Smart policies needed to overcome commodity dependency

Economic growth in Nigeria has fallen by 3% and the country’s public finances and current account balance have markedly deteriorated. (Lionel Healing, AFP)

Economic growth in Nigeria has fallen by 3% and the country’s public finances and current account balance have markedly deteriorated. (Lionel Healing, AFP)

COMMENT

It’s no secret that the global economic landscape has become increasingly challenging over the past few years, with many low-income developing countries feeling significant pain.

Conditions are not expected to improve soon, meaning that smart policies must be enacted now to navigate these challenging times without compromising on development. Institutions such as the International Monetary Fund are ready to assist with technical expertise and financial support, where needed. 

Falling commodity prices, increasingly tight financial market conditions and economic strains in several emerging market economies are affecting low-income developing countries. Growth in 2015 for these countries dropped to 4.6% from 6% in 2014, with commodity exporters being hit hardest. 

Economic conditions are set to remain largely subdued throughout 2016 and commodity prices are forecast to remain low, limiting the recovery in commodity-dependent countries. 

For now, the era of high commodity prices has come to an end, and commodity exporters need to adjust.
Weaker global growth, falling mineral demand in China and supply-side developments have drastically pushed down commodity prices.

From June 2014 to 2015, non-energy commodity prices declined by 26%, and energy prices dropped by almost two-thirds. For commodity exporters, this has been a major shock. For example, in Nigeria, an oil exporter, economic growth has fallen by half to 3%, and the economy’s public finances and current account balance have markedly deteriorated.

Although oil and other commodity prices are expected to start picking up in the near term, they will remain much lower than the highs seen in the recent past.

To meet this challenge, commodity exporters must align fiscal positions with sustained low export prices. In the short term, the pace of adjustment may be tempered with available policy space, use of reserves or borrowing – if countries can afford it. In the longer term, however, better tax collection and diversifying exports will be required.

Tighter external financial conditions pose another challenge. The cost of external financing has sharply increased over the last two years. Average interest rates on government bonds for commodity exporters, for example, almost doubled since end-2014, reaching about 12 percentage points in early February. Countries with high external debt, whether public or private, are particularly vulnerable.

In addition, in light of the recent appreciation of the dollar the problem is compounded in countries holding large amount of debt in US dollars. Moreover, the prospect of higher US interest rates, as the US economy recovers, would also increase the financing costs of external borrowing.

Countries with diversified exports, such as Bangladesh, Kenya and Vietnam, benefited from commodity price movements, with growth continuing at a robust pace. But even these countries are not spared from the rising cost of external financing and potential spillovers from lower global growth.

Early action to rebuild the fiscal and external arsenals is now needed. The large shocks experienced by commodity exporters provide a clear message about the importance of swift measures.

A number of low-income developing countries also bear the burden of domestic conflicts, such as Yemen and Burundi. Furthermore, many countries have been buffeted by severe natural disasters and other calamitous shocks. This includes Nepal’s earthquake and the impact of the Ebola epidemic on Guinea, Liberia and Sierra Leone.

Over time, low-income developing countries, more than others, will face greater risks from climate change. Almost 80% of these countries are highly vulnerable to increasing global temperature, compared with 40%  for higher-income countries.

Because of their geographical location and dependency on agriculture, these countries could experience as much as a 1.5 percentage point decrease in growth for each centigrade rise above their national average temperature.

Policymakers must act now to build resilience to climate change. Policies should include risk identification and adaptation assessment, self-insurance, and risk reduction through targeted investments in infrastructure and enhanced disaster management capacity. Some countries, such as Bangladesh, Cambodia and Nepal, have started these efforts by incorporating all climate-related spending into government budgets.

Adaptation to climate change for low-income developing countries will also require external financial support. Without this, attaining ambitious development objectives will be difficult. Development partners and multilateral institutions need to play their part to support these countries to build domestic capacity and to develop affordable hedging and catastrophic insurance markets, all of which are essential for building resilience.

The clock is ticking, but the good news is that it’s not too late. The right policy choices can go a long way towards boosting resilience and put these countries on a path to sustainable growth. The time to act is now.

Min Zhu is a deputy managing director, Stefania Fabrizio is a deputy unit chief and Futoshi Narita is an economist at the International Monetary Fund.

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