Oil Shocks, External Adjustment, and Country Portfolio

This study examines the intertemporal nature of countries’ external adjustment by using two types of oil income shocks with different timings, namely, giant oil discovery news shocks and contemporaneous oil windfalls arising from the possible exogenous changes in the international oil spot price. Empirical estimates based on a large panel of countries from 1970 to 2011 are consistent with the intertemporal model. Net foreign assets hike immediately upon oil revenue shocks, but decrease in the first five years after oil discoveries, and then increase sharply after oil production starts. Meanwhile, the external adjustments upon oil shocks are largely through the current account channel, and valuation effects only partially stabilize the current account adjustment for oil revenue shocks. Moreover, oil discoveries attract a large amount of foreign direct investment inflow to share the risk of oil extraction, and oil revenue shocks significantly increase the net holdings in low-risk foreign debt assets. Our results indicate that risk-sharing may play an important role in country portfolio diversification.