The Current Account of Oil-Exporting Countries

As oil prices soared to historically high levels in the summer of 2008, so did the current account balance of oil-exporting countries. With the more recent retreat in oil prices, these large surpluses have narrowed sharply and for some countries, there is even the expectation of small current account deficits in 2009. Such sharp swings in the current account balance are a recurring feature for oil-exporting countries. Another noticeable characteristic of these countries is a tendency to run, on average, large current account surpluses, and as a consequence, a tendency to accumulate net foreign assets. This article briefly surveys recent IMF research related to the current account behavior of oil exporting countries.

The intertemporal approach for the current account views the current account balance as the outcome of forward-looking dynamic saving and investment decisions. In its simplest form, it applies the logic of Milton Friedman's permanent income hypothesis (PIH) to countries. The basic intuition of the PIH model is that households attempt to smooth fluctuations in their consumption by saving more during good times, thereby accumulating assets that might sustain consumption levels in the event of a negative shock, such as an unemployment spell. Translating it to the analysis of countries, windfalls in export revenues due to transitory terms of trade shocks ought to be saved and put aside in a rainy day fund, and that is how countries seem to behave (Kent and Cashin, 2003).

Oil-exporting countries, however, present a special case. Not only do most movements in oil prices seem to be transitory (see Barnett and Vivanco, 2003), but because oil reserves are finite and exhaustible, the whole stream of oil revenue from beginning of exploration through depletion can be seen as transitory from a longer-term perspective. To the extent that current generations value the welfare of their children, some of the oil wealth will be saved and shared with future generations and this will be reflected in the behavior of the current account. The desire to spread the oil wealth across generations is often called the intergenerational equity motive.

There is a plethora of IMF research applying this intuition for specific oil-exporting countries, both for the determination of the current account and the fiscal balance. Typically in this literature, the authors derive an “optimal” path for the current account or fiscal balance that is consistent with a specific distribution rule (e.g., oil wealth should be consumed in equal amounts every year from today to eternity). Unfortunately, economic theory does not have much to say about how oil wealth should be distributed across generations. This choice in theory rests on a moral question, but ultimately depends on the aggregation of the preferences of policymakers and consumers. That is not a trivial issue because the optimal current account and fiscal balance paths predicted by the intergenerational equity motive are highly sensitive to the choice of oil wealth distribution rule. For instance, in a country with a growing population, the size of savings required to sustain constant aggregate consumption out of oil wealth indefinitely is substantially smaller than if the goal were to sustain constant per capita consumption out of wealth.

This point has also been observed in a number of recent studies. Maliszewski (2009) presents a welfare comparison of different fiscal rules for oil countries. Authors have differed on how they propose the sharing of oil wealth over time. The basic intergenerational equity model was used by, among others, de Carvalho Filho (2007) for Trinidad and Tobago; Leite (2004) for the Republic of Congo; Kim (2005) for Timor-Leste; Segura (2006) for São Tomé and Príncipe; Takizawa (2005) for Kuwait; and MCD Working Group on Exchange Rate Assessments (2008) for Middle Eastern oil producers. Bailen and Kramarenko (2004) analyzed both cases of constant and growing consumption out of oil wealth for the Islamic Republic of Iran; Lohmus (2005) considered the case of a constant per capita non-oil deficit for Kazakhstan.

Some applications of the PIH model have found large discrepancies between actual fiscal or current account balances and the levels required for an equitable distribution of oil wealth across generations. In search of more realism, some authors also incorporated habit in consumption in order to model a gradual transition toward the “optimal” path (e.g., Leigh and Olters, 2006, on the fiscal balance for Gabon; Carcillo, Leigh, and Villafuerte, 2007, on the Republic of Congo) or explicit adjustment costs (e.g., Engel and Valdés, 2000); and differences between underlying discount rates and the rate of return on financial assets are modeled as a consumption-tilting term in Thomas, Kim, and Aslam (2008).

However, the exhaustibility of oil reserves is not the only peculiarity of oil-exporting countries. Almost by definition, the exports of oil countries are typically less diversified and their prices are more volatile than for other countries, and that is directly reflected in higher volatility of terms of trade and income more generally. While in theory some small oil exporters might be able to hedge future oil prices—more on this later—in practice (in most cases) they do not. The observation that oil exporters are exposed to the vagaries of oil prices motivates Bems and de Carvalho Filho (2009a) to explore the importance of the precautionary savings motive in the current account of oil-exporting countries, building on the precautionary saving analysis by Ghosh and Ostry (1997). The intuition is that in the absence of explicit insurance, oil countries need to rely on self-insurance, and therefore they might save more during boom times than warranted by intergenerational equity.

The model by Bems and de Carvalho Filho (2009a) implies that precautionary savings are positively related to the weight of exhaustible resources in economic activity, i.e., less diversified countries have a stronger motive to run larger current account balances as a mechanism of self-insurance. This prediction seems to be borne out by the data. The cross-sectional distribution of current account balances generated by the calibrated model has a surprisingly good ft to the actual data. Interestingly, Shabsigh and Ilahi (2007) argue that oil-exporting countries that self-insure through the establishment of oil funds also manage to reduce the volatility of broad money and lower inflation.

Another stream of IMF research has used panel data methods to estimate the medium-run determinants of the current account balance for oil exporters and other countries (MCD Working Group on Exchange Rate Assessments, 2008; Bems and de Carvalho Filho, 2009b; Morsy, 2009; Arezki and Hasanov, 2009). This research draws on the so-called “macroeconomic balance” approach, which is based on the equilibrium relationship between current account balances and a set of fundamentals (measured, when relevant, as differences from trading partners' averages). These fundamentals include variables such as the fiscal balance, demographics, the oil balance, and economic growth, which are all robust determinants of the current account balance in a panel including advanced and emerging market countries (Lee and others, 2008), and fundamentals specific to oil countries such as oil wealth and the degree of maturity in oil production (Morsy, 2009).

Focusing first on those variables found to have similar effects on the current account balance in oil exporters and importers, the estimates imply that the effects of demographic variables and per capita GDP growth are statistically and economically indistinguishable across oil exporters and importers. On the other hand, changes in the non-oil fiscal balance (i.e., the fiscal balance excluding oil revenues) and the oil balance (oil exports minus oil imports) have a stronger positive effect on the current account balance for oil exporters than for importers; and an increase in relative income raises the current account balance significantly more in oil countries than in other countries, perhaps because of precautionary savings (MCD Working Group on Exchange Rate Assessments, 2008; Bems and de Carvalho Filho, 2009b). Morsy (2009) also finds that oil wealth has a signifcant negative impact on the medium-term current account, but her results are inconclusive on the effect of the degree of maturity of oil production. Arezki and Hasanov (2009) also find that fiscal balances have a much stronger effect on the current account of oil exporters than other countries.

While one could question the strength of the evidence about the relative importance of intergenerational equity and precautionary savings motives, there is little doubt that the incomes of oil-exporting countries have been more volatile than for other countries in similar levels of development. Borensztein, Jeanne, and Sandri (2009) argue that hedging future oil prices may generate large welfare gains, as it reduces the need for precautionary savings or improves a country's ability to borrow against future income. It is puzzling that so little commodity price hedging occurs. Daniel (2001) argues that governments have held back from the use of explicit insurance, mainly because of political constraints. Mexico has recently set an example, as its hedging of 2009 oil exports seems to have been profitable.

Finally, some other questions have also received attention in this literature. For example, Takizawa, Gardner, and Ueda (2004) argue that when there are positive external effects of public spending and the economy has too little capital, then spending oil wealth up front may be better than spreading it across generations. Enders (2009) builds a simple two-sector model to illustrate the joint determination of the current account and the real exchange rate in oil-exporting countries. Wiegand (2008) finds that sharp changes in the flows of savings from oil-exporting countries may be disruptive to oil-importing countries that rely on bank loans to finance external deficits, as do many central and eastern European countries.