v World Payments Imbalances and the International Adjustment Process

Chapter III discussed the policy options and fluctuations in the intervening years. The industrial directions of the domestic investment strategy of the countries had a mixed experience with surpluses and oil exporting developing countries and their individual deficits, both collectively and individually. country performances. The discussion showed that The combined current account deficit o[ the industrial the issue of the medium-term management of oil countries for the four-year period 1979-82 is estimated revenues is closely related to the long-term considera­ to be over $5 I billion. For the non-oil developing tions of how the oil reserves are managed. These countries, the situation is considerably worse, owing to two issues, in turn. are intertwined with the way the an unfavorable combination of the low world demand countries handle their financial relationships with the for exports caused by recession, a deterioration in the rest of the world. The main concern of this chapter terms o[ trade, import limits by industrial countries, is with the management of external payments imbal­ reduced development aid, and a substantial increase in ances that result from the decisions on oil production external borrowing at abnormally high interest rates. and pricing by the oil exporting developing countries, Their combined current account deficit for the same their internal economic development, and their trade four-year period is estimated to be in excess of $343 and aid relations with the rest of the world. billion. By contrast, OPEC's estimated combined cur­ The discussion assumes the continuity of payments rent account balance of the major oil exporting coun­ imbalances, the presumed reluctance, or inability, of tries for I 979-82 shows a surplus of $249 billion, private financial institutions to deal with these imbal­ partly reflecting a rise in oil prices of about 140 per ances in the same way that they did in the 1970s, and cent and an improvement in the terms of trade of some the possibility of devising new instruments and mech­ 80 per cent in 1979-80. anisms for the oil exporting developing countries' Clearly sub�tantial by any standard, the truly dis­ choice of investment outlay. Attention will focus on equilibrating feature of these imbalances is more the OPEC members, although the analysis applies to other difficulty of redress than size. In relative terms, the major oil exporting developing countries. increase in the OPEC surplus in 1979-80 was the same as that in 1973-74. In both periods, the incre­ mental surplus was equal to 1.3 per cent of the non­ The Problem OPEC gross world product.'"' OPEC's current account surplus of $I I 5 billion in I 980 was only about 6 per The two large oil price increases in 1973-74 and cent of gross world savings (assumed to be 20 per cent 1979-80 were followed by sudden and substantial of gross world product), again almost the same relative imbalances in world external payments. Table 25 magnitude as in 1974. Measured against the size of shows the surpluses and deficits for major groups of the world's total financial markets (about $I 2,000 countries. As can be seen from the table, the current billion in 1982), OPEC's estimated cumulative surplus account surplus of the oil exporting countries rose of $432 billion in 1973-82 is Jess than 4 per cent. from $6.7 billion in 1973 to $68.3 billion in 1974, What makes the I 979-82 surpluses and deficits a and gradually declined to $2.2 billion in 1978. By global issue is, thus, not so much their actual magnitude, contrast, the current account of the non-oil developing but the need for appropriate adjustment, with less countries (excluding the People's Republic of China) deteriorated further, from a deficit o[ $I 1.3 billion in 9'J See R.S. Associates, Inc., "International Economic leuer" 1973 to a deficit of $39.2 billion in I 978, with some (Washington), March 17, 1981.

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©International Monetary Fund. Not for Redistribution The Problem

adverse effect on world economic growth and equity The second characteristic of the oil surplus is that than in the first round, 1973-78. it is not expected to finance global deficits through There are in particular three aspects of OPEC's normal market adjustment in the medium run. The external surplus that distinguish it from the past situa­ surplus generated •by the 1979-80 oil price increase is tion. First, their financial transactions seem large likely to decline over the coming years, but imbalances compared with total international transactions. The among various groups of countries arc likely to persist. 1980 surplus of $1 15 billion, for example, was equiva­ By Fund staff estimates, OPEC may, by the end of lent to 77 per cent of the global current account deficit 1982, have left behind ten years of uninterrupted sur­ in that year. For the 1974-81 period, their cumulative pluses.'OO With the possible exception of the United surplus was equal to 53 per cent of the global deficit. 100 (Sec Table 26.) If the market for oil should continue Fund staff projections or a $1 billion surplus for 1982 have been revised downward by other an al ysts. The OPEC the next few years, this aspect of the to be sluggish in Secretariat puts the l 982 curr ent account balance :u a deficit problem may lose its significance. of $9.5 billion.

Table 25. Summary of Global Payments Balances on Current A ccount, 1973-83 1 (In billions of U . S . doll a rs) 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 - - - Industrial countries 20.3 - 11.0 19.7 0.3 2.6 33.7 5.8 -40.6 - 1.0 4.0 - 10.0

Developing countries Oil exporting cou ntries:: 6.7 68.3 35.4 40. 3 30.2 2.2 68.6 114.3 65.0 1.0 3.0 Non-oil de\•eloping eountries3 - 11.3 -37. 1 -46.6 -32.4 -28.8 - 41.1 -61.0 -88.9 - 103.3 -90.0 -70.0

By analytical troup - - - - Net oil exporters -2.6 -5.1 -9.9 -7.7 -6.4 -7.9 8.5 -12.4 22.2 19.5 16.5 Net oil importers:! -9.0 -32.0 -36.8 -24.6 -22.5 -33.3 -52.5 -16.5 -81.1 -10.5 -53.5 Major exporters of manufac.tures -3.7 - 18.8 - 19.1 - 12.2 -7.9 -9.8 -21.7 -32.4 -36.0 -33.0 - 19.5 ------Low·income countries3 -4.0 -1.5 7.6 -4.1 2.6 8.7 11.9 t6.6 1 3.1 -I 1.5 12.0 - - - - - Other nel oil importers -1.3 - 5.7 - 10.0 - 8.3 -12.0 -14.7 19.0 27.5 32.0 26.0 22.0

Byllrta - Africa• -2.1 -3.2 - 6.6 -6.1 -6.6 -9.4 -9.9 - 12.8 -t3.8 1 3.5 - 12.5 Asia3 -2.4 -10.0 -9.1 -2.5 -0.7 - 7.0 - 14.7 -24.5 -21.1 -17.0 - 17.5 Eur':Jfe 0.3 -4.4 -4.9 -4.7 -8.4 -6.6 -9.9 -12.5 - 10.1 -6.5 -4.0 - - - Mid le Eost -2.6 4.5 -6.9 -5.4 -5.1 -6.2 8.5 9.4 -10.9 - 13.0 -13.5 - Western Hemisphere -4.7 - 13.5 - 16.4 - 11.8 -8.5 -13.3 - 21.4 -33.2 -43.3 -37.0 22.5

- -39 - Total " 15 .7 20.2 8.5 8. 2 -1.2 -5.2 l.8 15.2 ..3 -93.0 77.0

Source : Fund sta ff estimates. t On goods, services, and private tra nsfers . 2 Figures ore revised acc ording to latest in£ormation. 3 Excludes data for the People's Republic of China prior to 1977. 4 Excluding South Afrka. u Reflects errors, omissions. and asymmetrie s in reported bal::mce of pa yments s ta tistics on current account, plus balance of listed groups with o1her countries (mainl y the U.S.S.R. a nd other nonmember countries of Eastern Europe and, for years prior to 1977. the PeopJe's Republic of China).

Table 26. Selected Oil Exporting De•·eloping Countries: Surplus and Related International Financial Flows, 1974-81

( In billions of U.S. dollars ) Total 1974 1975 1976 1977 1978 1979 1980 1981 1974-81

Surplus 68.3 35.4 40.3 30.8 2.9 69.8 1 15.0 70.8 433.3 0{ which, Low absorbers 43.8 )1.2 36.6 JJ.O /8.6 57.J JOJ.J 76.1 399.9 1/igll absorbers 14.5 4.2 J.7 -1.1 -15.7 11.5 11.7 -j.J 33.4 Tot�l financing through private markets 59 58 96 94 112 l SI 183 753' Global gross current account defi cits -80 -80 -80 -82 -87 -94 -ISO - 157 -810 Sour ces: International Mon et ary Fund. World Economic Outlook: A Sun•coy by th� S1nff of tile lntemati011t1/ Afonttary Fu11d, Occas ional Paper No. 9 (Washington, April 1982), and lnttrnntiOIUII Ctlpiwl MnrkeiS: Rect'm De•·t'/Opmems and Slrort·Term Prospects, 1981, Occasional Paper No. 7 (WashingtonJ AuguS-t 1981 ). l 1974-80. 61

©International Monetary Fund. Not for Redistribution .

V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS

States during the 1950s and 1960s, no other country to subsequent surplus within a short time after 1973; or group of countries has maintai ned such a persistently they accepted lower income growth, higher unemploy­ positive current account in the postwar period. ment, decreased foreign trade, higher inflation, and Third, the financial relationship between the sur­ reduced energy consumption. For the 1973-78 period, plus OPEC co untries and the deficit non-oil developing they had a combined surplus of about S64 billion, countries is largely indirect; that is, they deal with each while the non-oil developing countries incurred a deficit other largely throu gh the financial institutions of certain of about $197 billion. developed countries rather than directly. This is in The oil exporting countries' $183 billion current marked contrast to the surplus developed countries, account surplus for the same period101 was subse­ which regularly finance their trade partners' deficits quently spent on foreign aid and investment and on directly. At present, however, the de•1eloped countries' claims on foreign assets, mostly in the West. financial institutions often act as third-party inter­ By I 978, the combined surplus of the oil exporting mediaries between OPEC members and the other developing countries was reduced to a mere $2.2 billion devel oping countries. This change in the rel ationship -less than half the size in 1973-owing to a reduction has important implications for the international adjust­ in the real price of oil and the adverse change in their mem process, which is discussed below. terms of trade with the rest of the world. The trend and sources of energy use were also drastically altered.'02 The 1973-74 oil shortage was transformed to an oil glut in 1981-82. Recycling in the First Round

As can be seen from Table 27, the first round of 101 The discrepancy between the total (OPEC plu$ industrial count r ies) sur us and non-oil developing countr)' deficits payments imbalances ( 1973-78) was red ressed rather pl reflects errors, omissions. and balances of these groups with qu ickly and effectivel y, although the p:occss was neither other (mainly ccntra11y directed, nonmarket) economics. pai nless nor was its ·'burden" shared equally by all 102 Durni g 1960-73, OPEC oil supplied 40 per cent of the increase in total world primary energy and 63 per cent of the n t nations as countries. The i dus rial a whole managed increase in global oil use. After 1973, the growth in OPEC's to reverse their balance of payments fr om initial de ficit shate of energy supplies stopped altogether.

Table 27. Selected Oil Exporting Oc,-eloping Countries: E-�limaled Oispclsition of Current Account Surplus, 197�1 ( In billion s of US. dol lars ) Tot a l 1 974 t975 t976 1977 1978 t979 t980 t 981 1974-8t Current account surplus 68 35 40 31 3 70 115 71 433 Plus: Oil sector c::tpiwl transac aion (ouaflow) -t2 I -6 -t 2 -9 I 2 -22 Net borrowing 2 3 8 tO t6 10 7 8 64 Equals: Cash surplus avr1ilable for disposilion 58 39 42 40 2t 7t t23 81 475

Disposilion of cash surplus Placemenls in industrial countries and in Eurocurrency markets (net) 49 29 33 32 14 64 113 68 402 Bank deposits 30 tt 13 13 5 40 42 6 160 Oirecr placements 7 2 I 2 2 8 6 -I 27 Eurocurrency deposits 23 9 t2 II 3 32 36 7 t33 Short·term government securities I 8 -2 -t -t 4 62 242 Other capital rtows:! II 18 22 20 tO 18 6:} Fund nnd World Sanka 4 3 2 - -I -I I 3 II Flow of f u nd s to dcvelopin.s, countries·• 5 7 7 8 8 8 9 10 62 Sourc e : I nt e- r national Moneto. r )' Fund. Worl d E conom i c Out look: A Surl · «".\' b y 1h(" S1t10 of 1ile lnl trnatlmwl M on t tary F und, Occasional Pap erN o. 9 ( W ash ington, April l982 ) . J Comprise ( l) changes in accounts receivable or imported credits arising from timing diffe rences bttween oil exports and rece-ipts of payments for them ond (2) compensorion payments to oil companies ror full or pa rtinl n:uionnlization of oil fac:ilitics, together with other changes in direct in\'eStment capital or such oil companies. �Total net externnl borrowing by the public and private sectors (including banks). Includes small amounts of official transfer receipts, inward nOn·Oil direct investment capiU1I, :.md other miscellaneous capialt (e.g.. changes in short-term liabilities and pOsitions under bilateral payments agreements) . 3 Mainl)' placements in treasury bills in the United S ta tes <)nd the United Kingdom. "Includes net acquisitions of lon,·lerm gover nment securities. corporate stocks und bonds. bilateral lending (mainly to govern· ments). real estate and other direct mvestments. and prepa�•ments for imports. Also includes •·ei�Hively small amounts of placements in non-Fund members. as well as statistical discrepanc•es.

62

©International Monetary Fund. Not for Redistribution Recycling in the First Round

The first oil shock was thus almost totally ab­ the oil exporters, directly or through private and multi­ sorbed, albeit unevenly, by the world economy.'"' A national intermediaries. While OECD exports to recem analysis of the world energy situation identifies OPEC rose by some 20 per cent a year between 1974 four distinct adjustment mechanisms through which and 1978, the industrial countries' imports from the countries accommodated their increased oil costs: (a) rest of the world (including oil) declined substantially; a physical adjustment through shifts in demand and the non-oil developing countries tried to cope with the supply for energy in response to higher energy prices; situation by expanding their exports and limiting im­ (b) a trade adjustment through increased exports or ports. There was a slower economic growth in much reduced imports in order to pay the oil bill; (c) a of the world outside OPEC: the industrial countries' financial adjustment through recycling of oil revenues annual growth during 1973-78 was reduced to 2.5 per from surplus oil exporters to deficit oil importers; and cent from 5.1 per cent in 1960-73; the annual growth (d) a growth adjustment through lower demand for of the non-oil developing countries as a group was down energy by reducing national economic growth.'"' from 5.8 per cent to 4.6 per cent; and many of the A combination of the four adjustment processes poorer developing countries had to slow, or halt, their during 1974-78 had the following effects. Energy usc per capita income growth. in the industrial countries was reduced through slower The actual disposition of the surplus took place econom ic growth and energy conservation. The bulk under lour main considerations: safety and liquidity of o( accumulated surpluses were recycled back to the oil invested assets; preservation of the assets' purchasing t importing countries, both developed and developing, power; placement of the surplus under the oil expor ing through substantially larger imports (which grew by developing countries' limited human and inslilutional 25 per cent a year) , mostly from the industrial co un­ resources; and the need to help other non-oil develop­ tries; increased concessional aid to poorer nations ing countries. Tables 27 and 28 show how the surplus (averaging about 4 per cent of the GNP of the capital was disposed of during this period. Nearly 85 per cent surplus group); and increased international lending by was invested in the developed countries' capital mar­ kets, about 13 per cent was directed to the other 103 The did not easily. The adjustment. however. occur average price of crude had developing countries, and the remainder went to inter­ to rise from $1.80 a barrel to for of and S36 medium-term elasticities supply demand to national organizations. eight bring about significant struc.tural changes. And it took The channels through which these funds flowed years for s.hare OPEC's in total world oil produc.tion to decline to in varied over time. At first the funds were placed in lrom S3.5 per cent in 1973 43.6 per cent 1980 (and 35.6 per c:

Table 28. Selected Oil Exporting Developing Countries: Estimated Disposition of Cash Surpluses, 1974-81 (In per cent)

Total 1 97 4 1975 1976 1977 1978 1979 1980 1981 1974-81 c oun t r es Plcement s in ind ustrial i a (net) and in Euroc urrency markets 84 74 79 80 70 90 92 84 8S

Bank deposits 52 28 31 33 25 56 34 -I7 34 Direct placements 12 s 2 5 10 II 5 6 Eurocurrency deposits 40 23 29 28 IS 45 29 8 28 Shott·term sec ri ies1 -5 6 government u t 14 -s -3 flows� Sl Other capital s:} 77 19 46 52 so so 25 Fund and 5 I World Bank=� 7 9 -s -I 4 2 of runds developing Flow to countries.,. 9 18 l7 20 35 II 7 12 13 I nternational Fund, World E conom ic Oullook: A Sun · ey by tit� SwO of the {llftmati o ut�l Mon�tn r y Fum/ , Sou rce : M onetary Paper No. 9 (Wash i ngto n, Oc csiaonal April 1982). Mainly p ce n s Ki ngdom. I la me t in tre-asury bills in the- United States and the United . 2lncludes net acquisitions of long· and bonds. bilateral lending ( mamly te-rm government KCuritles, corpOrate stocks to govern· ments), real estate and amounts placements other direct investments, and prepayme-nts for imports. Also includes relatively small of in non·Fund as statistical members, as well discrepancies. Fund oil wi h other in the reserve :JIncludes investments in the facility nnd supplementary financing racility. toge-ther t changes Fund of World Bank bonds. position in tbe and dir«t purchases as regional • Includes bilateral sr ants and loans as well contribution.$ and capital subscriptions to and international development asencies (other than World Bank). of to de.veloping countries. Fu nd and Also includes relatively small amounts other capital flows Es are on highly uncertain information. timates based

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS and most of !he subsequen1 surplus was pu1 inlo capilal slock of cheap and exportable oil is s1ill concentrated assclS wilh longer malurilies. Thus, in 1974, !he 101al in a relatively small area with possibililies or major oil surplus was splil belween bank deposilS (52 per ccnl) supply inlerruptions. Second, in a delicately balanced and olhcr capi1al flows (19 per cenl). By 1978. 1he and volatile oil market, any interruplions in crude ex­ spli1 became 25-50 in favor or o1hcr capi!al nows. ports are likely 10 result in disproportionately higher With 1he 1979 price increases, the disposilion was spot market prices. which invariably affect the official once again reversed, wilh 56 per cenl going 10 banks OPEC crude price. Third, unlike !he siluation in the and only 25 per cen1 going 10 other capital flows. By 1970s, when some "swing" producers were willing and 1980, however, !he magnilude of !he surplus had been able to adjust their output levels in the direclion of anticipnlcd, and 54 per cen1 of it wem to olher cupilnl modera1ing oil price rises, there seems to be less such nows, wi1h only 34 per cent to !he ba nks. For 1he Acxibility in the 1980s. Fourth, in the absence of a 1974-82 period as u whole, !he aggrcga1e portfolio unified and predictable price strategy, successive and was divided be1wcen bank deposils, other financial sharp llucluations in the oil terms of lrJde, following inslrumen!S, and aid 10 other developing countries.'"-' periods of economic recovery and recession in !he In sum, while the recycling during 1974-78 look major oil importing countries, may not be easily pre· place with grca1er ease !han had been antkipaled, 1he ventable. Finally, erratic lluctualions in the price of cos1s of !he adjustmenl were not meager. Coming on oil oflen play havoc wi th normal trade relations be­ top of highly expansionary policies by the industrial tween oil exponers and their trading panners. coun!ries in the !ale 1960s. accelerating worldwide The cumulative effeclS of the first and the second inftluion in !he aflermalh of the 1971 currency realign­ oil shocks thus pose a con1inued challenge to the effec­ ment, and a global food crisis, the 1973-74 oil price livc operation of the international financial system. rise confounded economic policymakers as never before. The deficit counterpart or ru1urc surpluses will thus A hos1 of cautious and deflationary economic policies have to be managed through a combination of adjust· pursued by !he industrial countries aggravaled a reces· ment and financing if a reasonable growth in the world sion already underway and unduly reduced oulput no! economy and reasonable stability of !he world monetary only in OECD countries but also in the developing order are to be maintained. coumries. Highly ambitious and overly confident development policies pursued by the major oil export· ing countries resulted in lower·than-expcclcd returns Issues in Recyc.ling (and occasionally sheer waste). Most adversely af· fected in the adjustment process were the least devel· In the context of the oil exporting developing coun­ oped counlries-particularly in Sub-Saharan Africa­ tries' relations wi th the rest of the world, recycling where per capita income failed to keep up with popu· means the process of using surpluses 10 help deficit lalion growth. In the absence of appropriate policies countries through a mixlure of financing and adjust· to deal with !he post- 1971 developments in food, ment.'08 Fi nancing of oil deficits is considered neces­ energy, and raw materials, the global adjuslmcnl re· sary as a temporary device to allow !he affected coun­ quired in the 1974-78 period was perhaps several tries to adjust to changes in !he global cost/price times larger than OPEC's actual receipts from oil structure caused by energy developments. Financing exports.100 involves the rellow of !he world surplus to oil importing Assuming, ns most recent studies and projections do, deficit nations through increased imports, purchases of thai petroleum cannol be totally replaced by o1her debt and nondebt as.�ets, direct governrnent·lo-govern­ fuels in the next decade or so, and that the world mcnt lending, participating in direct investment or economy will be dependent on OPEC (and especially joint ventures, and foreign aid. Adjustment measures Middle East) sources at least throughout the 1980s, "" in the deficit countries include reducing oil consump· it would seem likely that some oil-related external pay· tion and imports, enlarging domestic oil production, mems imbalances may be around for some years. The

reasons are not obscure. Fi rst. much or the world's '"While the term '"r«.ydina.. has come into use only rcc:cndy, the c:oncept to which it rdm is lhe old problem of IGSThe precise rDa�Ditude of OPEC investments by various a curTCnt account deficit that is considered 10 be or longer. catepies and by indivM!ual coontries bas not beenpublish«! than·normal duration. Early poslwa:r Euf09C·s deficits viH·vis and haJ b«n the su.bje:ct of mue:b debate and doubt in the the Unittd States, tbe t9S0-70 deficits of developina countries press, and jn,«tisations by the U.S. Congress. vtl;...� viJ OECD countries, and 1he recent dtf.cit.J of the rest of tot 5« Jahmn,a.ir Amuzcg3r, •·Pclrodolbrs Atain,'" Wtuhln.g­ the •-orkl vis-a.vis OPEC countries are three such �xamples. totl Vol. 4 (Winter 1981), pp. 130-48. See also See J. Nicholas Robinson, "The Role ol Oil Funds Recycling Quarttrly, , Chenery (cited in rootnote 104). in International Payments and Adjustment Problems,. OPEC 101 See Chapter VI, below. R••l•••, Vol. 4 �Summer 1980), pp. 98-109.

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©International Monetary Fund. Not for Redistribution Issues in Recycling

finding suitable substitutes for imported petroleum, change rates would make the deficit country a good increasing efficiency in fuel use, and taking all other place to buy from, and a difficult place to sell to. necessary steps to reverse payments deficits. The lend­ Conversely, the surplus country would experience ing segment of recycling is designed to "buy time" for export-depressing changes in prices, wages, and ex­ the necessary domestic structural adjustments; the change rates that would turn it into a profitable sales investment portion is an integral part of the global outlet and a poor buyers' market. Even in a not so adjustment process itself. ideal world, the imbalances should not, as a rule, last The modus operandi of petrocurrency re cycling, :.s long. Deficits could not go on year after year because well as the choice of its insuumems, are obviously not the deficit country would soon run out of the means to totally independent or the size of the cumulative OPEC pay its creditors. Surpluses, too, would eventually stop surplus between 1980 and 1985 (and for the rest of growing, because rational creditors would sooner or the decade). The size of the surplus will depend on later stop selling their real goods and services against five key variables: (I) the behavior of OPEC oil increasingly Jess valuable promissory notes. prices-estimated to be in the range of a 0·3 per cent In the present world, however, such automatic or self­ increase in real terms; (2) OPEC crude oil exports­ regulating mechanisms do not always exist. For exam­ assumed to range from 18 milli on to 28 million barrels ple, it is argued that the deficit countries whose a day hy 1990; (�) OPEC'< import bills-:�ssumed to currencies a.re coveted by the world at large could grow at between 18 and 21 pe r cent a year; (4) almost perpetually finance their import needs as though OPEC's non-oil exports-expected to continue to grow these were acquired from domestic markets ' 12 For but to remain a relatively small proportion of total others, particularly the non-oil developing countries exports; and (5) returns on external investmems by (and especially those that are also not exporters of the surplus countries-unofficially estimated to range manufactures), the pressure on external payments for between I 0 and 20 per cent annually of accumulated food and fuel may be protracted. Corrective measures reserves. to deal with persistent deficits in these countries would Under different combinations of these variables, the mean further belt-tightening, a further reduction in cumulative OPEC surplus between 1980 and 1985 may essential imports, and a frustrating inability to maintain range between $210 billion and $250 billion in con­ a modest rate of growth. stant 1980 prices.'"" Needless to say, even small Surpluses, too, may not undergo automatic and con­ changes in the key variables could produce consider­ sistent adjustment in the real world. For some major ably larger or smaller imbalances 110 To these also oil exporting countries that possess limited real short­ must be added the familiar uncertainties about political term absorptive capacity, surpluses may become peren· stability in some OPEC regions, the share of surplus nial because conventional adjustment policies (i.e., of each OPEC member (in view of differences in reduction in oil production and exports or domestic absorptive capacity), unexpected developments in the currency appreciation) arc not acceptable to major world oil market, and last, but not least, the unpredict­ oil importers. Foreign exchange inflows may keep ability of energy technology.'" rising faster than they can be profitably spent or in­ vested at home. The fast-and-ready alternative for some surplus countries may not be expanded con­ Need for Adjustment sumption and imports, but rather suboptimum outlays. Oil-related imbalances differ from traditional cycli­ In the long run, almost any balance of payments cal or occasional payments deficits or surpluses, as do deficit or surplus-whether occasional or cyclical-is policy measures designed to cope with them. Oil im­ eventually adjustable. In an open world economy, porting industrial countries, facing larger oil import induced changes in domestic prices, wages, and ex- bills, a deterioration in their terms of trade, and domes­ tic inflationary pressures, can ward off their individual 109 Estimates are based on the assumption of constant real deficits by resorting to deflationary measures, erecting oil prices, moderate rates of economic growth in the industrial countries. .declining worldwide inflation, and no further decline in OPEC's share of world crude output. 112lntcrnational reserves increased :lt nn average annual ItO Some analysts now talk seriously about the pOssibility of rate of 15.3 per «nt between 1969 and 1978, of which up to a zero or even o negative OPEC externnl balnncc for the rest 82 per cent can be auribut ed to a rise in official holdings of orthe 1980s. U.S. dollars. It is argued that the· United States has been able 1 11 Forecasts of oil prices and supply have been systemati· to finance its oil imports in the same way as it has paid for c.ally wrong in recent years. Some analysts now talk about a domestic oil. See Bruce R. Scou.l "OPEC, the American price range of SlS-lSO a barrel of oil within the next five Scapegoat,'' Harvard Business R�'riew. Vol. 59 (January­ years, with equal possibilitjes of the actual prite being a.ny­ February 1981), pp. 6-30. Needless to say, 1he arc,ument has where in that range! consislenlly been refuted by the United States on many gro\mds.

65

©International Monetary Fund. Not for Redistribution Y • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS protectionist barriers against non-oil imports, or other­ needs and access to capital markets: countries that wise exporting their own inflation and unemployment. offer bright prospects for economic expansion may not Such policies, however, are not only internationally always be able to obtain financing at reasonable costs. harmful but also largely self-defeating if followed by Thus, although aggregate surpluses always (by defi­ the group as a whole. The catch, therefore, is to find nition) match aggregate deficits, they are seldom auto­ a cluster of measures that can help to maintain a matically or consistently canceled out. The pattero of reasonably high growth rate in the industrial world, international trade is presently such that OPEC mem­ guaranteeing both the possibilities of high domestic bers incur a surplus with some of their trading partners employment and a modest transfer of real resources and a defiicit with others. A rectification of such abroad. payments imbalances requires a multilateral route. For the oil importing developing countries, the chal­ Furthermore, OPEC members that are in a "perennial" lenge is vastly more formidable. The key lies in surplus position do not allow the process to reverse striking a balance between internal growth require­ itself over time: the rest of the world cannot reduce ments and available external finance. For national OPEC's claims on it until and unless OPEC moves growth, both energy and capital goods imports are into deficit. While part of OPEC's surplus is with the needed. To acquire these necessities, these countries non-oil developing countries, the latter often lack ade­ must achieve appropriate growth in the international quate financial institutions to manage these funds or purchasing power of their export earnings, improve arc unable to offer sizable lucrative opportunities for (or at least stabilize) their terms of trade vis-a-vis the OPEC's long-term needs. As a result, much of the outside world, and enlarge (or at least maintain) the OPEC surplus is routinely deposited in the private inflow of real resources from both OPEC countries and capital markets of the major OECD countries, or the oil importing industrial countries in order to pay invested directly in debt instruments issued by borrow­ for needed imports '"' The achievement of these feats, ers in those nations. Finally, there are often serious in turn, requires both a generally hospitable external mismatchings in the poorer developing countries be­ environment and a genuinely sustainable domestic tween actual need for foreign loans, direct investments, development Strategy. and financial help, on the one hand, and attractiveness for such capital flows, on the other. As a result, much of OPEC's bilateral foreign investment and direct lend­ Financing Requirements ing take place in deficit countries that are not always the neediest.114 In an ideal model, where supply creates its own The second reason for deliberate finance lies in the demand, balance of payments surpluses would find the role played by intermediation in the distribution of the means of financing the counterpart deficits. An OPEC surplus. Generally speaking, OPEC surpluses follow a surplus on current account is initially a credit entry in direct route mapped by the surplus countries them­ foreign exchange accounts of OPEC members with se lves, and an indirect route that is, as a rule, outside some foreign central or private ba nk. Whether used the countries' control. What is left of OPEC's surplus by the oil exporters immediately for direct loans, after direct intergovernmental grants and loans to foreign investments, or grants-in-aid or left as deposits deficit countries, direct purchase of industrial countries' in the banks for future usc, the surplus provides an medium-term and long-term public offerings, and actual or potential means of financing the oil importers' longer-term investments abroad usually ends up in deficits. The rationale for deliberllle recycling finance international commercial bank accounts. Part of the arises from three main phenomena. funds are kept with these banks temporarily before First, there is the problem of mismatching; that is, more permanent outlets are found. A significant part, in the real world, pa yments surpluses and deficits for however, although technically held in sight or short­ any pair of trading partners are seldom bilaterally term deposits, is routinely rolled over in such a way matched, and often they are triangular. Nor is the that it would be hard to distinguish it from longer-term need for oil imports and the opportunities for place­ deposits. The banks' task is to usc these deposits for ment of export proceeds exactly equal: a country may onlending to countries in current account deficit. This be fuel deficient but offer little attraction for foreign task was fairly effectively performed by the private private investment. The same is true of development IH Explanutions offered by oil country oficials for the con· 113 surp For a discussion of relationshjps among lhese va riables. centration o( lhc OPEC lus in in dustrial countries is that P non-oil developing countries suffer from o sec aul Hallwood ;md Stuart W. Si nclfiir, 011. Dt>bt. a,d Dc­ the m ney inadc· d l'dopm�m: OPEC ;, the Third Worltl (london and Botnon, qu:lcie.s, inclu ing monetary restrictions and recurrent changes 198t). in investment laws and regulations.

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©International Monetary Fund. Not for Redistribution Recycling in the Second Round banking community, as well as by the Fund and the occurred in the world energy balance, and the major World Bank, during 1974-78. lessons from the 1974-78 experience. The need for a continuation of active and even To be sure, the virtual elimination of the annual aggressive intermediation arises from both the mis· OPEC surplus by 1978 was the result of (a) a decline m:Hchings of surpluses and deficits and the familiar in the real price of oil between 1975 and 1978, (b) shortcoming.� of barter and bilatcrnl deals. Sometimes the rapid adjustment of OPEC economies (particularly -as is presently the case-the surplus countries may the low absorbers) through an extremely rapid expan­ lack adequate markets and institutions and the exper­ sion of defense and development imports, (c) the tise to deal directly with deficit nations; they have to development of non-OPEC supplies of energy, and (d) employ the professional services or international banks. re lated changes in the tempo or economic activity in Frequently, also, countries in deficit may ha,·e little or the industrial countries, as well as the magnitude and no direct access to the international private markets pattern of energy consumption (i.e., a reduction in of their trading partners: they have to be ''\'ouchsafed" world energy demand and the partial substitution oloil by financial institutions. Political and other considera­ by eoal and other fuel so urces). Furthermore, while tions may also make bilatcrttl lending difficult, if not non-oil developing countries managed to finance their impossible: anonymity, discretion, and even secrecy huge balance of payments deficits (and in fact increased may be necessary to effect transactions. their foreign exchange reserves), their total debt bur­ Finally, continued substantial imbalances in world den took a sharp turn upward."' According to OECD payments left alone may pose a threat to sustained estimates, total disbursed medium-term and long-term world economic growth and international financial sta­ public and private debt of the developing countries bility. Should oil importing deficit eountries be unable (including oil exporters) reached $337 billion by the to secure financing, they would be forced to cut down end or 1978 from a mere $87 billion at the end of on their imports through a mixture of deflationary 1971. The service on this debt rose to $57 billion policies, protectionist measures, and exchange controls. from only Sll billion in the same period, with S20 Such actions, while temporarily helping to improve billion of the 1978 figure consisting of interest alone. 116 their external balances and 10 reduce OPEC's surpluses The new surge of oil prices in 1979-80, although (owing to smaller oil exports), would adversely affect ostensibly spurred by political events in the Middle the exports of other countries and OPEC's own imports East, came in the aftermath of the declining real price (owing to smaller oil revenues). The overall result of oil since 1975, stubborn inflation in the industrial would be n slower growth or world output and inter­ countries, a fall in the external value of the U.S. dollar. national trade, along with unnecessary idleness of and the rising cost of oil substitutes. Part of the reason resources and labor. for the smooth recycling of the 1974-78 OPEC surplus A debtor country can repay its debt only if it has a was the greater reliance placed by the deficit developing surplus in its current account. If all deficit countries countries on foreign financing instead or making dim­ attempt to improve their payments positions, and no cult domestic adjustments, owing to the availability of creditor (and previously surplus) country allows its runds at low (or even neg;uive) rates of interest. trade balance to go into deficit, no debt could be repaid. Several factors, in turn, helped to ease the non-oil For the countries already heavily in debt-as are many developing eountries' overall adjustment burden. First, developing countries-the inability to obtain external those with easier access 10 world capitnl markets took finance, or to roU over existing loans, may lead to advantage or their high credit standing to tap surplus unfortunate consequences lor debt repayment. This funds. Second, foreign aid. particularly from OPEC. might subsequently result not only in a further decline turned sharply upward, setting new reeords for many in annual global economic growth but also in increased donors. Third, and most important, world foreign trade financial instability. Both or these would, in turn, make grew at higher annual rates than the growth of output protectionist pressures irresistible and further depres­ under a still relatively free trading atmosphere. sion and defaults inevitable. The second round of recycling may be somewhat dif­ ferent (and in some wa ys less worrisome). Capital fund

''' Non-oil developing countries' additiona.l reserves or some $39 bet.,.,een 1974 and 1978 olmost nutcbed their roreian Recycling in theSecond Round billk»n '"'"' inflow of $38 billion. "'See Organization for EconomicCoopelopment Committee, De,·�lopmtttt An examination the ways and means or coping A.ssistance or CtHJptTation, 1981 Rn•ittt' (Paris. 1982), and lnlemational with the new financing and adjustment issues requires Bank: for Reconstruction and Oevdopmenl, W«ld Oe\•tlo,. 1982). an understanding or the structural changes that have nttlllR•port, /982 {WashinSIOn,

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS inAows through borrowing and aid seem to have of debts owed by 9 countries (against 30 renegotiations reached a standstill, and external trade (particularly in involving $7 billion loans to I I countries in the pre­ agriculture) has come under growing protectionist vious 18 years}. Similarly, in 198 I some 25 countries pressures. Except for the as yet unknown require­ were in arrears by nearly $6.5 billion (against 3 coun­ ments of Iran and Iraq for postwar renovation and tries for $500 million in 1974). With some $597 billion reconstruction, OPEC's import capacity is not likely to of total non-oil developing country debt, much of it increase quickly, since many of the urgent projects on with short maturities and some at floating rates, and infrastructure have already been taken care of. Like­ two thirds owed by only 13 (out of some 150) coun­ wise, in the wake of the events in Iran in I 979, the tries, the debtors' ability to service their debts is surplus countries may not wish to follow as fast a increasingly strained. There were 15 new rescbedulings 110 tempo of economic activity and imports as in previous under way in 1982, and 10 more are likely in 1983. years. Thus, in the event that oil demand should pick up The thirty or so international private banks respon­ sharply, the oil exporting surplus countries may decide sible for some 53 per cent of non-OPEC developing to safeguard the real value of their wealth through the country debt (compared with only 36 per cent in control of oil output unless they can find more con­ I973), seem no longer willing, or legally able, to widen venient, and inflation-proof, recycling options. In this their exposure in poorer developing countries without same context, one ought to keep in mind that, while substantially wider interest rate spreads or supplemen­ OPEC surpluses may decline tO negligible (and thus tal guarantees, thus further reducing access by deficit easily manageable) levels, the end of global imbal­ countries to the private capital markets."' While it ances is by no means in si ght. The world is faced with may be possible to remove or reduce the current con­ a new recycling problem where the names of the sur­ straints facing the private banking system, and to rely plus countries may have changed but not the names on the latter's resilience to meet felt needs, it is widely of the deficit countries. The bulk of OPEC surpluses believed that surpluses of the 1974-78 magnitude may may shift to a small number of industrial countries, not be easy to recycle and that the two main recycling but the funds will have to be recycled nevertheless. mechanisms of the I 970s (massive private bank lend­ And the recycling that was expected from OPEC gov­ ing and a rapid reduction of the current account sur­ ernments and 'llOnetary authorities will now have to pluses) may beless effective in the future. Nevertheless, be performed more directly by the private banking the possibi lities of improving existing mechanisms and community, or by international organizations such as instruments should by no means be ignored or passed the Fund. over lightly. Given the structural and financial changes that have Significantly, non-oil developing countries with pro­ taken place in the world economy over the past decade tracted deficits might be in a much weaker position to (particularly changes in the distribution of global pay­ pay for their needed imports, or to service their debts. ments surpluses and deficits), the need for 'Purposeful By OECD estimates, these countries' debt service pay­ recycling may thus continue for some time-albeit in a ments between J97 I and 1982 have increased by more particular rather than in a general way. An effective than thirtcenfold (from $1 I billion to $I31 biUion). recycling process in the future will depend on the while the total debt rose by about six and a half times reserve management policies of surplus countries, ade­ (from $87 billion to $626 billion).'" With an estimated quate incentives and risk guarantees for direct invest­ debt service ratio of 21 per cent in 1982 (compared with ments, ingenuity in devising new transfer instruments, 9 per cent in 1974), severely depressed commod ity and continued foreign assistanc.e. prices, and rising protectionism in the industrial world, the borrowing capacity of non-oil developing countries Affecting Reserve Management is further diminished. Between 1975 and the end of Factors I 980, there were 16 official renegotiations on $9 bilJion In discussing the surplus management policies of the 111 See Rlnaldo Ossola, '1"he Vulnerability of the Inter· oil exporting developing countries, and the factors that national Financial System: International Lending nnd Liquidily enter into national directions and guidelines, it is im· Risk:' Banco. Nazionale del Lavoro, Quarurl� Review, Vol. 33 (September t980), pp. 29t-30S; see also Tim Anderson. ''The portant to remember at the outset the limited geogra­ Year of the Re-.sc,heduling," Euromom�y (London), August 1982. phical, as well as functional, dimensions of the surplus 118 To the utcnt that repayments represent short-term debt investable funds. The cumulative I 974-8 I cash surplus maturities and a high underlyins role of worldwide inflation, the cause for concern may be overstated. Two thirds of the (and nearly total gross foreign assets) of all OPEC debt and three fourths of the debt service are also accounted lltl for by 20 countries that may be in a beuer pOSition to handle See .. A Nightmare of Debl: A Survey," Tire Economist their debts. (London), March 20-26, 1982.

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©International Monetary Fund. Not for Redistribution Recycling in theSecond Round countries is reported by the Fund to be about S433 rakes on addit.ional oonsidera tions besides the custom­ billion.'10or this total, some 72 per cent was acccunted ary assurance of the payment of principal and interest for by Saudi Arabia, Kuwait, Qatar, and the United at maturity. These considerations relate to the main­ Arab Emirates and 81 per cent by those four plus the tenance of value of financial assets held abroad against Libyan Arab Jamahiriya. Som e 85 per cent of total erosion through inHation and currency fluctuations. assets represents public funds belonging to the govern­ While such risks exist for all nonindexed credits (and ment or its public sector agencies. presumably for all creditors), they present added sig­ The concentration of the overall OPEC surplus in a nificance for those surplus countries whose volume of few co untries and the largely publi c ownership of these oil production and exports may be beyo nd their imme­ funds obviously affect the magnit ude and distribution diate or short-term development needs. The argument of global recycling. The objectives and in terests of frequently advanced by these oountries points to the only a few governments with small constituencies and futility of producing more oil in exchange for assets the judgment and decisions of a few public offic.als in whose values decline ove.r rime. each government hiemrchy will, in the final analysis, To satisfy some of these broad safety cons iderations, give impetus and guidance ro recycling. At the same the surplus countries are frequently led to rel ate smaller time, because of the still nascent nature of local finan­ placement risks to the size or the host country in the cial markets, and the limited experience of some local world economy, the favorable politico-economic envi­ authorities in reserve management, parr of the recycling ronment, historical record of foreign investment treat­ decision is, of necessity, made not by the recipient ment, the range and variety of available securities, the governments but by their hired portfolio managers, or efficiency and sophistication of the money market in by the in ternational private banks where foreign ex­ the host country, and the independence of the country's change reserves are deposited. judici ary. For these reasons, the largest portion or The geographical concentration of the OPEC SUfPius surplus funds is invested in a dozen or so in dustrial in a few treasuries is further restrained by the mitedli coun1 rics. scope or national investment objectives and policies. A closely re lated aspect of safety involves investment Except for the first few months or so nfter the original immunity from seizure, blockage, or restrictions im­ oil price rise (1973-74) when surpluses were almost posed by the host country on polit ical grounds. OPEC exclusively held in liquid deposits in foreign banks, the officials have made reference to some recent risks pattern of OPEC investmen ts is becoming incr easingl y involved in holding foreign balances abroa d. 122 similar to that of priva te institutional investors. The An attractive return is the third objective of reserve outstanding feature of this investment pattern is the management for the surplus countries. These countries' search for a brood-ranged and diversified multiterm portfolio officialsbelieve that oil export proceedsshould portfolio that can yield the best obtainable return on a produce at least the same annual real returns on foreign global seale. The underlying objectives of thisbasically investments as on domestic outlays (including, theoreti­ conservative and business like attitude are liqu idity, cally, possible yearly increases in the real value of oil >afety, and an attractive return. kept underground). Based on this criterion, they nrc Liquidity and short-term accessibility is a foremost inclined to favor investments that offer them such a consid eration for all surplus oil exporting developing competitive return. While this ideal target has not been countries, even the low absorbers, because they pJblicly routinely achieved in the past (owing to higher real and officially regard their oil revenues nor as a dispen­ increases in petroleum prices), its attractiveness has able surplus but as funds needed ultimately to tinaoce not diminis hed. A variant ort hisideal norm is the cost their domestic economic developmen t.••• Surpl�s bal­ of alternative energy sources. Suggestions by some ances are thus to be invested "temporarily" untl such OPEC officials and others for the issuance by borrowing time as they must be called upon to help pay rising countries of energy bonds whose principal and interests import bills. For this reason , among others, !urplus are nor valued in monetary terms but in terms o! a co untries do not seem interested in committin& their given volume of oil and oil equivalents are believed to reserves ro long-term obligations unless special incen­ contain a guarantee of .,fair" return. tives or guarantees are offered. 122 Su ··Kuwait's $70 billion Finance Minis[e.r;• Woll Sltttt Safety is another maj or objective. But safety here JOf�rnol. November 25. 1981, p. 31. TheUnited Na1ions Confer· ence on Trade and De-velopment. Trlllle and Dn·elopm�nl (New York, UnitedSlll< the ...,. iJ . deployment 121 Of the surplus couotrie.s, only Kuwait and Lbe United the of OPEC in,·utm

©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT I'ROCESS

The OPEC's largely conservative recycling policy ment securities, government-to-government loans, and based on these three criteria shies away in most cases loans to international financial institutions (including from two types of transaction. First, surplus OPEC the World Bank and the Fund). It is believed that members arc understandably mindful of the political only a small portion has gone into eq uity investment sensitivities of host governments to massive foreign in the industrial countries and a comparatively smaller direct involvements in certain nationally strategic indus· amount into non-oil developing countries. By some tries. They try to adopt a low-key, nonaggressive, and estimates, no more than 20 per cent of the surplus somewhat anonymous position in their real estate or funds is in direct or nonportfolio investments (primarily equity investments.123 Surplus funds :�re thus kept real estate and shares of over l 0 per cent of the voting mostly in foreign banks in the form of deposits or power in private corporations). Most of the latter has trusts or held in foreign public bonds and other debt also been concentrated in the U.S. economy and instruments. Second, surplus countries with substantial denominated in U.S. dollars, with Japan and the Fed­ short-term holdings in foreign currencies (mostly in eral Republic of Germany holding lesser amounts."' U.S. dollars) seem to shun sudden shifts of their assets There is, thus, large scope for significant increases from one currency to another for speculative purposes. in total direct investment by the surplus countries. The Government officials of the surplus countries have ex­ reasons advanced for the modest record in the past pressed their dislike of "aggressive" portfolio manage­ generally renect the mutuality of reservations held by ment. Movements of dollar assets into gold or other both home (the investor) and host (the recipient) currency speculation is often atlributed mainly to pri­ countries regarding the advantages and practicality of vate citizens or professional portfolio managers rather foreign direct investments. Public and private organi­ than to official monetary authorities. zations have dealt with these issues at length. Their conclusions and recommendations are generally applic­ able to the oil countries as well. Home country policies Jnveslment Potential and Prospects affecting risk capital commonly relate to the questions or safety, yield, and repatriation of principal and in­ The role of the oil exporting developing countries' terest. Host country policies concern the behavior and foreign direct investment••• in the recycling process has performance of foreign private investors (particularly been the focus of auention and comment in the past transnational companies). The surplus oil exporting few years. The surplus OPEC members have been developing countries are naturally subject to the same repeatedly urged to take more positove steps in risk considerations and requirements as other countries sharing and equity investment in the oil-deficit coun­ involved in tran sferri ng risk capital. tries, and particularly in the non-oil developing coun­ tries. It is believed that direct investment by the oil exporting developing countries could play a significant Posture on Direct Investment part in helping to finance balance of payments deficits and in expanding the productive base of the oil import­ or the many reasons underlying the scant enthusiasm ing developing countries. of OPEC investors for recycling through nondebt instru­ Despite such urgings and presumed benefits, and ments, the following are the most familiar. despite the immense potential claimed for equity invest­ Although direct investments are more attractive than ments in both the developed and developing countries, debt instruments as a hedge against inHation (and by far the largest part of the OPEC surplus has been investment in the developing countries is said to be placed in bank deposits, short-term financial instru­ three times more profitable than business ventures in the normally ments, top-rated corporate bonds, long-term govern- industrial countries), such commitments are less liquid and riskier (with elements o( both illiquidity and risks disproportionately greater in non-oi l develop­ 1:.:1 The surplus countries self-imposed limits for some Jarge include the purchase more than per cent of the ing countries because of the limited knowledge of busi­ of no S voting of a y c m an s ay n aw::�y rom cert:tin stock n foreign o pany d t i g f ness opportunities and imperfections of the capital sensitive indu.'Strie�. market) . One of the oil exporting developing countries' 1!4. The concept al statistical ei n direct u and definitions of for g investment are a priJ1C ple the difference common complaints is that the areas of interest to matter of debate. l•t i , between direct and pOrtfolio investment hinges on dte issue of their investos, such as manufacturing, banking, insur­ a e t control. For oper at onal purposes, t e r m nagem n and i herefor . any holding of a certain pen;cntage of the o inary shares or ance, and even agriculture, are often closed to them by rd voting stock of a host country's terp sei a mea�mre en r (si,gnifylng slalutcs or administrative regulations in industrial coun- management and co tro ) may e as of n l be r garded direct invest· the past, was 10 be cent, but recently an For the source s me figur es and arguments in this ment. Tn il thought 2S per of o a p i$ regarded O.$ direct invcstntent. sectoi , sec "' A ab Euromom!)' 1980. tO er cent or more holdin.g n r Banking;J (london), April

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©International Monetary Fund. Not for Redistribution Recycling in the Second Round tries. The "open" fieldsor real estate, tourism, or small Host Coumry Incentives and Impediments industry are, in tum, limited both in scale and profit­ ability. It is further contended that, if Western indus­ Countries that seek to attract foreign direct invest­ trial countries find it appropriate to deny OPEC inves· ment generally follow a twin policy or offering certain tors outlets of their choice, the Iauer should not be incentives to, and expecting certain performance from, expected tO risk their funds in less profitable projects. foreign investors in order to regulate both the magni­ Since foreign investment decisions are, as a rule, tude and the direction of risk capital. Incentives arc made by government officials, direct investments are normally intended to increase the potential rate of not normally favored over other assets because (i) return on foreign inve&mcnt and to reduce potential government authorities, unlike private entrepreneurs. investment risks. Performance requirements are com· are not quick-profit optimitell but are interested monly imposed, largely by developing countries, to mainly in their citizens' welfare, feeling an obligation ensure that foreign investments contribute to national tO keep most of their reserves in safe and liquid outlets, socioeconomic objec ti ves.. '"" and (ii) governments arc more publicity-hys than arc Host nations' investment incentives fall into six private investors, and they arc sensitive to adverse broad categories: (i) ftscnl incentives, including tax reactions in the host country to ccrtuin direct invest­ holidays, accelerated depreciation, w:oiver of import ment intrusions and activities. duties on capital goods used in production, exemption The governments' penchant for easier and less con­ from property taxes, and financial guarantees; (ii) cash troversial placement or surplus funds is buttressed by grants; (iii) credit incentives. including preferential the ract that shon-term bank deposits have in recent access to local capital markets; (iv) public provision of years offered in vestors more anractive yields than have infrastructure for a particular project; (v) protection other assets. The claimed superior profitability or from imports or local competition; and (vi) capital direct investments, while possibly obtainable in the long and operating subsidies to the investor. While these run under favorable circumstances. has not been avail­ incentives are intended to attract foreign investment, able in the short-to-medium term because of the unusu­ the past record fails to show any major influence on ally high real rates of interest in 1974-8 1. the decisions of foreign investors. It can thus be safely or the six traditional ingredients of successful direct us�urncd that their role in nuracting investment funds investment-capital, technological know-how, mana­ will also be rather small. gerial skills, ability to protect foreign assets against By contrast, performance requirements and other confiscmion, home country need for raw materials and factors tend to exert a m·Jch greater (and often adverse) markets, and accommodating financial institutions­ influence. Performance requirements are normally insti­ OPEC investors are generally only well endowed with tuted and imposed by the host nation to regulate the one, capital; the others, at least in part, have to be now and destination cf equity portfolio and direct acquired elsewhere under various substitutional arrange­ investment. Factors that serve us disincentives or out­ ments. Furthermore, the benefits commonly available right obstacles to the attraction of risk capital are not to developed country investors abroad in the form of nlwuys or the recipient's own making, and arc in some employing their own nationals, se lling their own capital cases external to the process itself. The rationale for goods and services, and expanding markets arc unavail­ these requirements is clenrly understandable. Since able to OPEC investors. foreign direct investmcrt, by its very nature, involves For these reasons, the analogy or OPEC to surplus some degree of management and control by foreign countries of the ei ghteenth and nineteenth centuries. investors over the condact or the enterprise, and since and the willingness in those periods to welcome adven­ such managerial decisions can affect the host country's ture and take ri sks in the developing countries, may economy to a significant extent, host governments can­ be somewhat farfetched. In the colonial days, surplus not remain indifferent or neutrnl to the intentions and nations were simultaneously military powers, pioneers operations of foreign investors. The body of laws and in technology, and advanced in industrialization; they regulations governing the behavior or transnational in­ had a highly developed banking system but were short vestors are thus primarily aimed at bringing about a on raw materials and markets. It was easy, rational, pattern of foreign invenment thnt may contribute to and profitable for them to take direct investment risks. the achievement of the host country's national objec­ Surplus OPEC members are in no such position. In tives and priorities."" Nevertheless, the host country's particular, some of the low absorbers with larger sur­ tn Affec:tin.c capital certain aun.c· pluses to invest suffer from insufficient technical human­ the flowof risk also arc tions. :a.s wdl as some barriers, ahat are Jarat-ly beyond the: power and in adequate managerial expertise and institu­ control o( home and host countries. Nadottnl Ugislntion and tional backups needed for extensive foreign ventures. 121 For details. see RrRulatiOIIl

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS insistence on the use of such measures may under cer­ abuses and inequities involved in bilateral investment tain circumstances become counterproductive, that is, relations. Part of it must also be attributed to ignorance, discourage investment or create economic distortions. prejudice, and misconception. But a large pan still The complex of factors that tend to frustrate the remains to be scrutinized and explained. inflow of risk capital (equity portfolio or direct invest­ OPEC officials have often expressed great astonish­ ment)-whether intended as regulations or not, but ment and dismay at the less-than-favorable way their nonetheless a deterrent-extends over a wide range. It investment decisions have been received in the indus­ includes political, psychological, economic, legal, insti­ trial countries. Reams of newspaper articles are pre­ tutional, administrative, and operational eJcments. sented to show the extent of inimical reactions in One of the most significant deterrents to the inter­ Europe, the United States, and elsewhere to OPEC's national flow of risk capital is the existence, or appear­ investment intentions. Even in countries where the ance, of political risk in the host country. Political risk executive branch of the government has been favorably in a generic sense refers to all hazards, real or perceived, disposed to the encouragement of risk-capital inAows, involved in the conduct of business under a different the parliament and the public at large have often dis­ political jurisdiction than the investor's own. Political played open opposition to such investments. risks include the old-time risk of nationalization with­ OPEC investors at both the public and private level out adequate compensation, 128 the risk of being denied privately complain that, in some parts of the develop­ due process in adjudicating claims against private or ing world, their equity purchases and directly productive public entities, and the risk of having to face unfavor­ ventures do not enjoy the same treatment as those of able new domestic laws and regulations. They also the industrial countries. In their view, there is some­ include apprehensions about political instability, civil times a measure of aloorness or a patronizing attitude strife, government changes, and revolution, as well as on the part or the more advanced developing countries the politically inspired freezing of assets, embargoes, toward investment by smaller and less technologically and other restrictions. advanced oil exporters. They believe there is a reluct­ Some of these risks are commercially insurable by ance by some older developing country bureaucrats or the private sector or public entities at relatively small professionals to accept managerial controls and pre­ cost; others are not. The political risks that are not rogatives by younger oil-country nationals. They seem insurable are among the most obvious reasons for to think that some poorer developing countries do not OPEC's reluctance to engage in long-term equity invest­ always take OPEC investments seriously, and wish to ment. To bear such risks, investors from these countries think of these investments as a form of aid. And, finally, explicitly or implicitly expect a corresponding premium they equate increased possibilities of setbacks and de­ in the form of higher profits and shorrer periods of rauhs with the small size and poor economic heallh of realization-which tend partially to defeat the very the host countries. They believe that some poor devel­ purpose of such investments in the Third World.•2o oping countries ohen harbor a confidence in the Psychologically adverse attitudes on the part of the world's sympathy with their plight, and an ultimate. host country are another major impediment to foreign faith in OPEC "compassion," should they not abide by private investment. In general, a complex set of his­ their obligations. torical and cultural factors seems to exist universally Spokesmen for the oil exporting developing countries against foreign investment. Even in industrial countries also privately concede that many developing countries of much greater experience and sophistication in busi­ silently bear a combination of rear, respect, and admira­ ness matters (and a long history of acting both as a tion for the large industrial countries' advanced tech­ provider and a recipient of risk capital ), sentiments nology, managerial superiority, and military might­ regarding foreign direct investment are not always fav­ none of which surplus OPEC members can match. orable. Foreign investors are sometimes regarded as Part of the problem may also be traced to the nature insensitive to the host country's interests, local business or OPEC's investment objective. In general, OPEC's customs, and social mores. Part of the explanation can role in most foreign investment projects is likely to be probably be found in the annals and allegations of past largely risk capital; organization, management, and

R t iOiilrg t o TrOtrs� Nalioll ol Corporations. sc h technology are rrcquenlly provided by host countries It is eduled to be the published by U n ited Nations . or by industrial countrY associates. OPEC's motive in 128 This s now fairly the statutes of risk. i neg_li,gible, since such ventures can thus be readily-although not all too v p most industrial and de elo ing cotmtrics provide for fair sa correctly-deduced to be pure profit, and nothing compen tion. 12t'l ex Political risks ist in debt capital as well. But they arc else. OPEC investments are thus often unfavorably af­ believed to ha v n much more constraining influence on equity e fected because, for better or for worse, a large part investments because lhc investments arc normally for longer or the Third World has a different attitude toward terms and are more conspicuously vulnerable.

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©International Monetary Fund. Not for Redistribution Recycling in the �cond Round profit. and pure profitseekers do not, as a rule, re­ anroeting foreign equity interests. OPEC officials have ceive a very friendly welcome among some deve lopi ng stated that the bulk of their surplus funds go to in dus­ countries. trial countri es simply because of the streng th of the Economically, the obstacles are both pervasive and infrastructure for investment in these countries--some­ deep rooted. One category of barriers that is the unin­ thing the Third World has not yet sufficiently developed. tended side effect of performance requirements includes Institutional hurdles of this kind are particularly effec­ elements that, however rational from the standpoint of tive in reducing the poss ibilities of portfolio in vestment, the host developing country's interests, may never the­ which is frequently preferred over direct investment. less add to producti on costs and reduce international Operationally, there are scores of hurdles that have competitiveness. Among thes e are (i) "local content" to be overcome before a business venture can be estab­ requi rem ents, whereby foreign investors must procure u lished abroad. Language barriers, nonfnmiliarity with certain percentage of total inputs from sources within local laws and regulations, the necessity of having the host country; (i i) export requirements, whereby investment applications approved and coordinated by a foreign investors must allocate part of the total output large number of local age ncies, the time and travails to export; (iii) "technology transfer" requirements, involved in obtaining incentive benefits, and the diffi­ whereby foreign investors are required to bring in new culties of strict compliance with the local investment technology and foster local technological research and laws often make potential foreign investors reluctant to development; (iv) local management and employment act. requirements, whereby foreign in vestors must include a The state's dominance over the economic arena in a certain number of host country citizens in the mana­ majority of developing countries and the large size of ge rial positions and also train local nationals for tech­ the public sector, as well as the underdeveloped char­ nical and manager ial tasks; and (v) "national priority" acter of private enterprise (outside the agrieuhurol and requirements, whereby foreign investors arc asked to local service sec.tors), are among the adm inistra.tive concentrate their activities on econ omicall y less devel­ barriers to direct investment. This is sometimes re­ oped regions of the nation. ferred to as administrative "mismatch." Private inves­ Another category of economic hurdle relates to un­ torsin oil exporting developing countries, ns a rule, shy insurable "economic risks," which also act as disincen­ away From providi ng risk capital to state enterprises tives. They include (i) exchange controls and other abroad. The private sector in capital importing coun­ exchange policies that may limit rep at riation of pro fit tries, too, is naturally reluctant to accept OPEC govern­ and principal; (ii) exchange fluctuations and possi bili­ ments or their state enterprises as pMt owners or part­ ties of currency devaluations; (iii) fiscal policies that ners. The possibilities are th us frequently limited to may raise the tax burden on equity flows relative to the oil exporter governments' selling up their own other forms of capital Dow; (iv) ioDation ri sks that enterprises abroad, or inves ting in foreign state enter­ may reduce intern ational competitiveness of investment prises. While this form of pu blci partnership between output; and, most important, (v) the small size of the OPEC governments and developing country autho rities local market and the absence of externalities. has been established in ma ny instances, both the exist­ Legal requirements are frequently the most evident ing arrangements and future prospects are somewhat and the most immediate factors that foreign investors restricted. have to contend with. They include (i) outright restric­ To be sur�, some of the barriers mentioned above tions which, for reasons of national priori ty, apply to are faced by all potential direct investors in develo ping bot h portfolio and direct investments in certain "closed" countries, not just by oil export ing developing countries. sectors (e.g., defe nse-related activities, nuclear power, Why then do foreign direct investments by the indus­ public utilities, radio, television, the press, commercial trial count ries take place in some developing countries, banking and insurance, and wholesale and retail trade); and why does the bulk of these private ou tlay s come (ii) the percentage of ownership and managerial con­ from industrial country enterprises and transnati onal trol allowed to foreigners in the "open" sectors; (iii) corporations-<>flen using a part of OPEC's surplus limitations on expatriate employment; (iv) regulation deposited in the financial markets? The main reasons of local and foreign borrowing; and ( v) control of for this indirect and circuitous investment route must takeov ers. be sought in the oil exporting developing countries' Institutional barriers to foreign in vestment-con­ relative lack of experience, expertise, and entrepre­ sidered by some observers to be the single most im­ neurship, as well as their limited interest in obtaining portant impediment-are found largely among the foreign raw materials or capturing part of the foreign developing countries. In particular, inadequate capital market. For these reasons, there is a need for fresh and money markets are among the disincentives to ideas and incentives.

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Channels of Surplus Flowback capital markets. These concerns can, in turn, be met through different mechanisms and arrangements. 132 At the start of the oil money accumulation in the mi d-1970s, some soothsayers were overly pessimistic, if not outright alarmist, in their prognostications of an Safety and Liquidity Considerations eventual financial crisis. And the dreaded disasters were not solely figments of unsophisticated imagination. The instruments with the highest measure of financial An eminent group of international bankers and econ­ liquidity and political security are offered almost ex­ omists back in 1974 warned the world of a rapidly clusively by international financial institutions. They approaching "denouement" that could lead to national will be referred to later. All other debt and nondebt bankruptcies and even political upheavals.'"" The abil­ instruments arc in varying degrees exposed to risks of ity of the private banking community to deal with the delayed repayment or default by the ·recipients or residual surplus was questioned not only by the unini­ blockage by national authorities. Private markets, as a tiated laymen but by the sophisticated practitioners rule, can hardly offer risk-free outlets for loans or themselves. In the end, however, the oil exporters' investments. business sense and the private markets' resilience Short of ideal liquidity and security, the choices open proved the doomsday prophets wrong. Tens of billions to surplus countries include, first and foremost, a geo­ of surplus dollars were recycled in the 1974-78 period, graphical and functional expansion of depositories. In almost without a hitch. the past, the largest portion of OPEC investments has Recycling in the 1980s may turn out to be equally been in U.S. dollars (the currency in which oil prices manageable, for two additional reasons. First, the mag­ are quoted) and has been placed in the United States nitude of the surpluses may be much smaller than the or the Eurodollar markets. As experience is gained by first round's. Second, the expansion and increasing surplus country authorities and portfolio managers, sophistication of Arab banks and investment corpora­ other avenues have been opened up. Non-Western tions may facilitate the channeling of nonconcessional countries have recently been able to tap OPEC's surplus funds to potential users. But the cause for concern is funds on a very small scale. Opportunities for further not totally eliminated.'" There are still barriers that government-to-government loans or other credits to will have to be overcome. These mechanisms of poten­ nonmarket economies may be explored, particularly tial recycling are usually divided between fixed-obliga­ by some surplus governments that have closer political tion "investments" (or direct lending programs by the or other ties with these governments. A vastly more OPEC countries to governments and multilateral insti­ profitable area-and one that has been largely ne­ tutions) and joint foreign direct investments, parallel glected-is intra-OPEC lending. In fact, one of the financing, and cofinancing of risk-capital ventures. most baffling aspects of OPEC as a group is the ex­ Since the recycling role of intergovernmental financial tremely limited scope or bilateral or intragroup lending institutions will be discussed below, this section will be and borrowing. Except for a few reported cases (for limited to a discussion of private or semipublic means example, the I 980 and 1981 defense loans to Iraq by that have been devised to help the recycling process in some Gulf countries, and the Saudi Arabian-Nigerian the framework or the oil exporting developing countries' financial arrangements), deficit countries within OPEC objectives, and the stability and liquidity of the private routinely finance their development needs in the inter­ money markets. national capital markets and through Western inter­ The surplus countries' concerns focus on (a) the mediaries in which their fellow members have entrusted safety and liquidity of investments; (b) positive (i.e., their surpluses. The Arab Monetary Fund (the so­ inflation-adjusted) returns and positive yields (i.e.. called Arab lMF) does its share in a small way. But corrected for gains and losses in exchange ftuctua­ many deficit OPEC members fall outside the purview tions); (c) some management control over invested of its operation, and its loans are small and for only assets; and (d) indirect assistance to other developing short durations. The possibilities for intra-OPEC bank­ countries to help them to obtain greater access to the ing are indeed immense. In particular, the possibility of an arrangement for OPEC members si milar to the original General Arrangements to Borrow in the Fund

130 Khodada.d Farmanfarmaian, and others, "How Can the seems worth exploring. World Afford OPEC Oil?'' Foreign A0airs, Vol . 53 (January 1975), pp. 201-22. S 131 For 3 crilical account of private bank lending to develop-­ tS2 See Rahman obhan, ••Jnstitution.al Mechanisms for ing countries, sec Anthony Sampson, The Money Letldtrs Channeling OPEC Surplus withni the Third World."Third (London, 1981). World Q�tarterly, Vol . 2 (October 1980), pp. 72t-4S.

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©International Monetary Fund. Not for Redistribution Recycling in the Second Round

Inflation-Adjusted Investments ease of obtaining an indexation guarantee from an international agency compared with a national treasury Of the modalities that provide varying degrees of that might be reluctant to set a precedent for internal protection against the Joss of purchasing power caused borrowing, added incentive for oil production against a by inllation, or decline in value through exchange possible future drop in energy prices, and immunity depreciation, three schemes, each with several varia­ from political freezing of assets. For deficit count ries, tions, have been proposed in the past few years. The the advantages would be an assurance of long-term oil first scheme involved "energy bonds," and two variants supply, access to OPEC funds without political or of the scheme were offered by Iranian oil authorities economic strings attached, a pooling of in vestment in the mid-1970s. One variant was to establish a risks through international management (and thus low­ special energy bank that would issue interest-bearing, ering credit costs), and a greater nondiscriminatory long-term energy bonds against surplus dollar deposits. mobility of recycled funds.'" The obvious flaws in The nominal value of the bonds, and the loans subse­ this proposal, as always, rested with the choice of the quently made to deficit countries (for balance of pay­ indexation basket, the "appropriate" management and ments purposes and for development of alternative "equitable" di stribution of reinvestable credit by the energy sources), was to be expressed in units of both international agency, the underwriting liability for main­ energy and currency (corresponding to the value of tenance of value, and the method of distribution of energy at the date of issue). At maturity, the bank (inflation-related) losses among oil importing countries. would arrange for the return of an equivalent amount Closely associated with these inflation-hedging pro­ of energy, or its prevailing market value, or just the posals have been commodity indexed issues-gold­ nominal value of the bond-at the depositor's discre­ indexed and oil-indexed bonds that have been offered tion. The second variant of the scheme was for energy by some countries. These issues have three important bonds to be is sued directly by the deficit governments characteristics: to the extent that commodities main­ and payable in equivalent energy units or at the pre­ tain their relative value against other goods, they pro­ vailing market value of energy at maturity.'" For vide a good inflation hedge; since the coupon of these obvious reasons, these proposals did not appeal to bonds tends to be much lower than the standard bond, deficit countries. Under the first proposal, there was they decrease the carrying costs to the debtor; and, zero advantage to the borrowers who had to repay a since commodity prices do change over time, they allow higher currency amount if energy prices went up but international diversification of relative price fluctuations. the same currency value if alternative energy costs The second scheme, which was also designed to went down. Under the second proposal, symmetry was provide an ioDation hedge, involved the private market allowed, but chances were that energy prices would in intermediation of oil surpluses for the development of all probability not decline. the poorer developing countries. National or regional Under a third version of this scheme, medium­ private capital markets would be established in Asia, term to long-term nontransferable, noninterest-bearing Latin America, and elsewhere to tap excess petroleum energy bonds would be is sued (by an international revenues for balance of payments financing as well as agency) for sale to the oil exporting developing coun­ for longer-term regional and national development. tries. As an incentive to oil producers, the bonds would The surplus oil countries would be offered high-yield­ be fully indexed against inflation in terms of a selected ing, liquid, secure, and fully indexed assets for invest­ basket or goods and services (including oil) to assure ment in the Third World. a slightly rising real value over time for a barrel of Essentially, the scheme envisaged (a) agreements petroleum whether extracted or kept in the ground. It between interested developing countries and oil ex­ was hoped that the agency would recoup its "inflation porters in each of the oil exporting countries or regions liabilities" through reinvestment of the proceeds. Short to organize capital markets; (b) auctioning off the of reaching this goal, the proposal called on oil import­ surplus reserves of oil exporters to the highest-bidding ing governments to make up the deficiencies according wholesale commercial banks for onlending to other to a prearranged formula. This proposal was said to commercial banks in the form of call margin credit; (c) contain several advantages for both the surplus and loan repayments to be adjusted fully for inflation plus the deficit countries. For surplus countries, there would a positive interest rate; (d) establishment of an index­ be a guaranteed bond value against escalating inflation, ing system for debt securities in each country or

133 Sec "A New 13• Se J. Levy, "Recycling Surp us via Reza Fallah and Fereidun Fesbaraki, Pro­ e Walter l Petrodollars posal for ex o of East Ind at i n Oil P·rices," Middl� EtJst Eco11omic Internationally Issued Indexed Energy Bonds," Middlt (April ?, 1980), pp. 1-7. Survey, Vol. 20 (June 27, 1977), pp. t3-IS. EconomicSurv�y. Sllpplemem, Vol. 23

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS region; and (e) a crash program to train underwriters Factors responsible for the lack of consensus, and for and market makers '"' The advantages claimed for this the delay in the establishment of the account (apart scheme were that it would achieve the full recycling of from the appreciation of the U.S. dollar in the mean­ the oil money, first to the non-oil developing countries time, and the lessening of a perceived need for such an in the form of investment capital and then to the indus­ account) , relate to the conditional nature of its liquid­ trial countries in payment for exports of capital goods. ity, its limited scope for a secondary market develop­ The evident drawbacks included the problems of reach­ ment, and the sharing of costs in the maintenance of ing intergovernmental agreement for implementing the asset value over time. scheme, the difficulties in establishing fuii-Aedged capi­ tal markets in the developing world in a short time, and the gu arantee of security and liquidity of oil money Market Stability and Management Control lent to private commercial banks. A related proposal of recycling through nondebt The two other important preconditions of effective instruments was the establishment of mutual funds in recycling involve the avoidance of currency instability developing countries and the cross-listing of stocks in resulting from shifts of surplus funds from one currency industrial countries. It was believed that the difficulties to another and an appropriate allowance for a degree or in making direct investments in the non-oil developing control by surplus authorities over their investments. countries could be partially overcome by the creation These two objectives, however, are not always mutually of such a scheme. There would also be the possibility compatible. A necessary reduction in undue exchange of individual companies cross-listing their own stocks. Auctuations requires some "permanency" in the terms The third scheme for partially protected placement of the deposits (as in the Substitution Accoun t). And opportunities for the surplus oil exporting developing yet, any such permanence would by its very nature re­ countries involves the issuance of SDR-denominated duce the extent of control by investors over their assets. instruments. With the recent change in the quality and Nor is a compromise always easy to work out. In transferability of the SDR, there has been increased general, recycling through SDR-denominated claims private interest in SDR-based issues. These issues with some callability provisions, but without full liquid­ range from SDR-denominated certificates of deposit to ity, may satisfy both conditions. SDR-denominated bonds.'3< They allow the oil export­ However, if full management control over assets ing developing countries to invest in instruments that should be an overriding consideration for the surplus oil are Jess subject to exchange rate volatility; they also exporting developing countries, one sure way to achieve give the private market a potential for increased li quid­ it would be to continue to expand and strengthen their ity for its SDR-denominated contributions to interna­ own nation:tl or consortium financial institutions. This tional organizations. will give them the best opportunity to evaluate risks A more elaborate, and vastly more sophisticated, and to further extend direct, medium-term and long­ variant in this category is the proposed substitution term, credits to international borrowers without the in­ account in the Fund, for which consensus remains to termediation of the major private banks in industrial be worked out. Through this account deposit claims countries. These efforts can also be facilitated by lend­ denominated in SDRs would be issued in exchange for ing to national or regional development banks against official U.S. dollar reserve assets. Such a substitution certain national or regional official guarantees. on a routine basis would curtail speculative shihs of dollar holdings into other reserve currencies. As such, not only could the account provide a new and relatively Increased Developing Country Access to more secure outlet for surplus petrodollars, it also Capital Markets would be expected to contribute to greater exchange stability and an improvement in the international mone­ Apart from the above suggestions and practices, tary system. And, short or the establishment of a mul­ there may be other mechanisms to help transfer surplus ticurreocy reserve scheme, the account could indeed funds to non-oil developing countries. Of particular serve as an effective substitute for dollar reserves.'" interest, for example, arc mechanisms similar to Japan's Overseas Economic Cooperation Fund. Under such mechanisms, the aid agency would guarantee non-oil J35 See David Kleinman, ••oil Money and the Third WorJd," Tire Bartker, Vol. 124 (September 1974), pp. t06t-64. developing countries borrowing liabilities vis-�-vis t3& See Morgan Guarnnlee Trust Company, "World Financial Markets," (April 1981), pp. 6-10. 13i see A mutal April 30, 1980 1980), 72, tMF S11rvey, For details, International Monetary Fund, (Washington, p. and Report of Executive Board jor Financial Year Vol. 9, 4, t980 and t980, the tire Ended February Mar

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©International Monetary Fund. Not for Redistribution Recycling in the Second Round

OPEC members or financial markets of industrial na­ growing role to play.••• The most crucial task, perhaps, tions; the agency funds would also be used to lighten is the promotion of appropriate economic policies as an the debtor countries' interest burden. Similarly, the ef fective path to national solvency and long-term eco­ secondary banks and financial institutions in the United nomic prosperity. To this end, the Fund and the World States and other major industrial countries could be Bank, as the largest and most active international finan­ encouraged to make concerted efforts to obtain a wider cial institutions, serve as instruments of promoting and more active distribution of OPEC deposits. Such proper choice-each in its respective area of responsi­ a move would help to reduce the major international bility and operation. While offering balance of pay­ banks' monopoly of being OPEC depositories, and ments and development finance under carefull y laid-out would gi ve smaller but more energetic banks a fresh conditions, these institutions may be instrumental in opportunity to put their talent and connections at the encouraging deficit member countries to adopt eco­ service of foreign depositors, as well as smaller inter­ nomic policies that affect their fundamental structural national clients. problems. Some of these problems involve the growing Other suggested modes of accelerating nonconces­ ratio of current account deficit to GOP. "• A partial si onal transfers from OPEC to non-oil developing solution to this payments disequilibrium is, of course, countries include placing some OPEC funds on deposit borrowing from international financial centers. But in­ with central banks of the other developing countries, ternational finance unaccompanied by necessary struc­ financing Third World capital issues in OPEC-denom­ tural adjustments may result in unsustainable long-term inated currencies, a more active participation by OPEC indebtedness. One principal aspect of adjustments is in regional financial institutions, and the establishment the obligation by borrowing members to take some dif­ and expansion of secondary markets for OPEC invest­ ficult political decisions in correcting domestic economic ments in the non-oil developing countries' debt instru­ distortions. This kind of self-discipline places special ments.1as emphasis on the adoption of effective energy policies to maximize energy conservation and increase supply. The pursuit of such a discipline by the deficit countries, in Institutional Role in Recycling Process turn, can be encouraged only by the official interna­ tional organizations (to which borrowing members be­ The private recycl ing process worked with a good long). Private banks are neither able nor particularly deal of sophistication and efficiency during the 1970s. suited to obtain such commitments from their clients. One can also foresee continued intermediation by the The unique capacity of the international organiza­ commercial banking system in the future. Yet, there tions to induce deficit countries to adopt economic ad­ seems still a need for the process to be expanded and justment programs (i.e., to manage their external improved through official channels. The oil exporting imbalances in such a way as ultimately to live in accord developing countries want the kind of investments that with their self-generated income) may be the best not only produce a positive real rate of return but also guarantee that international lo;ms will be repaid, and allow a larger composition of portfolios; more intpor­ that the creditor members' deposits will best be safe­ tant, they desire instruments that reduce "sovereign guarded. Furthermore, the very nature of the interna­ risk." The private banking system in the industrial tional agreements under which the organizations arc countries is becoming increasingly concerned that from established tends to reduce "sovereign risk." This risk now on they may have to take on greater ri sks than arc decreases as the "costs" of default increase. A censure justifiable by the financial returns involved; in particu­ by the international community of a defaulting country lar, there is the question of whether the recycling in the would be too costly for any nation to dismiss lightly. international markets can disturb national domestic There is not yet a consensus on the exact role to be monetary policy and affect exchange rates. Finally, the played by international financial institutions in the developing world is most C•Oncerncd about having access to world capital marketS without being charged unduly l3U For a cri tical view of the role of international organiza­ , high premiums. tions, sec M.M. Sakbani, ••A Critique of the l rcvailing Mone· tary System: Principal Themes of a Reformed System" Third To accommodate these divergent interests, the inter­ World Quart

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSfMEI'IT PROCESS

recycling process. For example, !here are differences institulions. There may, however, be other considera· among indus1rial countries with respcc1 10 1he manner tions against borrowing in the international markets. in which Fund resources are to be augmented (i.e., There has also been interest on the part of the low­ quotas versus borrowing) ; the nature of Fund inter­ absorbing oil exporting developing countries in setting medial ion (routine and permanent versus temporary up new joint institutions. Some of these require the and of lnst resort); and conditions to be allached to the formation of a subsidiary agency whose capital would usc of Fund resources. A similar variety of views exists be financed in part by the oil exporting developing among the developing country members of the Fund. countries and by countries that the subsidiary intends Nevertheless, there appears to have been renewed to serve. Other proposals would merge the oil export· intcres1--at least among some-to use the Fund (and ing developing country capital with the expertise and the World Bank) as a vehicle for recycling."' It should backing or the international organizations. Some of the be noted, however, that these counlries' desire to offer major contributions of the new organizations and credit to inlernational organizations to reduce "sover­ schemes to the recycling process would be to substitute eign risk" or to avoid other political encumbrances on for the missing ingredients in the foreign direct invest· foreign-held assets is usually accompanied by their ment recipe. In other words, oil exponing developing interest in having a larger voice in the management of countries' deficiencies in technology and management the se organizations. But this natural desire to have a know-how, their inability to protect their investments more important voice in the organizations which they against political risks, and their inadequate financial partly finance is 001 always achievable without cor· links with host countries can be significantly made up responding relative reductions in the decision-making through collective actions. power orother members. Such counterbalancing reduc­ In this context, several proposals have been talked tions, in turn, are not easy to implement for a variety about in international circles. One such scheme has of reasons, including the unwillingness of affected been an Algerian-Venezuelan proposal to convert the countries to reduce their shares. OPEC Fund from a purely coneessional lender to a full· Another obstacle to a major direct tapping of oil fledged international bank in which the present organ­ exporting developing country surpluses by the interna­ ization may become simply nn 11aid window."142 The tional org anizations is that the desire for a multifaceted bank's capital would be provided by the oil exporting portfolio works both ways. That is, there will stil l be developing countries and would tap surplus funds at a tendency on the part of these countries to have their market ra1es for onlending to deficiH:ountry govern­ i assets wdely distributed both acr oss nat ional bound· me nts. In poorer developing countries, an interest sub­ aries and across financial organizations. For tbis rea­ sidy would be provided through the "aid wi ndow'' or son, a very substantial increase in the role of interna­ other voluntary contributions. tional institutions in the recycling process would require Another associated proposal is for the establishment a good deal or new inventiveness, 1act, and hard of a fully commercial, dividend-paying, international ba rgaining. finance corporation that would draw its capital sub­ An important alternative to direct contributions is scriptions from surplus oil exporting developing coun­ the possibility of indirect recycling through borrowing tries and industrial countries and make loans and equity in the priva1e markets. In th is way, while the oil investments in foreign public and private enterprises. exporting developing countries place their mo ney in the The corporations would be controlled and managed ac­ i in ternational markets, the funds arc captured ;y offi­ cording to strict accounting and business pr ncipl es, cial institutoi ns in exchange for their own liabilities. and would engage in business-like operations. By pool­ This indirect recycli11g bas the advantage that, a:though ing capital investment expertise, information, and politi­ the funds come, either directly or indirectly, from the cal neutrality, the corporation would be able to promote oil exporting developing countries, there is no need for foreign direct and portfolio investments that would difficult changes in the nature and operations of the ensure greater return, better security, and less risk for oil exporting developing country investors. Many or the variegated obstacles to direct investment referred u1 A recent indication of this waJ the ability of tlte Fund to borrow di rectly from the Saudi Arabian Monetary Authority to in a previous section could thus be avoided or (SAMA) in April 1981. Accordina to the aareemcnt reached with SAMA, the Fund can bo

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©International Monetary Fund. Not for Redistribution Rceyclin& in the Second Round mitigated.'" A third related arrangement involves the agencies and the creation of new multilateral institu· revival of the multinational guarantee scheme for the tions. There has also been "trilateral cooperation" be· protection of direct investment. This proposal, which tween OPEC, private corporations in industrial coun­ in the past has failed to attract sufficient support. may, tries, and companies in the Third World. Sales ofcrude under proper safeguards, provide one of the essential oil to needy countries on concessionary terms by Iraq, requirements of any successful transfer of ri sk capital. Algeria, Kuwait, the Libyan Arab Jamahiriya, and Objections by both the non-oil developing countries Venezuela are examples of another form of ai d. and the industrial countries to some of the main features For a variety of reasons, OPEC aid has so far been of the scheme could perhaps be overcome by innova­ distributed through a number of diversified channels. tive changes in the original scheme.'" These channels include (a) national funds created for Closely related to these proposals arc certain tripar­ the specific purpose of providing externnl assistance, tite arrangements that seck to provide for the long-term such as the Abu Dhabi, the Kuwait, the Saudi Arabian, financing of non-oil developing country deficits while and the Iraqi Development Funds; (b) nationally fi. protecting the real value or OPEC assets against inOa­ nanced trust funds administered by other institutions, tion, exchange devaluation, and/or political risk. In such as Algeria's Special Fund and Nigeria's Special return, OPEC is expected to agree on long-term as­ Fund administered by the African Development Bank surances of supply and a steady and predictable annual and Venezuela's Special Fund administered by the increase in the real price of oil.'" Still another variant Inter-American Development Bank; (c) multilateral of these proposals is a triangular co-management pro­ institutions established by individual OPEC members posal under which individual members of OPEC and and other developing countries, such as the Arab Fund the European Economic Community and the non-oil for Economic and Social Development, the Arab Bank developing countries select and define a series or priority for Economic Development in Africa, the Islamic De­ programs (e.g., energy and raw materials) for equity velopment Bank, and the Islamic Solidarity Fund; investment under certain mutually agreed codes of (d) multinational institutions in which OPEC has behavior. played a leading role, such as the International Fund for Agricultural Develo pment and the Common Fund for Commodities; (e) OPEC's own collective aid facil­ External Assistance ity-the OPEC Fund for International Development, which is entrusted both to coordinate OPEC members' An effective means of recycling surplus oil funds has aid policies and to act as an aid donor in its own ri ght; been, and continues to be, the oil exporting developing and (f) existing international financial institutions, such countries' numerous foreign assist ance facilities. Since as the International Monetary Fund. the World Bank, the early 1960s, with the e.stablishment of the Kuwait t.he International Development Association, the United Fund for Arab Economic Development, OPEC mem· Nations Development Program, the World Food Pro­ bers have been large donors of direct and indirect aid gram, and others, to which OPEC members have offered to other developing countries. OPEC assistance has loans or grant.s for onlending to countries in need.'" helped poorer nations to meet part o( their external Other financing proposals include a proposal by Iraq deficits and finance part of their development programs. for the establishment of a new fund to be jointly OPEC aid takes a variety of forms. Bilateral assis· financed by OPEC and the industrial countries to com­ tancc includes medium-term and long-term balance of pensate non-oil developing countries for the adverse payments support grants and loans, project aid, centrul effects of higher costs of imports from oil exporting bank deposits, nnd bank guarantees of commercial loans and industrial countries. There has been a similar sug­ to developing countries. Multilateral assistance involves gestion by Iran for reimbursing poorer developing coun- direct contributions to existing international financial a.ae See J.T. Cummings, and othtrs, ..An E«>nomic Analysis HJ For more detailed discussHlns of these propOSals. ICC of OPEC Aid," OPEC Bullttin, Supp/tmtnt, Vol. 9 (Sutttrirs, R.S. Asso· lbnhim F.l. Sbibaua, OPEC os Donora ciatcs (Wuhina:ton, 1982). Group, OPEC Fund for International Oeve1oprMnt (Vienna. H!i M See. for example, H. W. Arndt, and otbers, T/,� World 1980); ttnd ehdi M. Ali, F;n4ncltt.l lhe EnertY Requirtmtnts , Economic Crisis: A Commonwtalth Pt'rspectivt, RcpOrl by a of Dt, t,oping Counlrits. OPEC Fund for International Oevel· aroup of experu, Commonwealth Secretarial (London, J980). opmenl (Vienna, 1981).

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©International Monetary Fund. Not for Redistribution V • WORLD PAYMENTS IMBALANCES AND THE INTERNATIONAL ADJUSTMENT PROCESS tries for their additional oil bills resulting from increases to differences in the definition of nonconcessional mul- in oil prices. tilateral flows (such as contributions to the Fund's The total size and the distribution of OPEC aid to facilities and to the International Development Asso- other developing countries are compiled and reported ciation), the time period of disbursement, and access separately by the OECD and the United Nations Con- to data. The basic data published by both sources are ference on Trade and Development (UNCfAD ). The summarized in Tables 29 and 30. By UNCfAD esti- two sets of data display certain important differences mates, between 1974 and 1981 some $55 billion (or in both the aggregates and, particularly, the details of 15 per cent of the total OPEC "identified investable the resource flows. The discrepancies are due largely surplus") had been transferred in net disbursements to

Table 29. Selected Oil Exporting Developing Countries: Concessional Aid, 19·73-81' (In millions of U.S. dollars) Donor Country 1974 6 9 8 19 t980 t98 1973 1975 197 1977 1 7 79 1 47 4 4 44 Algeria 25 41 5 7 272 65 65 (0.28) (0.37) 7 (0 ) (0.18) ( 89 (0. ) (0.1 ) (0.2 ) .33 (0.24) 0. ) 17 6 Iran 2 2 8 25 -ISO 408 753 221 7 7 0 1 ( 8 ) ( 593 ( 2 ) (0 0 ) ( . ) 0. 7 1 .13) (1.16) 0. 9 (0.37) (0.03) . 1 Iraq II 23 2 23 1 829 143 0.2 4 15 1 6 173 (2.53)847 (2.13) ( 1) (3.98) ( 1.63) ( 1.44) (0.33) (0.76) (0.37) 356 946 532 4 Kuwait 63 1 1,309 991 1 645 685 (8.62) (5.33) (5.64) 7 (2.04) ( .98 (7.40) (3.64) (8.20) (1.79) 1 ) libyan Arab Jamahiriya 215 14 259 94 113 lOS 282 lOS ( 1.26)7 0.6 ( .6 ) 146 ( .45) 0. ) (3.33) (2.29) ( 3) 0 3 (0.85) 0 (0.92) ( 37 Nigeria 5 38 0 42 1 9 IS 14 83 64 3 4 (0.03) (0.04) ( . (0.04) ( 5 ( 1 (0.05) (0.19) 0 13) (0.07) 0.0 ) 0. 7) Qatar 8 94 280 284 1 5 94 1 5 338 195 1 109 7 . 2 (9.26) .9 ) ( (6.0 ( 25) (2.64) (156 ) ( 15.59) (7 5 (7.76) 3.75) 3) 4. 8 Saudi Arabia� 1,118 2,153 3,033 3,13 5,507 5,944 5,798 (9 ) 2.756 (6.47) 8 4 4,674(6.12) (14.80) .32 (7.76) (5.33) ( . 5) (5.09) (4.77) 0 0 0 9 United Arab Emirates 289 51 1,046 1, 21 1,06 891 67 906 799 ( . 8. ( 2 ) (5.09) (2.88) (12.67) 7 04) ( 1 1.69) ( 88) 7. 7 (6.27) (3.38) Ve1tezuela 6 1 56 18 0 3 108 liS 109 125 67 (0.11) (0 2 ) I I) (0.34) C O . I 5 ) (0.22) (0.21) . 3 (0. .!2;lli ( 0.10 ) 2 3 , 6,263 8,292 , 9 2 8 Total ,13 4 579 6.239 6,104 7 786 ,1 9 7, 36 2 5 ) . ) (2.46) ( 8 ) 74) (1.46 (2.25) ( . 3 (2.92) (2 32 (2.03) 1.8 ( 1. ) Sources : Organizatjon for Economic Cooperation and Development , Development Assistance Commine c: , De v e/ op m �m Co ­ op eration, 1982 Re v iew (Paris, 1982). • Net disbursements. Figures in parentheses are as per cent or GNP. 2 Data supplied by Saudi Arabia to the Fund and published in International Monetary Fund, IJ\1F Sur�·�y. Vol. 11, November IS, larger 1982, pp. 3S4-S6, are than these estimatc::S owing to a broader inclusion or "aid" categories.

Table 30. Selected Oil Exporting Developing Countries: Di sbursed Concessional Assistance, 1974-811 (In millions of U . S. dollars) Donor 9 4 9 1976 8 Coun try 1 7 1 75 1977 1978 1979 1980 19 1 geri 5 6 02 2 262 Al a 1 41 4 1 2 9 163 366 211 2 25 iran 402 560 74 8 78 3 2 Iraq 418 235 85 11 564 1.029 2.203 696 2 9 500 1,433 1,723 Kuwait 6 7 07 1,686 1,847 1,483 Libyan Arab 5 430 21 Jamahiriya 147 212 13 121 524 8 785 Nigeria IS 14 82 220 250 9 Qatar 297 244 103 214 5 7 416 2 2 2 2 9 1 3 2 64 Saudi Arabia 1,049 ,968 , 96 2,304 1,981 , 0 , 30 3, 5 United Arab 1.066 Emirates 523 1.019 1,577 780 1,118 1,211 862 Venezuela 51 33 65 723 746 494 612

Total 2 8 6 6 ,002 8,257 8 49 3,503 6,333 5, 3 . 86 7 9,819 , 4 Sources: United Nations Conre.rence on Trade and Development, Trade and Dt·� · tlopmtut Rt-port, / 981 and / 98 2 (New York , 1981 and 1982 ; and Fund staff estimates. l Jnduding contributions) to the International Development AssoC-iation.

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©International Monetary Fund. Not for Redistribution Summary non-oil developing countries, with 68 per cent of the Table 31. Main Components of OPEC Aid, 1974-80 assistance in the form of grants and the average grant (In per cent) element of conccssional loans exceeding I 0 per cent. OPEC assistance as a whole has been untied. 1974 1916 1978 ami 198 0

As shown in Tables 29 and 30, the largest donors Bilateral grant s 65 42 49 61 65 Bilateral 19 16 23 have been Saudi Arabia, Kuwait, and the United Arab conussiono.l loans 23 39 Contributions to multilateral Emirates. These three countries together accounted for institutions 12 19 32 2) 12 54 per cent of the OPEC official flows in 1975 and for Of which, x i 75 per cent in 1980. As a percentage of GNP, these Arab oil e port ng dev loping COlJntry it�stitutionse countries' official flows averaged about 10 per cent for 7 15 20 10 4 the 1974-80 period. For the oil exporting developing c a development countries a group, the official flows averaged nearly Total offi i l as I 00 00 00 00 I 00 assistance I I I 3 per cent during this period. About two thirds of the Sources: Organization for Economic Co operation and Oevel · flows to other developing countries are in the form of , D tv elopnrtm opmcnt Dcvdopmc:nt A ssistance Committee- , Co-operation , bilateral grants and concessional loans (Table 31); the an nual re view$ ( Paris). remainder is channeled through 'multilateral institutions. The main recipients of this aid have been African and cits, and the prospects are for continued gaps through­ Middle Eastern countries, which together received out the 1980s. For a variety of reasons, the outlook for dealing with about two thirds of the total."' payments imbalances in the 1980s is rather uncertain. Altogether, the oil exporting developing countries' For many of the poorer developing countries, balance foreign aid record has been laudable, in itself and in of payments deficits cannot be sustained for long. For comparison to other aid donors. According to a recent others, the limits on access to commercial capital are World Bank report, "relative to their incomes, OPEC being rapidly approached. And the middle-income members were six times more generous in their aid developing countries, who have served as an engine for efforts than the industrial countries.""8 According to recycling the oil exporting developing countries' surplus UNCTAD, OPEC's aid performance as a group during through the international capital market, find that not 1978-$1 surpassed that of Development Assistant only are borrowing conditions markedly stiffer "9 Committee members by a ratio of 10 to l. but that debt servicing is considerably more burdensome, if not intolerable. Summary While the private capital market is expected to play a continuing major role in the international adjustment The decisions of the oil exporting developing coun­ process, international financial institutions and national tries regarding oil production, pricing, imports, lending, govern ments will also have to share in coping with borrowing, and foreign investment have a crucial bear­ external deficits. International agencies can assume a ing on the magnitude and pattern of global imbalances more active part in bridging the gap between surplus and their adjustment. Up to now, oil importing coun­ and deficit countries. Governments of the oil exporting tries-both developing and developed-have been able developing countries, in addition to pursuing a pre­ 10 manage the transition from cheap oil to more expen­ dictable oil pricing and production policy, could sub­ sive alternatives at some costs. Economic growth in the stantially ease the global recycling task by maintaining industrial countries has slowed considerably, and ex­ a high and steady growth rate, importing more from ternal balances have shown moderate deficits. Non-oil the other developing countries, increasing their direct developing countries have maintained hi gher growth foreign investments, and expanding bilateral aid and mul­ rates than the major oil importing countries, but their tilateral assistance to lhe non-oil developing countries. external accounts have shown persistent and large defi - In sum, the solution to the world payments imbal­ ances is neither one dimensional nor a quick fix. It takes many forms, and it takes time. Above all, it takes JH For details of individual OPEC member contributions, close cooperation among the concerned parties. tcrnu, and other characleristics of OPEC official development ss tance, well donors, see a is as as a comparison with other U!) Organization for Cooperati n and Development, For a recent account of the s:i tuation, see Group of Thirty. Economic o A Development Assistance Committee, Development Co..opua· The Outlook for lnunrmioual Bank Lmding: Survty o} Opi"ion tlon, /982 Review (Paris, 1982). Among Leading International Banker�· (New York, f How Batrktrs tile World Financial Market: A H8 International Bank or Reconstruc.tion and Development, 1981), and Ste Survey 1982). World D�velopmcnt Report, 1982 (Washington, 1982), p. 14. (New York,

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©International Monetary Fund. Not for Redistribution