Monetary and Fiscal Institutions in Resource-Rich Arab Economies - Economic Research Forum (ERF)

ERF held a conference on Monetary and Fiscal Institutions in Resource-Rich Arab Economies on November 4-5, 2015, in Kuwait City, Kuwait. The event, held in cooperation with the Arab Fund for Economic and Social Development, was intended to address the challenges facing macroeconomic institutions in oil-rich Arab countries, particularly those responsible for monetary and fiscal policies.

The problem is that while oil-rich Arab countries account for close to half of global oil reserves and a quarter of natural gas reserves, they have neither achieved economic prosperity nor approached the ranks of developed nations. The efficiency (or lack thereof) of monetary and fiscal institutions in resource-rich Arab economies could explain this phenomenon, at least partially.

More than 50 participants from the region and abroad examined the prospects and policy options for achieving fiscal and monetary stability in oil-rich Arab countries. Over five sessions and a panel discussion, experts tried to understand the rules and procedures governing fiscal and monetary policies in oil-rich Arab countries, the degree of independence and interaction between fiscal and monetary institutions, and the influence of politics on both.

Regional policy leaders and experts participating at the conference included former Kuwaiti Minister of Finance Abdlatif Al-Hamad, Kuwaiti former Deputy Prime Minister and Minister of Foreign Affairs Mohammad Al-Sabah, Economic Advisor at the Amiri Diwan Yousef H. Al Ebraheem, former Egyptian Minister of Finance Ahmed Galal, Ibrahim Elbadawi (Dubai Economic Council), Samir Makdisi (American University in Beirut) and Sami Atallah (Lebanese Center for Policy Studies). World renowned experts who spoke at the conference included Adeel Malik (University of Oxford), Jeffrey Nugent (University of Southern California), Michael L. Ross (University of California), Emilie J. Rutledge (United Arab Emirates University), Raimundo Soto (Universidad Católica de Chile) and Shantayanan Devarajan (World Bank).

Galal began the conference saying that initially the big question for oil-rich Arab countries was how to turn natural resources from a “curse” and into a “blessing,” noting, however, that very little attention was given to the issue of institutions. The next generation of questions, according to Galal, moved on from examining policies to examining intuitions. In this regard, he stressed that this conference is being held under the belief that institutions and governance matters, and while some economists may like to think “the world is under their fingertips,” no one can deny the importance of governance.

Presenting the keynote speech, Malik presented on the Political Economy of Macroeconomic Policy in Arab Resource-Rich Economies, focusing on linkages between different aspects of macro policy and how policy is shaped by political considerations. He maintained that macroeconomic policies in oil-rich economies usually target political, not economic, stabilization and that ultimately the matter has more to do with politics than economics. Achieving this stability he notes, depends more on “deep pockets” than institutions.

In his speech, Malik identified two challenges facing oil-rich Arab economies, namely: underdeveloped debt markets (partly explained by the political sovereign being reluctant to concede space to the private sector); and low levels of central bank independence (partly explained by the absence of an independent economic constituency that could demand and receive policy signals). He concluded that oil-rich countries tend to achieve stability “largely by adjusting the distributional equilibrium rather than building institutional resilience.”

Moving on to the first session, on Oil and Fiscal Policy, Nugent began by stressing that evidence is mixed on whether oil abundance is a curse or blessing. He then went on to explain that while some resource-rich Arab economies had, through Sovereign Wealth Funds for instance, made considerable progress over time to escape the very deficient position they started at, in terms of budgetary and other fiscal institutions; a lot of reform is still needed since there is “alarmingly” little progress in raising non-oil revenues, even in countries that are quickly running out of oil.

In the context of the current low oil prices, Nugent advised oil-rich Arab economies to: strengthen the rule of law and checks and balances; take immediate action to reduce expenditures on subsidies for fuels and food, the military, excessive government salaries and pensions, and duplicative expenditures and functions across rival ministries and agencies; increase government investment relative to consumption; increase non-oil revenues through taxation; and improve efficiency of investment and raise positive externalities.

Next, Mohaddes explored the issue of oil, volatility and institutions in oil-rich Arab economies. He began by noting that in oil-rich Arab economies it is not the abundance in revenues from oil that brings about the so-called curse, but rather the volatility in oil revenue and the government’s inappropriate economic and political responses to these volatilities.

Thus, having a good quality of institutions and lower fiscal and oil revenue volatility would have positive repercussions on Arab oil-rich economies. In this sense, Mohaddes cited Norway as an example of a resource-rich country that was able to avoid some of the negative consequences of oil revenue volatility through a democratic political system with good economic and political institutions (such as the Norwegian Government Pension Fund) and an accountable government. Overall, in order to offset some of the negative consequences of oil revenue volatility, Mohaddes advised resource-rich countries to set up “forward-looking institutions with the aim of saving when commodity prices are high and spending accumulated revenues when prices are low.”

In the second session, on Resource Abundance, Fiscal Dominance and Monetary Outcomes, Bassem Kamar of the International Monetary Fund presented research he conducted with Soto on Monetary Policy and Economic Performance in Resource Depen¬dent Economies.

First, Kamar began by pointing out that there is a big difference between abundance and dependence, especially when it comes to oil. He gave the examples of Bahrain and the UAE as countries that despite being abundant in oil are not dependent on it as an export. The main issue, according to him, is that while in oil-abundant countries resource rents are positively related to growth; in oil dependent countries resource rents have a large, negative, and significant effect on growth. Moreover, during his presentation, Kamar noted that floating regimes are inferior both in terms of growth and inflation and that no alternative monetary regime is clearly superior to intermediate regimes for dependent countries.

To conclude, he advised resource dependent Arab countries to use their monetary policies to target diversification and competitiveness and not pegging and noted that the design of appropriate institutional requirements requires differentiation between populous and GCC economies.

Next, Elbadawi spoke on Fiscal-Monetary Interdependence and Exchange Rate Regimes in Oil-Dependent Arab Economies. The gist of his presentation centered on differentiating between three types of resource-rich economies: populous ones (like Algeria, Sudan and Yemen), the GCC, and comparators (like Chile and Norway). In order for populous oil Arab economies to progress, Elbadawi contended, they need to work on the basics. Such basics include developing better and more stable and predictable institutions and “breaking free” from fiscal dominance. On the other hand, in terms of the “de facto hard currency peg,” Elbadawi said that while so far it has been appropriate for the GCC, these countries still need to reconsider the “optimality of the regime,” as their economies diversify and become more complex. On the longer term, Elbadawi noted that these countries would need to follow the path of Norway and Chile by adopting explicit fiscal rules alongside high technical capabilities for conducting monetary policy.

In the third session on Central Bank Independence and Institutional Reforms, Rutledge spoke on prospects for a GCC currency union. She identified some precursors for a GCC currency union, including a “GCC Central Bank” and a “Gulf Stat” – a Eurostat equivalent for Gulf countries. However, she stressed that ultimately decisions to create a successful and sustainable single currency are driven by political, not economic calculations, since such a currency would require some ceding of national sovereignty. Since such political concessions do not seem to be on the horizon, Rutledge dismissed a single currency as a short-term prospect and instead highlighted the idea of a parallel currency, a so-called “Gulf Dinar,” as a preliminary step towards further integration. Provided GCC leaders see benefits in a closer union, the adoption of a “Gulf Dinar” would offer numerous advantages, such as enhancement of intra-regional trade and investment, without necessitating the same degree of relinquishing of sovereignty that a currency union entails.

On her part, ERF economist Hoda Selim presented on Central Bank Independence in Resource-Rich Economies. She began by asking to what extent are Arab central banks independent, transparent and accountable, noting that Arab countries have less developed institutions (central banks) and a low stock of credibility that could affect policy effectiveness. To answer that question, Selim divided oil-dependent Arab economies into two groups: high rent per capita countries and low rent per capita countries; and then proceeded to make some observations. She identified major institutional weaknesses in both groups of Arab countries related to political autonomy and accountability, noting that the low political independence of central banks is associated with overall weak political institutions.

Firstly, she pointed out that the appointment and dismissal of central bank governors and board members in most Arab central banks are strongly influenced by the executive government. Secondly, she observes that Arab central bank governors’ term of office are shorter than that of executive governments. Thirdly, she noted that Arab central banks generally have broad mandates that include growth and financial stability In this context, Selim outlined a reform agenda for Arab oil-rich countries allowing them to undergo political reform to support macroeconomic institutional reform and thus improve management of natural resources. Such reform includes, per Selim, strengthening the political autonomy of central banks to untie monetary policy from politics; the setting of rigorous accountability and transparency procedures to bolster the credibility of monetary policy; the prioritization of central bank objectives in order to ensure policy inconsistencies are avoided during implementation; and, finally, countercyclical fiscal policy and fiscal rules to smoothen fiscal spending and promote fiscal discipline.

On the second day of the conference, Monaldi explored Oil, Rents and Politics in his presentation titled “Oil and Politics: The Venezuelan Experience.” He drew a depressing picture of the situation in Venezuela, saying that the Latin American country has a “very bleak” future. Monadli explained that while most countries improve after shocks in terms of savings and micromanagement; this is not the case in Venezuela – a country that risks becoming the first oil-economy with hyperinflation. The lesson that can be drawn from the Venezuelan experience, according to Monaldi, is that lack of institutions, like central banks, stabilization funds and the wider political institutions, can lead to disastrous performance even in a country with massive natural resources.

Speaking next, Ross looked at resource abundance from a political science perspective and identified what he called a “political resource curse,” in that oil seems to have a strong effect on government accountability, press freedom, corruption and both national subnational politics. According to Ross, today there is a “profound difference” between oil producers and non-oil producers in terms of democratic level. However, he notes that his is not because oil-rich Arab countries are regressing, but because the rest of the world is more rapidly progressing towards democracy. In this sense, Ross claims a significant association, cross-region, between oil endowment and lack of political freedom. Ross attributes this, among other things, to the notion that when governments do not need to collect taxes they become less accountable.

To conclude, Ross notes the following: Hossein Mahdavy’s premise, introduced in the 1970s, that oil reduces political accountability has shown itself to be true and this effect has grown over time and is true across countries; transitions occur when oil rents drop; and, finally, there is no precedent for high-rent oil producers undergoing political transitions and so we cannot analyze this matter.

Finally, speaking in the panel discussion on Institutional Reform in the Arab World Devarajan stressed that oil-rich Arab countries are not really in an emergency at the moment, citing Kuwait as an example of a well-functioning oil-rich country. Still, he said that while this is not an emergency, Gulf countries can still achieve much greater potential and fortunately have the time and political space to pursue the achievement of this potential.

One challenge the World Bank economist mentioned in this regard is that of accountability, highlighted by the fact that oil revenues in oil-rich countries go directly from the oil companies to the government and do not pass through citizens. This leads citizens to not know the extent of oil revenues or at least believe that they do not know. Moreover, he notes that in some cases citizens may not even fully think of oil revenue as their own money, which leads them to not scrutinize government spending enough.

In the end, Devarajan stressed that Gulf citizens need to realize that oil wealth is not distributed to them by their government but is redistributed. Unfortunately, such redistribution, is carried out by the government in the worst way possible: through energy subsidies and civil services wages, Devarajan contends. Thus, he advises oil-rich countries to replace fuel subsides with cash transfers – a more suitable way through which oil wealth can be redistributed. In terms of the need for oil-rich countries to diversify, Devarajan noted that the reason for the current worry is how to manage the post-oil era, keeping in mind that it is a long way away, “maybe 20-30 years away.”

In this context, he noted that developing industries today does not mean that they will be lucrative 20 years from now and it is very difficult to predict which industries will be profitable at that time. A better idea, per Devarajan, is to think of “people, not industries,” and focus on investing in the human capital that can push the countries forward through ideas and skills when the oil runs out.

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Working Papers

Is the Announced Monetary Union in GCC Countries Feasible? A Multivariate Structural VAR Approach

Magda Kandil and Mohamed Trabelsi

Abstract This paper tests the desirability and feasibility of establishing a monetary union in GCC countries using a multivariate structural Vector Autoregression Model (VAR) for the ... read more

Don’t Blame the Abundance of Oil!

Kamiar Mohaddes, ERF Research Fellow and Senior Lecturer and Fellow in ... read more

It Takes Two Functioning Cylinders to Operate the Macroeconomic Locomotive

The Fiscal-Monetary Interdependence in Oil-Dependent Arab Economies This blog is written by Ibrahim Elbadawi, ... read more

Institutions, Oil and Macroeconomic Management… What Does it Take to End the Resource Curse?

This blog is written by Hoda Selim, an economist at the Economic Research Forum Natural resource ... read more

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