78. Following the sharp rise in oil prices in late 1973 and early 1974, the oil exporting countries adopted highly expansionary fiscal and monetary policies aimed at rapid development of the non-oil sector and at immediate improvement of the welfare of their populations. In late 1975 and 1976, however, several oil exporting countries shifted these policies toward restraint in order to combat sharply accelerating inflationary pressures and, in some cases, to contain emerging current account and overall balance of payments deficits; while these policies have tended to be maintained, the primary economic policy objective of these countries remains the rapid development of the non-oil sectors of their economies.

1. oil exports and government revenue

a. Government oil revenue

The value of oil exports from the major oil exporting countries rose from $35 billion in 1973 to $112 billion the following year. 12This declined to $103 billion in 1975, reflecting a reduction in export volume attributable to global recession, official conservation efforts, and consumer reactions to sharply higher oil prices. Export volume recovered in 1976 and 1977 to approximately the 1973 level, and the value of exports increased to $126 billion and $137 billion, respectively. Assuming that the price of oil remained unchanged throughout 1978, it is expected that the value of oil exports declined slightly from the previous year. 13

Government oil revenues in the major oil exporting countries grew at a more rapid rate than oil exports, reflecting, inter alia, increases in income tax rates and royalty rates and, in several cases, increased equity participation by governments. 14 Government oil revenues jumped from $23 billion in 1973 to $85 billion in 1974. In 1975, notwithstanding a decline in the value of oil exports, government oil revenues increased further to $91 billion, in part owing to delayed payments from the previous year. Government oil revenues exceeded $100 billion in 1976 and increased further to $118 billion in 1977. Budget estimates indicated no change in 1978. The fiscal data indicate that the major oil exporting countries have succeeded in increasing their share of gross oil export proceeds from around 65 per cent in 1972–73 to around 85 per cent in 1976–77.15

b. Oil revenue and total government revenue

Obviously, the growth in oil revenue has exerted a dominant influence over movements in total government revenue, although there have been changes over time. For the 12 major oil exporting countries, oil revenues as a proportion of total government revenues increased from 65 per cent in 1972 to 85 per cent in 1974. Thereafter, the proportion declined; and it was projected at around 75 per cent for 1978. This reflects more the relatively modest growth in oil revenues since 1974 (The average annual growth between 1974 and 1978 is estimated at less than 9 per cent.) than any rapid growth in government revenue from the non-oil sector.

Total government revenues increased by 50 per cent, to $33 billion, in 1973. They tripled in 1974 and then increased at an annual average rate of around 15 per cent, reaching $151 billion in 1977. They were projected to increase by only 4 per cent in 1978, reflecting largely the stagnation of oil revenues. Expressed in relation to GDP, government revenues jumped from 30 per cent in 1973 to an average of 48 per cent in 1974–75. Thereafter, the proportion declined to 45 per cent in 1977; and it is projected to decline further in 1978. The major factor underlying this decline is the changing composition of GDP with an increase in the comparatively lightly taxed non-oil sector relative to the oil sector. The share of the oil sector declined from 50 per cent of aggregate GDP in 1974–75 to 42 per cent in 1977; and it was projected to decline further, to 37 per cent, in 1978.

2. policy issues and choices

The sudden and sharp rise in oil revenue eased or eliminated the financial constraints on development in the oil exporting countries. Nevertheless, the authorities were faced with difficult and novel issues and choices regarding the feasible speed of development of their non-oil sectors, the appropriate roles of the public and private sectors, tolerable rates of inflation, and acceptable standards of income distribution. 16 Decisions on these issues differed somewhat from country to country, depending, inter alia, on the size of each country’s population and oil reserves, its stage of development, and the domestic resources other than oil available to it. While varying emphases were, of course, observed, all countries aimed for a rapid increase in the rate of growth of the non-oil sector. Unparalleled increases in expenditures were undertaken, aimed at developing infrastructure and diversifying industrial bases. Current expenditures were increased rapidly, mainly in the form of sharply increased wages and salaries, defense spending, subsidies, and transfers to public enterprises. (Data on aggregate government expenditure are provided in Section II.3.)

The objectives of expanding the non-oil sector and providing immediate improvements in the welfare of their populations cannot explain fully the extraordinary pace with which expenditures were implemented, especially in view of the inevitable concomitant costs of the severe strains placed on the domestic resource base and the consequent price and balance of payments implications. Additional factors surrounding the unprecedented and unexpected pace of government expenditures may have included the following. First, in the case of tradable goods, it is likely that some large-capacity plants were constructed rapidly with the aim of reducing the attractiveness to neighboring oil-rich countries of constructing similar facilities. Second, as would be expected, there were internal pressures to share the wealth widely; and large capital expenditures may have helped (at least in the short run) to keep current disbursements within reasonably manageable limits. Third, maintenance of the real price of oil in the near term may have required production cuts by the OPEC as a group; and the greatest pressure may have fallen on those members with the largest surpluses.

In the initial period following the oil price rise, it appears that relatively little attention was paid to the inflationary implications of sharply increased government spending and that comprehensive policies were not, in general, prepared to cope with the problem. Part of this situation is explained by the pressures to spend that were discussed previously. Also, the inflationary implications of sharply increased government expenditure may not have been fully appreciated. The economic reasoning may have been that financial resources deriving from abroad represent an increased availability of real resources. Clearly, the reasoning is valid to the extent that oil revenues permit additional imports. To the extent that inflationary pressures were correctly forecast, it may have been assumed they could be attacked by means other than curbing of government expenditure: price controls, subsidies, and tax reductions. It is also possible that a certain amount of inflation was regarded as an inevitable and tolerable price to be paid for rapid development.

3. government expenditure and emerging bottlenecks

The growth of government expenditure in the major oil exporting countries has, by any standards, been spectacular; in some respects, it has been more spectacular than the growth in government revenues. Aggregate government expenditures increased by 49 per cent in 1973, doubled in 1974, and increased by a further 50 per cent the following year. 17 Thereafter, the rate of growth in spending declined to 28 per cent in 1976 and 24 per cent in 1977. Budget estimates implied a further deceleration (to 16 percent) in 1978. The pattern is similar for both high- and low-absorption countries, except for 1973 and 1976, when the growth rates were considerably higher in the low-absorption countries.

Expressed in relation to GDP, government expenditure has increased from around 27 per cent of GDP in 1972–73 to around 45 per cent of GDP in 1977–78. The ratio jumped sharply in 1975 to 40 per cent and has been increasing by about 2 per cent a year since then (See Chart 1.). This continuing increase is almost entirely attributable to the low-absorption countries; in the high-absorption countries, the ratio has been relatively constant at approximately 40 per cent since 1975. 18

Chart 1.
Chart 1.

Major Oil Exporting Countries: Ratio of Government Expenditure to GDP, 1972–78 1

Per cent

Citation: IMF Staff Papers 1979, 001; 10.5089/9781451956528.024.A003

Sources: National budget documents and author’s estimates.1 Dotted lines indicate budget estimates.

It is significant that the budget estimates for 1978 implied that, for the first time since 1972, an overall budget deficit would emerge for the 12 major oil exporters taken as a group (See Chart 2.). The magnitude of the projected deficit is $14.5 billion, which is equivalent to almost 4 per cent of these countries’ combined GDP. The budget estimates of government expenditures do not appear unrealistically high; nor do the revenue estimates appear to be understated. The high-absorption countries have been incurring overall budget deficits since 1975. Their 1977 deficit was equivalent to 6 per cent of GDP; and a deficit equivalent to 7 per cent of projected GDP was estimated for 1978. The low-absorption countries have been in budgetary surplus positions since 1972 and were projected to remain so in 1978. However, their overall budget surplus has been reduced sharply, from a peak of 35 per cent of GDP in 1974 to 14 per cent in 1977. This was projected to decline further to 3 per cent of GDP in 1978. 19

Chart 2.
Chart 2.

Major Oil Exporting Countries: Government Budget Surplus/Deficit, 1972–78 1

Billions of dollars

Citation: IMF Staff Papers 1979, 001; 10.5089/9781451956528.024.A003

Sources: National budget documents and author’s estimates.1 Dotted lines indicate budget estimates.

In the initial stages of sharply increased government expenditure, a large proportion of the increase was spent on imports, purchased either by the government or by recipients of government wages, salaries, and transfer payments. By early 1975, however, considerable congestion emerged in the ports of several major oil exporters. While congestion was the most obvious and widely-publicized bottleneck, it was only the tip of a very large iceberg. By early 1975, the following generic catalog of bottlenecks was confronted by all of the low-absorption oil exporters and, in large part, by most other oil exporters:

Every economist would agree that in any country there is some limit to the rate of capital formation that can be carried out at any given time with a resulting increase in productivity. There are technical and other limitations. Among the technical ones are the size of the construction industry, the availability of materials for capital construction and of workers for construction and subsequent operation, the capacity of the ports and transportation system…, of the country’s housing to house expatriate or migrant builders and workers, and of the existing productive complex into which or onto which the new enterprises must be fitted and on which they must depend in part for their productivity. Other limitations would include the number of individuals in the society with adequate managerial and technical capabilities, including in the extreme case the capability of making contracts with foreigners to do the capital formation, and the values and motivations of many groups in the society: of workers, which affect their availability for new enterprises; of government officials, which will determine the degree of waste, corruption, and misdirection of investment… 20

The quotation refers specifically to what may be termed capital-absorptive capacity, but it clearly is applicable to total spending-absorptive capacity: the importation, transportation, and distribution of consumer goods imports requires many of the abilities and other inputs outlined therein. Skilled and unskilled labor were virtually unavailable in the low-absorption countries by 1975; and in particularly short supply was the experience and know-how required to build up very rapidly economic infrastructure and an industrial economy. Absorptive capacity involves a substantially more complex capability than solving short-term port and transportation problems that limit imports; properly defined, the concept relates to the long-term problems associated with the creation of self-sustaining growth of non-oil sectors. 21

4. implications for domestic liquidity and prices

Continuing rapid growth in government spending and increasingly severe bottlenecks resulted in sharp increases in domestic liquidity and intensification of inflationary pressures. For the major oil exporting countries, domestic liquidity expanded at an accelerating rate from 1972, reaching a peak growth rate of 45 per cent in 1975. 22 The introduction of more restrained fiscal policies and an easing of supply constraints contributed to a deceleration thereafter, to a rate of 33 per cent in 1977 (See Chart 3.). Consumer price data for the same group of countries indicate an inflationary pattern similar to that displayed by domestic liquidity.23 The inflation rate accelerated sharply from 4 per cent in 1972 to a peak of 18 per cent in 1975, and thereafter declined moderately, to less than 15 per cent in 1977 (See Chart 3.).

Chart 3.
Chart 3.

Major Oil Exporting Countries: 1 Growth Rates of Domestic Liquidity and Consumer Prices, First Quarter, 1972–Second Quarter, 1978 2

Per cent

Citation: IMF Staff Papers 1979, 001; 10.5089/9781451956528.024.A003

Source: International Monetary Fund, International Financial Statistics, various issues.1 Excludes Qatar, Oman, and the United Arab Emirates.2 Weighted by nominal GDP, expressed in dollars.

As was discussed in Section I, in order to identify the contribution of fiscal policy to these liquidity developments, attention should focus on domestic, rather than overall, budget balances. Tolerably accurate estimates of the domestic balance are available for only six of the major oil exporting countries. 24 The increment in the liquidity stock, subject to the caveats noted in Section I, should correspond to the domestic budget balance; and, likewise, on taking first differences, the rate of change in the liquidity increment should correspond to the rate of change in the domestic budget balance. Chart 4 shows the relationship between percentage changes in domestic budget balances and liquidity increments for the six oil exporting countries for which the data are available for the period since 1973. 25 The close relationship between the two sets of percentage changes provides strong support for the hypothesis that domestic budget balances are the primary determinants of movements in domestic liquidity. 26

Chart 4.
Chart 4.

Six Oil Exporting Countries: 1 Percentage Changes in Domestic Budget Balance and Domestic Liquidity Increment, 1973–78 2

Per cent

Citation: IMF Staff Papers 1979, 001; 10.5089/9781451956528.024.A003

Sources: International Monetary Fund, International Financial Statistics; national budget documents; and author’s estimates.1 Saudi Arabia, Iran, Kuwait, Nigeria, Venezuela, and Oman.2 Weighted by nominal GDP, expressed in dollars.3 1978 budget estimates.

5. fiscal policy and overall balance of payments developments

A detailed analysis of the relationship between fiscal and balance of payments developments in the oil exporting countries would involve, inter alia, improvement of the available data on movements in total international reserves of the major oil exporting countries. It is sufficient to note here that, in an oil exporting country with a limited home production base, there is likely to be a close relationship between overall fiscal and balance of payments developments. Government oil revenues are the principal source of foreign exchange, and a large proportion of government expenditures will consist of payments for imports and for other external transactions. Also, government injection of oil revenues into the domestic income stream via its domestic expenditures will be reflected in private sector imports, given a limited home production base and a reasonably open economy. 27 Chart 5 shows the relationship between the overall budget surplus of the major oil exporting countries and changes in their total international reserves. 28 The two series move in close consonance, except in 1977. 29

Chart 5.
Chart 5.

Major Oil Exporting Countries: Overall Budget Surplus/Deficit and Change in International Reserves, 1972–78 1

Billions of dollars

Citation: IMF Staff Papers 1979, 001; 10.5089/9781451956528.024.A003

Sources: Change in total reserves data (end of period) derived from International Monetary Fund, International Financial Statistics; budget data derived from national budget documents and author’s estimates.1 Excludes Oman and Qatar.2 Change in reserves up to June 1978.3 1978 budget estimates.

III. Restoring and Maintaining Domestic Financial Stability

The data provided in Section II indicate that the oil exporting countries as a group have experienced some success since 1975 in moderating excessive rates of growth in domestic liquidity and prices. The hypothesis suggested above is that a primary instrument with which these results were secured was substantial moderation in the rate of growth of domestic budget deficits. This section discusses the use of other instruments employed in these countries in pursuit of domestic financial stability and considers some current issues in policy formulation and implementation.

1. reappraisal of economic objectives

The success of economic policy is rightly judged in terms of the economic objectives to which it is directed. The primary economic objective of most oil exporting countries since the oil price rises of late 1973 and early 1974 has been to secure rapid growth and development of their non-oil sectors. 30 Present development plans of the major oil exporting countries provide for continuing rapid growth in the non-oil sectors but envisage inflation rates below those experienced between 1973 and 1976, perhaps reflecting the view that longer-term economic and social goals will best be achieved within a framework of reasonable financial stability.

It is, of course, true that the weight attached to the restoration of domestic financial stability varies among oil exporting countries, and also within a given country over time. Nevertheless, there was a clear tendency in many oil exporting countries for control of inflation to increase in importance as a policy objective in the wake of the rapid and accelerating inflation in 1975. In some cases, this attention to inflation came about as a result of sharp reductions in balance of payments surpluses, or even the emergence of significant deficits. However, rapid and accelerating inflation was imparting costs not directly related to external equilibrium: diversion of resources into speculative activities, adverse impacts on private sector confidence, and encouragement of a relatively undiversified economy (not to mention the possibility of hyperinflation). For the low-absorption economies in particular, output and employment were not constrained by insufficient demand but rather by supply bottlenecks. Until these constraints were eased, the primary effect of incremental domestic expenditure was likely to be an exacerbation of inflation.

2. policy approaches

This section discusses the policy approaches most generally used by the oil exporting countries in the pursuit of, inter alia, reasonable domestic price stability: a range of policies involving direct action on prices, supply management policies, and overall fiscal and monetary policies. This list is by no means exhaustive, nor are these policies mutually exclusive.

a. Direct action on prices

Four major elements of fiscal policy can be identified in almost all oil exporting countries during 1974 and 1975: (1) the introduction or substantial expansion of direct subsidy payments on a wide range of goods and services; (2) the introduction or expansion of indirect subsidies through the pricing policies of public enterprises (including those responsible for electricity, water, and refined petroleum products for domestic use); (3) the reduction or elimination of several categories of domestic taxation (particularly import duties and taxes on goods and services); and (4) the abolition of user charges for government-supplied services in health, education, and other areas.

An important objective of these policies was to provide rapid improvements in the living standard of a large proportion of the population. However, these instruments may have been chosen to reduce inflation generally (by means of breaking rising price expectations), as well as to offset the impact of inflation on particular groups. The actual inflation experience of countries following this approach suggests that such policies met with only limited success. This may support the view that any decline in price expectations would probably be short-lived if it were produced by policies involving a direct increase in the domestic budget deficit and domestic liquidity; and, clearly, each of the the four elements of fiscal policy outlined above implied both developments. 31 Attacking the symptoms of inflation by means that exacerbated the causes was likely to yield, at best, only temporary results. Several oil exporters subsequently turned to an instrument that offered a reduction in inflationary expectations without, at the same time, producing more expansionary fiscal and monetary policy—price controls.

Price controls appear to have played a significant part in holding down the rate of increase in official price indices. It is more questionable whether they also reduced underlying inflationary pressures, measured with reference to fiscal and monetary data. In some cases, the brunt of the controls was borne by public enterprises, with predictable consequences for their financing requirements. Recently, some countries have substantially relaxed or abandoned price controls.

b. Supply management

Policies to augment aggregate supply have played a considerable role in the recent growth performance in oil exporting countries. The contribution of immigration has varied according to the differing political and social attitudes in individual countries and no doubt will continue to be determined largely by these attitudes. Substantial government expenditures have been directed toward removing, or at least easing, key bottlenecks. Rapid progress has been made toward eliminating port congestion and increasing substantially the capacity of inland rail and road systems. Port congestion represents a critical bottleneck, the elimination of which greatly assists the restoration of domestic financial stability. 32 However, existing bottlenecks are considerably more diffuse, and new ones will inevitably come to light in a rapid and largely unpredictable manner.

Oil revenues aside, the oil exporters are still characterized by the major features of less developed countries (LDCs): insufficient infrastructure, limited endowments of skilled labor, inadequate developmental institutions, widespread illiteracy, and a large proportion of the population in economic sectors where productivity remains low. Oil revenues remove one constraint to development, the financial one, but this does not, of itself, remove others, such as lack of skilled labor; of managerial, administrative, and entrepreneurial talent; and of infrastructure. Large investment drives, on ports for example, remove one bottleneck but add new ones through the pressure exerted on other elements of the infrastructure (internal rail and road transportation, for example), on the small group of decision makers, on skilled manpower, and on the domestic resources of the construction and service sector. In brief, measures to augment aggregate supply involving the easing of key bottlenecks have a critical, but limited, role to play in restoring domestic financial stability. They need to be accompanied by appropriate demand management policies, which are now considered.

c. Fiscal and monetary policies

The aggregated data in Section II support the hypothesis that, in the oil exporting countries, a close relationship exists between the domestic budget balance, liquidity expansion, and inflation. Fiscal policy is the primary determinant of domestic liquidity and aggregate domestic demand, and it must be the primary instrument of demand management. The extent of the slowdown in the growth of domestic budget deficits during 1976 and 1977 that was attributable to discretionary action by the authorities is difficult to know. It may have been the outcome of well-conceived comprehensive stabilization programs or merely a welcome, and to some extent a fortuitous, fallout from physical and administrative constraints on absorptive capabilities; some combination of the two may be the most plausible explanation. 33The distinction is important since, notwithstanding the apparent recent success in moderating liquidity growth and inflation, the task of economic stabilization confronting the oil exporting countries remains complex, and policy formulation must take account of a number of factors.

Large ongoing projects and development plans indicate continued high rates of government spending (albeit substantially below those of 1973–75). To the extent that the public’s expectations of inflation and real income increases are based on past experience, their expectations are likely to remain high. Substantial balance of payments deficits have emerged for a number of major oil exporting countries. While domestic liquidity expansion moderated in 1976 and 1977, it is possible that a substantial domestic liquidity overhang remains to be absorbed. Further, in several countries, price controls may not have been relaxed sufficiently to remove the quite severe distortions that built up primarily in the 1974–75 period. This may not appear an unduly complex scenario; indeed, many countries would choose to cope with the economic problems of the major oil exporters in preference to their own. Nevertheless, there is one unique element of complexity in determining appropriate fiscal and monetary policy in the oil exporting countries—namely, the speed and scale of their economic transformation during the past half decade. Structural changes have undoubtedly occurred that must vitiate the usefulness of economic relationships in these countries that were observed prior to 1973. Further, structural change is clearly not a once-and-for-all phenomenon, but rather a continuous, rapid, and somewhat unpredictable process. This obvious but fundamental point needs to be borne in mind later on in this paper, where some issues involved in fiscal policy formulation and implementation are considered briefly.

3. demand for liquidity in oil exporting countries

As a starting point in the design of fiscal and monetary policy in oil exporting countries, the following traditional and straightforward approach could be attempted. First, estimate the demand for liquidity that is consistent with price and real output targets for the forthcoming period. Second, forecast the private sector’s balance of payments deficit and its legitimate domestic bank credit requirements. Finally, judge whether the resulting residual is consistent with the projected target for the domestic budget deficit. Clearly, this would be the first round of an iterative process. The question arises whether econometric estimates for the demand for real cash balances could be used as one input into the determination of the demand for liquidity, in light of data deficiencies and the problem of rapid structural change alluded to previously. 34 Even purely qualitative policy prescriptions must be based on the same faulty data and on some implicit theoretical model. The results of some econometric testing of a liquidity demand function for five oil exporting countries are reported in Appendix II. They indicate that a stable relationship exists between the demand for real liquid balances and real non-oil GDP. For four countries, the results indicate significant lags in the adjustment of the actual to the desired liquidity stock. The estimated short-run elasticity of demand is always less than unity, and the estimated long-run elasticity is always greater than unity. The results are plausible, although, given the absence of a variable to capture the monetization effect, the estimated income elasticity of demand is probably biased upward.

4. economic management infrastructure

Quite apart from the inherent difficulties of devising an appropriate macroeconomic policy, data bases remain seriously inadequate in some oil exporting countries; and, more generally, there is a need to improve the coverage, quality, and speed of compilation of macroeconomic statistics. Institutional developments with respect to the control of fiscal and monetary aggregates have not, in general, kept pace with the rapid increase in the scale and complexity of the oil economies. The dramatic growth of government operations, in particular, has placed considerable strain on the budget and accounting machinery. In many cases, the financial and planning ministries do not have the power of their counterparts in countries where financial constraints require the reconciliation of competing claims. Development plans and budgets frequently represent processes whereby projects and programs are compiled but not fully reconciled, and individual ministries and public enterprises enjoy considerable autonomy. 35 In these circumstances, the ability of the authorities to control the level of expenditures in line with the macroeconomic requirements of the economy is considerably reduced. In part, these tendencies reflect the influence of the progressive easing of financial constraints in most oil exporting countries since 1970; in part, they reflect the enormous increase in the workloads of finance and planning ministries. In some of the oil economies, the monetary authorities have relatively narrow functions (partially reflecting acute shortages of skilled manpower), and new problems of control of monetary aggregates have arisen with the rapid development of specialized banking institutions. These problems are aspects of the general problem of adapting the infrastructure of financial management to the transformed economic situation. Without improvements in data, in the fiscal and monetary policy machinery, and in the monitoring of policy execution, the capacity of oil exporting countries to devise and implement stabilization programs will remain constrained. While considerable improvements have been made in several countries, more needs to be done, particularly in light of the prospect that financial constraints will remain much tighter than in the period from 1973 to 1976.

IV. Agenda for Further Research

The previous discussion indicates a number of areas worthy of further investigation, including the following:

(1) The relationship between fiscal policy and the balance of payments in oil exporting countries; this will entail, inter alia, considerable improvement in the international reserves data.

(2) A more detailed analysis of the determinants of domestic liquidity expansion that takes into account developments in private sector balance of payments deficits and that sector’s use of domestic bank credit.

(3) Analysis of government revenue and expenditure data on a disaggregated basis, in order to throw light on how domestic budget deficits are moderated, as well as on possible future developments.

(4) Analysis of macroeconomic developments in the oil exporting countries in terms of the supply and use of real resources, for its own sake, as well as to provide a check on the usefulness of an essentially monetarist approach.

Most importantly, the paper highlights the need for a considerable improvement in the macroeconomic data that are essential for successful formulation and implementation of appropriate economic policy.

APPENDICES

I. The Domestic Budget Balance and Domestic Liquidity

The overall budget balance B is the difference between total expenditures (domestic Gd and foreign Gf), and total revenue (domestic Rd plus foreign Rf). Symbolically,

B=Gt+GdRfRd(2)

or

B=(GdRd)+(GfRf)(3)

where (GdRd) is the government’s domestic budget balance and (GfRf) is the government’s foreign balance. The overall balance is financed through foreign borrowing, ΔFg; domestic nonbank borrowing ΔLd; and net credit from the domestic banking system, ΔCg. (The symbol Δ represents the absolute change in any variable during the accounting period.) Ignoring domestic non-bank borrowing for the moment, then

(GdRd)+(GfRf)=ΔFg+ΔCg

or

(GdRd)=ΔFg(GfRf)+ΔCg(4)

The government’s foreign balance and government foreign borrowing will represent the change in net foreign assets attributable to government operations, ΔNFAg; thus,

(GdRd)=ΔNFAg+ΔCg(5)

Since ΔNFAg and ΔCg are components of domestic liquidity, it is clear that the direct effect of the government budget on liquidity creation is determined by the domestic budget balance. Any nonbank domestic borrowing by the government would enter negatively on the left-hand side of equation (5).

The traditional framework of the monetary survey is as follows:

ΔM=ΔCp+ΔCg+ΔNFA+ΔNUA(6)

where

M = domestic liquidity (money and quasi-money)

Cp = claims of banking system on private sector

Cg = net claims of banking system on government

NFA = net foreign assets of banking system

NUA = net unclassified assets of banking system

To arrive at the alternative presentation, ΔNFA needs to be divided into the change in net foreign assets attributable to private sector operations, ΔNFAg, and to government operations, ΔNFAg. Using this distinction, and substituting equation (5) into equation (6), we have

ΔM=ΔCp+ΔNFAp+(GdRd)+ΔNUA(7)

II. The Demand for Liquidity in Oil Exporting Countries

The conventional formulation of the liquidity demand function, whereby the demand for real liquid balances is related to the level of real income and to the rate of return on alternative financial assets, requires some modification for the oil exporting countries considered here. First, non-oil income is preferable to total income as a variable indicating the scale of transactions in the economy. The oil sector is essentially an enclave, with almost all of its transactions occurring in foreign currency and with the government. Second, in most oil exporting countries, the availability of alternative financial assets is very limited. The more relevant opportunity cost of holding liquid balances is the rate of return on physical assets or goods, for which the expected rate of inflation may be a suitable proxy. Thus, the demand for real liquid balances can be specified in log-linear terms as follows: 36

log(MP)tD=a0+a1logYt+a2πta1>0,a2<0(8)

where M = nominal stock of liquidity

P = price level

Y = real non-oil GDP

π = expected rate of inflation

The superscript D refers to demand.

It could be assumed that the actual stock of money adjusts to demand within a single time period (in this case, one year) and that equation (8) could be estimated as it stands using actual money stock data. At the very least, this assumption needs to be tested against an alternative formulation that provides for an adjustment mechanism between the actual and desired money stock. A straightforward adjustment mechanism between the actual and desired money stock is as follows:

Δlog(MP)t =λ[log(MP)tDlog(MP)t1]1>λ>0(9)

where λ equals the adjustment coefficient. This involves the assumption that the actual stock of money adjusts proportionately to the difference between the demand for real balances in the current period and the actual stock in the previous period. However, the formulation also involves the assumption that a reduction in the real value of the nominal money stock owing to rising prices is subject to immediate adjustment. This assumption has been criticized in the literature and an alternative formulation has been suggested whereby equation (9) is specified in nominal terms. 37 Combining a nominal adjustment function with equation (8) above yields the following:

log(MP)t =λa0+λa1logYt+λa2πt+(1λ)log(Mt1Pt)(10)

while using equation (9) above yields the same equation, except that the last term on the right-hand side of equation (10) becomes the usual lagged dependent variable.

There is no consensus in the economic literature on what constitutes the most suitable proxy for the expected rate of inflation. A common version of the adaptive expectations mechanism is as follows:

πtπt1=β[ΔlogPtπt1]1>β>0(11)

where β is the expectations coefficient and Δ log Pt is the current rate of inflation. In some cases, it is assumed that β is equal to unity (the static expectations case), and the expected inflation rate is equated with the current actual inflation rate. In other cases, an appropriate value for π can be generated from equation (11) independently. The tests carried out involved four versions of the static expectations case (current and previous inflation rate in logarithmic and nonlogarithmic forms), as well as tests with the independently generated values of π. 38

Finally, a dummy variable V was included in an attempt to capture any structural change emanating from the oil price rise at the end of 1973.

The estimation results are set out in Table 4. 39 The various versions of the expected rate of inflation were not statistically significant at the 5 per cent confidence level for any of the countries and were dropped. According to the standard statistical criteria, the lagged liquidity stock deflated by the current period price level consistently gave better results than the lagged dependent variable. For most countries, the results indicate significant lags in the adjustment of the actual to the desired liquidity stock, which are of relatively long duration for Indonesia and Venezuela. The estimated short-run income elasticity of demand is always less than unity (ranging between 0.49 for Venezuela and 0.89 for Nigeria), and the estimated long-run elasticity of demand is always greater than unity (ranging between 1.41 for Nigeria and 1.82 for Venezuela). 40

Table 4.

Five Oil Exporting Countries: Demand for Real Liquid Balances1

article image
Sources: Domestic liquidity and price data (both annual averages) are taken from International Financial Statistics; real non-oil GDP data are taken from International Bank for Reconstruction and Development data files.

All equations are estimated using the ordinary least-squares method of estimation and the Cochrane-Orcutt adjustment for autocorrelation. One asterisk indicates that the coefficient is significant at the 5 per cent confidence level; two asterisks indicate significance at the 1 per cent confidence level. Figures in parentheses represent adjusted t-statistics. Empty cells indicate that the particular variable was insignificant, and that the equation was re-estimated with the variable omitted. The coefficients on the significant variables did not change appreciably in most cases.

These results are plausible, 41 but, given the absence of a variable to capture the monetization effect (that is, the effect of enlargement of the money economy through the absorption of the nonmonetized sector), the estimated income elasticity of demand includes this effect and is therefore probably biased upward. 42 If it is reasonable to assume that monetization will continue at the same rate, no problems arise from the viewpoint of a financial programming exercise. However, the available evidence indicates that monetization is a discontinuous process. 43 Finally, for two countries (Nigeria and Venezuela), a dummy variable introduced at the time of the oil price rise was significant with a positive sign. This may represent the effects of a more rapid rate of monetization after 1973.

*

Mr. Morgan, economist in the Fiscal Analysis Division of the Fiscal Affairs Department, is a graduate of La Trobe University, Australia. He received his master’s degree and doctorate from the London School of Economics. Before joining the Fund, he was an economist at the Australian Treasury.

1

The estimates of the reserve increase between 1973 and 1980 ranged from $180 billion to more than $600 billion. A discussion of these estimates may be found in Rimmer de Vries, “The Build-Up of OPEC Funds,” World Financial Markets (Morgan Guaranty Trust Company, New York, September 23, 1974), pp. 1–10; “Survey: The Gulf,” Economist, Vol. 255 (May 17, 1975), p. 27; and Donald A. Wells, Saudi Arabian Development Strategy (Washington, 1976), p. 2.

2

The increase in international reserves of the major oil exporting countries between the end of 1973 and the end of 1977 is estimated to be in the range of $60–95 million. The former estimate derives from official estimates appearing in the Fund’s monthly publication, International Financial Statistics. The latter estimate is taken from the Fund’s Annual Report 1978 (Washington, 1978), p. 19, where it is noted that the dividing line between capital movements and reserve asset changes is uncertain for some oil exporting countries.

3

The 12 major oil exporting countries are Algeria, Indonesia, Iran, Iraq, Kuwait, Nigeria, Oman, Qatar, Saudi Arabia, the Socialist People’s Libyan Arab Jamahiriya, the United Arab Emirates, and Venezuela. This classification is consistent with International Financial Statistics.

4

See Bank of England, Quarterly Bulletin, Vol. 19 (March 1979), pp. 28–29.

5

Where this distinction is made in the remainder of the paper, low-absorption countries are considered to be the five mentioned previously, which have relatively undiversified economies as evidenced by small non-oil sectors, shortages of natural resources other than oil, and, typically, small populations.

6

Government imports will, however, involve domestic expenditure in the form of internal handling and transportation costs.

7

The domestic deficit data in this paper could not be adjusted to take account of these transactions. This is analogous to the problems raised by government transfer payments. Obviously, recipients of these transfer payments may use them to finance imports. This problem assumes considerable importance when the relationship between transfer payments and imports changes, as may occur when severe port capacity constraints are eased.

8

Given the limited role played by domestic nonbank borrowing in the economies considered here, the terms are used interchangeably for the remainder of the paper. The central bank often acts as a conduit for government investments from abroad. In oil exporting countries, such income is usually not recorded as central bank profits in the budget.

9

See Appendix I.

10

Ibid.

11

This approach can be complemented by an analysis of the supply of, and the demand for, real resources. The total supply of goods and services to the domestic economy is equal to the sum of GDP and imports minus exports. If non-oil GDP is defined to include the domestic activities of oil companies (such as construction, transport, and communications) and non-oil exports are insignificant, then aggregate domestic supply is closely approximated by non-oil GDP plus imports. Aggregate domestic demand (domestic absorption) equals government purchases of goods and services plus private sector expenditure. The obvious point to note from this simple and traditional framework is that the oil sector (or, more precisely, oil exports) makes no direct contribution to domestic supply; its indirect contribution is via imports.

12

Derived from International Financial Statistics.

13

In projecting U.S. dollar magnitudes for 1978, it has been assumed that the most recent exchange rates available at the time of writing (August 1978) between the U.S. dollar and the currencies of individual oil exporting countries would prevail for the remainder of the year.

14

There are a number of important differences between the balance of payments data from which oil export data are derived and central government fiscal data from which oil revenue data are derived. Balance of payments statistics are on an accrual basis, whereas budget data are more often on a cash basis. In some cases, fiscal years did not correspond to calendar years, necessitating difficult, and sometimes arbitrary, adjustments to the fiscal data. The budgetary systems of some oil exporting countries are highly fragmented, which creates difficulties in the derivation of comprehensive, consolidated central government data. Additionally, nonfinancial public enterprises engaged in oil production and marketing may retain some oil revenue, and state or local government shares of oil revenues will sometimes be excluded from central government data. Details regarding the coverage of the fiscal data are available on request from the author.

15

Data assembled by the U.S. Council on International Economic Policy derive average government revenue per barrel of oil, taking account of production costs, royalty and tax arrangements, as well as government equity participation. These data are fully consistent with the percentages cited above. See International Economic Report of the President (Washington, January 1977), pp. 174–76.

16

Decisions were also required on the appropriate rate of depletion of oil reserves. This paper assumes that, for the oil exporters as a group, the rate of oil production is, by and large, determined by the rest of the world’s requirements. It is also assumed that oil prices charged are, in the main, determined centrally (by the Organization of Petroleum Exporting Countries (OPEC)). Thus, this paper regards oil revenues as largely exogenous and focuses on the deployment of given oil revenues in pursuit of other objectives.

17

The government expenditure data include net lending—that is, lending undertaken for purposes of public policy rather than for management of government liquidity or for earning a return. For a discussion of the distinction between net lending and financing transactions, see the Fund’s, A Manual on Government Finance Statistics (Draft, Washington, June 1974), p. 130.

18

The projected large jump in the government expenditure/GDP ratio for the low-absorption countries in 1978 reflects, in part, low GDP growth (which, in turn, reflects projected developments in the oil sector).

19

Again, this estimate does not rely on unrealistic budget estimates of expenditure. Aggregate government expenditures in nominal terms were projected to increase by 20 per cent in 1978 over 1977 expenditures, and this is easily the lowest growth rate in the period since 1972. The sharp decline in the surplus reflects primarily the large impact of stagnant oil exports on government revenues and GDP growth.

20

Everett E. Hagen, The Economics of Development (Homewood, Illinois, 1975), pp. 430–31.

21

For a discussion of absorptive capacity with special reference to the oil exporting countries, see Farid Abolfathi, and others, The OPEC Market to 1985 (Lexington, Massachusetts, 1977), Chapter 2, pp. 23–32.

22

Data are drawn from International Financial Statistics. Oman, Qatar, and the United Arab Emirates are excluded from Section II.4 owing to unavailability of official price data.

23

Consumer price data are considered to provide the least unreliable indication of inflationary trends in the major oil exporting countries, but they remain subject to a number of serious deficiencies. Expenditure weights are often very outdated, and coverage is sometimes confined to relatively small segments of the population. Key items in the index have been heavily subsidized in many cases. In the oil exporting countries where widespread price controls have been in force, movements in official price indices may provide little guide to the extent of underlying inflationary pressures. These important reservations need to be kept in mind in evaluating the price data in Chart 3.

24

These are: Iran, Iraq, Kuwait, Nigeria, Saudi Arabia, and Venezuela.

25

These aggregate percentage changes are calculated in a manner analogous to those appearing in Chart 3—namely, percentage changes for individual countries are calculated in terms of domestic currency, and these changes are weighted by GDP expressed in dollars.

26

The pattern of movements in domestic liquidity and prices for these six countries is virtually identical to that in Chart 3, reflecting the fact that this subgroup accounts for almost 70 per cent of the weights employed there.

27

It should be noted that a significant proportion of balance of payments capital account transactions of the government would be included below the government budget surplus/deficit line.

28

Oman and Qatar are excluded from both series, since official data on their reserve movements are unavailable.

29

The divergence in 1977 may reflect, in part, increased foreign borrowing to bolster international reserves. Data from various sources that are assembled in the July 31, 1978 (Vol. 7) issue of the Fund’s fortnightly newsletter, the IMF Survey, indicate higher foreign borrowing in 1977 by several oil exporting countries, including Iran, the United Arab Emirates, and Venezuela. (See, in particular, pages 228, 231, and 232.)

30

Fund staff estimates indicate that the average annual growth rate in non-oil GDP in the 12 major oil exporting countries over the period 1974–76 was around 12 percent, and that it declined to 9–10 percent in 1977–78. See Annual Report 1978, op. cit., p. 14.

31

It could be argued that a reduction in import duties would contribute to an easing of inflationary pressures by leading to an increased flow of imports. This is not plausible for a large number of oil exporting countries during 1975–76, since the flow of imports was constrained not by deficient demand but rather by insufficient port capacity.

32

Clearly, there is a wide range of sectors (the nontradables sectors) where imports can make little or no direct contribution to improved supply availabilities; these sectors include government, real estate, water, electricity, gas, wholesale and retail trade, and consumer and business services.

33

In a large number of oil exporting countries, government subsidy expenditures declined in 1976 and 1977 as a result of the fall in international prices. Data on food price declines are provided in the Fund’s Annual Report 1978, op. cit., pp. 15–17.

34

In several oil exporting countries, the required data over a sufficient time span for estimating even the most rudimentary liquidity demand functions are either nonexistent or subject to severe limitations.

35

The Pertamina crisis is the most spectacular example of the problems that can arise from decentralized financial authority. Pertamina, Indonesia’s state-owned oil enterprise, entered into extensive foreign borrowing related to its large investment program, which expanded well beyond the confines of its role in the oil sector, and was only partly coordinated under the country’s development plan. In the second half of 1974, large cost overruns on a number of major projects, difficulties and delays in arranging long-term foreign financing, and a reduced flow of oil income led to Pertamina being unable to meet a large volume of short-term debt repayments falling due in 1975 and gave it little prospect of meeting substantial commitments falling due in future years. The Government committed itself to assist Pertamina in meeting its obligations, thus becoming involved in a difficult struggle to overcome severe balance of payments difficulties. This problem has been satisfactorily resolved.

36

The logarithmic form (semilogarithmic with respect to the rate of inflation) is used essentially for convenience, as elasticities are obtained directly. There is also some empirical evidence that this is the preferred functional form. See Bijan B. Aghevli and Mohsin S. Khan, “Government Deficits and the Inflationary Process in Developing Countries,” Staff Papers, Vol. 25 (September 1978), p. 388.

37

See William H. White, “Improving the Demand-for-Money Function in Moderate Inflation,” Staff Papers, Vol. 25 (September 1978), pp. 570–73.

38

The method used here is taken from Bijan B. Aghevli and Mohsin S. Khan, “Credit Policy and the Balance of Payments in Developing Countries” (unpublished, International Monetary Fund, December 27, 1976). It involves the generation of a series of values for π corresponding to alternative values of β ranging from 0.05 to 1.00. This requires the assumption that, at some point, actual and expected inflation rates were equal. The series of π were substituted into equation (10), and one was selected on the basis of the minimum standard error of the estimated equations.

39

The results for Indonesia and Saudi Arabia need to be treated with even more caution than those for the other countries because of the relatively low number of observations.

40

The short-run elasticity is given by the coefficient on real non-oil GDP. The long-run elasticity is derived by dividing this coefficient by one minus the coefficient on the lagged liquidity stock.

41

“If a country is experiencing a rate of economic growth, let us say of 8 per cent a year, in order to keep prices stable you will probably have to increase the quantity of money by something like 15 or 16 per cent a year. The reason for that is that a country at that stage of development is experiencing a spread of monetary institutions, a spread of the money-way of doing things. And therefore with every one per cent increase in income people desire to have a 2 per cent, roughly 1 1/2 to 2 per cent, increase in the real quantity of money, in the quantity of money measured in command over goods and services. Because people are coming to use money increasingly in their transactions, they are coming increasingly to adopt money as a store of value.” Milton Friedman, “Monetary Policy for a Developing Society,” Bank Markazi Iran Bulletin, Vol. 9 (March–April 1971), p. 710.

42

There has been little success in obtaining suitable proxies to isolate the monetization effect. Some attempts are described in Anand G. Chandavarkar, “Monetization of Developing Economies,” Staff Papers, Vol. 24 (November 1977), pp. 665–721.

43

Ibid., pp. 694–702.

IMF Staff papers: Volume 26 No. 1
Author: International Monetary Fund. Research Dept.
  • View in gallery

    Major Oil Exporting Countries: Ratio of Government Expenditure to GDP, 1972–78 1

    Per cent

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    Major Oil Exporting Countries: Government Budget Surplus/Deficit, 1972–78 1

    Billions of dollars

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    Major Oil Exporting Countries: 1 Growth Rates of Domestic Liquidity and Consumer Prices, First Quarter, 1972–Second Quarter, 1978 2

    Per cent

  • View in gallery

    Six Oil Exporting Countries: 1 Percentage Changes in Domestic Budget Balance and Domestic Liquidity Increment, 1973–78 2

    Per cent

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    Major Oil Exporting Countries: Overall Budget Surplus/Deficit and Change in International Reserves, 1972–78 1

    Billions of dollars