Thursday,19 October, 2017
Current issue | Issue 1291, (14 - 20 April 2016)
Thursday,19 October, 2017
Issue 1291, (14 - 20 April 2016)

Ahram Weekly

Oil prices and the MENA region

Both oil-exporting and oil-importing countries in the Middle East are feeling the effects of falling international oil prices, writes Sayed Moawad

Al-Ahram Weekly

Oil prices have dropped sharply since June 2014, bringing to an end the four-year period of relative price stability. The size and speed of the decline has been significant but not unprecedented. Over the last four decades, five episodes of price declines in excess of 30 per cent have been observed, coinciding with major changes in the political scene in the Middle East, the global economy and oil markets.

Oil has a strategic nature and is an important commodity that affects the world economy. Oil is a global good that surpasses geography, national boundaries and history. Furthermore, oil is like an ocean with an unlimited, strange and unsafe side, providing an uneasy ride to those who sail on it, as one economist has said.

Oil prices have plunged recently, affecting everyone — producers, exporters, governments and consumers. Overall, some decline in oil prices is a shot in the arm for the global economy. But both oil exporters and importers are likely to feel the effects of oil price developments, and the sharp declines, as well as their causes and consequences and policy responses to the recent plunge in prices, have led to intensive debates.

Oil is a strategic good for three main reasons. First, there are the technological developments that led to the emergence of various means of transportation that use oil. Second, there was World War I and World War II, with their extensive dependence on oil to operate ships and airplanes. Third, there was the use of cheap oil, in particular Arab oil, to reconstruct Japan and Western Europe after World War II.

The recent plunge in oil prices has been driven by a number of factors, inter alia several years of upward surprises in the production of unconventional oil, weakening global demand, a significant shift in OPEC policy, the unwinding of geopolitical risks, and the appreciation of the US dollar.

In recent years, the understanding of the nature of energy prices shocks and their effects on the economy has evolved dramatically. Only a few years ago, the prevailing view in the literature was that at least the major crude oil-price increases were caused by supply disruptions triggered by political disturbances in the Middle East.

At the same time, there has been increasing recognition of the importance of shifts in the demand for oil. Robust evidence has been provided by recent research that oil demand shocks have played a central role in all major oil-price-shock episodes since the 1970s.

There is a strong relationship between oil and development. Some see oil as a “curse” based on the rent-seeking effects that may hinder economic development by weakening a state’s institutions and causing the development of a profiteering business group that cares only about its own profits without giving due attention to creating a productive private sector.

However, recent literature has showed that the oil “curse” is not an imperative. Oil can be a “blessing” and a cause for real development provided that four conditions are met. These conditions are, first, deepening the role of national oil companies to attain the greatest share of oil rents; second, following effective economic policies to keep the stability of the oil price and earnings on the one hand and reducing the fluctuation of prices on the other; third, developing human resources as an alternative income source besides oil; and fourth, rationalising the spending of oil earnings to achieve fair and sustainable development for current and future generations.

Oil-price shocks in the MENA region: The Middle Eastern oil endowment has facilitated unprecedented economic and social development in Saudi Arabia and the Gulf region. Since the 1970s, oil income has enabled economic prosperity through extensive spending on infrastructure, investment in human capital, and the provision of a wide range of social services.

It has also generated positive externalities for growth across the region by increasing trade and cooperation and contributed to an impressive rise in human development indicators. However, abundant oil wealth has also had a negative impact on economic development. The conjecture of a negative correlation between oil endowment and economic growth is broadly called the “oil curse”. This correlation has been researched widely in the literature, with particular focus on two main sources.

One main source is a loss of competitiveness due to domestic currency pegging to the US dollar, the reserve currency in which oil is priced globally. Although pegging enables stable inflation and interest rates, it reduces non-oil export competitiveness. Low economic diversification limits private-sector investment opportunities and causes private investment to become dependent on the stimulus of government expenditure.

Another main source of the oil curse is the ill effects of rent-seeking and the political largesse oil income enables, resulting in the inefficient use of the resource, particularly in the absence of strong institutions and checks and balances on the management of oil income.

Growth in the Middle East and North Africa (MENA) region was stable in 2015 at 2.5 per cent. Accelerating activity in most oil-importing countries more than offset the slowdown in oil-exporting countries. Growth is expected to jump to more than five per cent in 2016 and 2017.

But overall the MENA region continues to experience tepid economic growth for the fourth consecutive year as it struggles to promote inclusive and more widely shared prosperity for a growing population and to markedly reduce unemployment, a critical issue facing nearly all countries in the region.

This energy-rich region of some 440 million people with significant financial resources is plagued by structural bottlenecks, weak institutional structures, social disintegration and total chaos in Syria, Iraq, and Libya and, to a lesser extent, Yemen.

In recent years, the MENA region has increasingly developed along three divergent paths. First, there are the Gulf Cooperation Council (GCC) states, which are politically stable and underpinned by prudent policies and ample external financial assets (estimated by the IMF at $2.27 trillion at the end of 2104).

Second, there are the non-GCC oil exporters, which are losing production and export revenues due to sabotage in the oil fields (Iraq and Libya) and international sanctions (Iran), with only Algeria maintaining a steady growth trajectory.

Third, there are the non-oil countries, impacted directly or indirectly by regional chaos and thus resulting in varied performances ranging from a precipitous decline in Syria to anaemic growth in Egypt and Lebanon, only modest jobless growth in Jordan and Tunisia, and the slightly improved performance in Morocco.

Oil-price shocks affect macroeconomic performance in both the oil-importing and oil-exporting countries. Recent research on oil’s macroeconomic relationships in oil-importing countries shows that oil-price shocks have asymmetric effects on economic growth.

The effects of oil-price shocks on economic performance and their mechanism in oil-exporting countries are different from those in oil-importing countries. The economies of most oil-exporting countries are heavily dependent on oil revenues, and therefore any change in oil prices has a dramatic effect on economic performance.

To cut a long story short, it has been established, in the literature, that the relationship between oil-price shocks and economic output is asymmetrical. However, it can be understood that this relationship may be symmetrical through indirect transmission channels.

The expected impact of oil-price decreases on economic growth and development in the MENA region will depend on the length and expectations of oil-price trends. The oil-exporting countries may suffer negative consequences, but these countries can mitigate these through counter-cyclical expenditure policies.

Furthermore, the oil-exporting countries will lack the ability to meet domestic spending commitments as a result of declining revenues from oil, and this will cause them to draw down reserves, reduce public-sector salaries, and cut spending on fuel subsidies.

In testing the effect of oil-price shocks on the MENA countries, some studies have concluded that the shocks have had a positive and statistically significant effect on Algeria, Iran, Iraq, Jordan, Kuwait, Oman, Qatar, Syria, Tunisia and the United Arab Emirates. On the other hand, they have had no statistically significant effect on Bahrain, Djibouti, Egypt, Lebanon, Morocco and Yemen.

Regarding monetary policies, the sharp decline in oil prices will significantly reduce global inflation, with low or even negative inflation coming about as a result. Central banks might react with more accommodative policies that could lead to deviations from forecast inflation and from medium-term policy objectives.

The monetary policies adopted by the region’s central banks will depend on the source of the oil shock (supply or demand-driven) and its impact on aggregate demand and labour-market conditions.

From the fiscal perspective, a number of developing countries provide large fuel subsidies to their populations. Fuel subsidies tend to have distributional effects and tilt consumption and production toward energy-intensive activities. The fall of oil prices reduces the need for fuel subsidies and introduces an opportunity for subsidy reform with limited impacts on the prices paid by consumers.

Fiscal resources released by lower fuel subsidies could either be saved to rebuild fiscal space lost after the global financial crisis, or reallocated towards better-targeted programmes to assist poor households, support critical infrastructure and increase human capital investment.
    
Commodity markets: Energy accounts for up to 50 per cent of the production costs of many commodities, and therefore the drop in oil prices will definitely reduce the cost of production of many commodities.

The decline in oil prices has already affected the prices of some commodities. The prices of fertilisers have declined by around 8.5 per cent, food prices by around 4.8 per cent, metal prices by around two per cent and raw materials by around one per cent.

The sharp decline in oil prices since June 2014 has been significant but not unprecedented. A combination of supply-related factors and a shift in OPEC policy played a crucial role in the decline, which has had mixed effects on both oil-importing and oil-exporting countries. Oil-importing countries will attain a significant increase in real incomes, will benefit from higher household incomes, lower input costs and improved external positions.

Oil-exporting countries may suffer financial problems accompanied by adverse contagion effects on other emerging and frontier markets. There will be a need to reform fuel subsidies and allocate more resources to households, infrastructure and human capital.

In short, the Arab countries should deal with the new facts in the oil market on effective and flexible grounds and should look for new sources of public revenues through the following 11 policy changes:

- Developing the taxation system, provided that tax collection is from the wealthy not from the poor for fairness purposes;
- Amending budgets to austerity budgets with the purpose of rationalising public expenditure to the extent possible;
- Diversifying economic sectors and developing convertible industries and services by financing them through the accumulated surpluses from 2003 until mid-2014, when oil prices were rising;
- Working hard and depending extensively on industry as a source of wealth and income;
- Restricting revenues from depletable resources, even if their use is necessary;
- Making fiscal adjustments according to the size of buffers (fiscal vulnerability) where exchange-rate flexibility could facilitate such adjustments, particularly in oil-exporting countries with external vulnerabilities and/or fiscal rigidities;
- Tailoring monetary responses to the domestic position, inflation expectations and external pressures;
- Underscoring the need for real reforms in the financial sector in order to foster the diversification of the oil-exporting countries’ economies;
- Deciding how much of the oil windfall should be saved and balancing the rebuilding of policy space with managing domestic cyclical risks;
- For oil-importing countries with significant vulnerabilities, saving much of the windfall, with countries suffering large output gaps spending it; and
- Using the period of declining oil prices as an opportunity to strengthen monetary policy frameworks in oil-importing countries.


The writer is in charge of anti-dumping policy at the Ministry of Trade and Industry. This article is based on a paper given at the 15th annual conference of the Middle East Economics Association.

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