The perils of commodity price volatility
19 Feb 2016
Since 2011, the price of oil has fallen by 51%. Copper, coal and iron ore prices have dropped by 38%, 53% and 67%, respectively. Commodity dependent countries in Sub-Saharan Africa are facing serious fiscal and balance of payment deficits, hindering the progress towards the sustainable development agenda.
Some countries increased supply of commodities to compensate for the fall in prices. Equatorial Guinea boosted oil exports by 13%, but revenues declined by the same percent. The Democratic Republic of the Congo (DRC) increased copper production, but revenues declined by US$360 million.
Others cutback on supply in the hope that prices will go up. For example, Angola and Nigeria decreased the supply of oil, but revenues declined by US$5 billion for Angola and by US$26 billion for Nigeria. Chad, Congo and Gabon have cut production, but saw oil revenues decline by over US$2 billion. Zambia experienced a fall in revenues by 23% after reducing copper production. Liberia’s iron ore production declined by a third and its revenues fell by two-thirds.
In the short run, there are five options. The first is withdrawing from sovereign wealth funds (SWFs). However, Nigeria’s Stabilization Fund, valued at US$0.5 billion, will not suffice; given its fiscal deficit is around US$11 billion. Many other countries do not have SWF outlets as they are still in the early stages of establishing them.
Second option, drawing down on central bank reserves. But there is little room left. Prior to the price shock, both Nigeria and Angola had reserves that could cover eight months of import bills. Today, reserves cover less than 6 months of imports for Angola and 4 months for Nigeria. Equatorial Guinea and Zambia have reserves that cover 3 months of imports, while the DRC only has enough to cover one month.
Third, contemplate cutbacks in public expenditure. Often such cuts fall on the social sector, mainly health, education and transfers that protect poor households. These cuts will hinder the progress towards the SDGs.
Fourth, initiate domestic resource mobilization efforts. For these to be effective, international agreements are needed that curb illicit financial flows as well as closing loopholes for tax evasion and avoidance.
Fifth, explore external borrowing. However, strict conditionalities may be attached to loans obtained from international financial institutions or a rise in the debt-to-GDP ratio if the borrowing is from the private sector. Concessional lending with no strings attached is needed.
In the long run, economic diversification is the only viable solution. Commodity-dependent countries generate over a third of their fiscal revenue and foreign exchange from hydrocarbons and minerals. Their manufacturing sector, as a share of GDP, is 5% on average, compared to 14% in the Latin American and Asian commodity-dependent economies.
The current price shock presents yet another opportunity to embark on economic diversification strategies. This is not a novel idea. At the core of the African Mining Vision and Agenda 2063 of the African Union is economic transformation. However, it has not yet been taken seriously in terms of implementation. It is time for action.