Speech

Policies to Restore Orderly Oil Market Conditions, Remarks by John Lipsky, First Deputy Managing Director of the International Monetary Fund

June 23, 2008

1. Minister Al-Naimi, my IMF colleagues and I would like to thank King Abdullah and the Saudi Arabian authorities for organizing this timely and important meeting. Restoring orderly oil market conditions has taken on new urgency in light of the likely destabilizing impact that the rapid and volatile movements in oil prices have on the global economy.

2. Let me begin by discussing the global macroeconomic implications of the recent oil price surge, which has surprised virtually all observers. To put this into context, current oil prices are now significantly higher in real terms than the previous record reached in the late 1970s.

• The oil price surge, together with the sharp rises in other commodity prices, has boosted inflation across the globe. In advanced economies, headline inflation has become uncomfortably high—at about 3½ percent in the euro area and 4 percent in the United States—at a time when economic activity is slowing notably. While measures of core inflation so far have remained quite well anchored, there are some signs that expectations are edging higher. This is complicating monetary policy decision making, as central banks have to tread a fine line between containing inflation and supporting demand, although slowing growth is likely to help eventually.

• The inflation concerns are even more serious in emerging economies. Inflation pressures have risen sharply, as the effects of the rising prices of oil and other commodities have come on top of pressures from strong growth in activity. The risks that the high oil and other commodity prices could spark more generalized inflation through second-round effects have risen in a number of countries, boosted also by the large weight commodity prices carry in consumer baskets while inflation expectations there are less firmly anchored. While many central banks have tightened their monetary policy stance, these responses often have been timid. As a result, real interest rates have turned negative in many countries, and inflation objectives look likely to be missed in many instances.

• Surging prices of oil and other commodities in tandem with higher inflation also present increasing downside risks to global growth, by reducing purchasing power, as well as from the increasing need for monetary policy tightening to contain inflation. If oil prices remain around current levels, they would, on average, be some $30 higher in 2008-09 than projected in late February. According to IMF estimates, such upward revisions imply lower annual global growth by about ½ to ¾ of a percentage point.

• The macroeconomic impact of rapid and unpredictable oil price movements extends well beyond inflation and growth. On the external side, the recent oil price surge is expected to lead to balance of payments difficulties in some fuel- and food-importing low-income countries in Africa and Central America that have not benefited from offsets from other commodity exports. We are working with these countries and stand ready to support them with our lending facilities. On the fiscal side, countries that have resisted full pass-through of international prices to end-users could experience significant deterioration in fiscal performance.

4.This brings me to the policy agenda. The background paper proposes a broad set of measures, which are broadly similar to our own policy recommendations. With such a broad agenda, however, a key question is that of priorities. Fundamentally, the first priority should be to loosen those policy constraints that have contributed importantly to the surge in prices. Specifically, priorities must squarely fall on policies that have fostered market rigidities and helped to prevent demand and supply from responding appropriately to the signals from rising prices.

6. On the supply side, output projections routinely have been revised downward in recent years, particularly for non-OPEC producers. IMF analysis suggests that real oil investment has been held back by a confluence of cyclical, technological, geological, and policy constraints. Among the latter, the deterioration in the investment climate and the oil investment regime in a number of countries, as well as limits on the cooperation of national oil companies with international oil companies stand out. The perception that a meaningful supply response to high prices may be slow in coming has been one reason for increasing market pessimism and a steady increase in long-dated futures prices. Improving the stability and predictability of investment regimes and encouraging greater cooperation between national and international oil companies would strengthen the supply response.

8. Such policies would be key to foster improved supply-demand balances, as they will allow oil prices to truly reflect the scarcity of the resource. Policy action along these lines is most likely to be successful if it is undertaken in a multilateral context where everyone does their share—and is perceived as doing so—to improve the supply-demand balance in oil markets.