Why oil is Africas hope and despair


Senior Member
Jun 29, 2007

High oil prices can have harmful effects on oil-importing African countries, especially those with a high debt burden or limited access to international capital markets.

In a paper titled, The Impact of High Oil Prices on African Countries, Hafedh Bouakez of the Institut d’Economie Appliqué, of HEC Montreal, Canada, and Desire Vencatachellum of the Research Department of the African Development Bank, argue that high oil prices lead to a decrease in output and consumption and to a worsening of the net foreign asset position of such said countries.

The paper says: “For the medium oil-importing country, the five-year cumulative output loss resulting from a doubling in the price of oil can be as large as 23 per cent under a fixed exchange rate regime.

“This recessionary effect, however, can be substantially mitigated through local currency pricing (LCP) or through foreign aid. In this regard, the model can be used to determine the optimal degree of intervention by the government given its objective function.”

The authors say that for the median oil-exporting country, the five-year cumulative increase in output associated with a doubling in the price of oil exceeds 70 per cent, regardless of the exchange rate regime under which the country operates.

“This manna, however, is accompanied by a sharp appreciation of the real exchange rate, which may hinder the competitiveness of the country. It is therefore important that oil-export revenues be spent in a way that favours future growth, and not in wasteful or badly planned projects.

“It should be emphasised, however, that while the analysis above focuses on ‘median’ countries, there is a great deal of heterogeneity within the groups of oil-importing countries and oil-exporting countries,” they add. “This means that the effects of oil-price shocks can differ dramatically from one country to another. However, the proposed model can be configured to represent any of these countries.”

The paper was presented at the 2nd African Economic Conference 2007, held recently at the UN Conference Centre in Addis Ababa, Ethiopia. The conference’s theme was “Opportunities and Challenges of Development for Africa in the Global Arena,” and was organised by the African Development Bank Group (AfDB) in conjunction with the UN Economic Commission for Africa (Uneca) and the African Economic Consortium. It brought together policy-makers, economists and researchers to discuss development issues in Africa and is part of AfDB’s campaigns to involve African intellectuals in dialogue on the continent’s development agenda.

Mr Bouakez and Mr Vencatachellum say that while he high price of oil is a unique opportunity for African oil producers to use the windfall gains to speed up their development, it is also having adverse effects on net-oil importing countries, in particular those that cannot access international capital markets to smooth out the shock.

The report constructs a general equilibrium model, which is tailored to reflect the characteristics of African economies, to quantify the effect of the increase in the price of oil on the main macro economic aggregates. The model is general enough that it imbeds both oil producing and oil importing countries.

“Our results indicate that a doubling of the price of oil on world markets with complete pass through to oil consumers would lead to a 6 per cent contraction of the median net-oil importing African country in the first year.

If that country were to adopt a no-pass through strategy, output would not be significantly affected but its budget deficit would increase by 6 per cent. As for the median net oil exporting country, a doubling in the price of oil would mean that its gross domestic product would increase by 4 per cent under managed-float and by 9 per cent under a fixed exchange rate regime. “However, inflation would increase by a much greater magnitude under a managed fixed exchange rate regime in median net oil exporting country.”

Experts say that although in real terms, the price of oil is still lower than in the late 1970s and early 1980s, the recent upsurge can have dramatic consequences on oil-importing countries.

In 2006 the African Development Bank (AfDB) implemented a survey to investigate the extent to which governments of its regional member countries have intervened in the retail market for fuel to limit the pass-through of international oil prices. 20 out of the 24 countries that Mr Bouakez and Mr Vencatachellum have data on, 20 had legislation in place to control the retail price of petrol and only four had full pass-through.

As a result, while the price of oil had nearly doubled between 2000 and 2005, domestic prices have increased at a much slower pace. For example, the price of regular petrol increased by 65 per cent in Benin, 76 per cent in Mali and 77 per cent in Mauritius. Moreover, the survey indicates that governments subsidise, or limit the pass through of, kerosene more than other types of fuel on the grounds that it is mainly used by the poor.

The paper argues that oil-exporting countries stand to benefit from the significant influx of foreign revenue hey can harness for their development. They are challenged to manage the oil windfalls for the benefit of the whole population, as well as future generations and cushion their economies against the so-called Dutch disease.

However, the benefits of the high price oil are not evenly spread across Africa. The five top oil-producing countries — Nigeria, Algeria, Libya, Angola and Egypt — account for more than 80 per cent of the continent’s production.
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