Gov’t Has an Addiction, New Capital Can Exacerbate It

Late last month, Prime Minister Abiy Ahmed (PhD) announced the commencement of trial project for the extraction of crude oil in the Ogaden Basin of the Somali Regional State. For citizens whose nation has long been taunted as resource-poor and is currently grappling with a bitter macroeconomic crisis, this was music to their ears.

Lack of natural resources has meant that the nation must depend on imports, such as fuel, and cover the cost by processing value-added export goods. The latter, even when it comes to agricultural commodities such as coffee, has not been realised while the former has continued to climb given growing demands. Under these circumstances, indeed, natural resources can seem like godsend.

Although there is still no confirmation that the reserve is large enough for commercially viable production of crude oil, Abiy had added that the nation would be able to earn over a billion dollars from natural gas exports from the Ogaden Basin in the first years of operations.

This coincides with the planned partial privatisation of state enterprises in the commanding heights of the economy by the Executive Committee of the EPRDF.

Theoretically, this should alleviate the forex crunch, help the government up its capital expenditure for infrastructure development  and allow manufacturers to import needed raw materials. It should also help the nation settle its external debt, currently standing at around a third of gross domestic product (GDP).

This though would entail that the new capital injected into the economy will be allocated efficiently. It presupposes that institutions, unsuccessful at warding off corruption and weak management of resources, can mature enough to be trusted with significant amounts of capital that would be funnelled into the government’s coffer.

The efficient use of such resources is also prevalent on the policies that Abiy’s administration, and subsequent ones, can effect. If lack of a strong competition in the service sector – aviation, logistics, finance and telecom industries – continues, quality enforcement remains weak, government borrowing crowds out credit for the private sector and public sector bureaucracy subsists, it will be hard to account for productivity.

It will make the nation dependent on natural resources, which are influenced profoundly by the vagaries of global energy commodity prices. How oil-producing countries such as Libya, Iran, Nigeria, and Russia have fared in the face of falling prices starting in 2014 should be a lesson here. Venezuela had 35 billion dollars wiped out of its national wealth when the price of a barrel of oil hit 45 dollars.

As for the foreign currency that is to be generated from privatisation, the conversion of physical assets into liquid ones could fall prey to the ill-advised exchange rate policy that has indirectly incentivised financial outflows and the flourishing of the black market.

The end result, as Abiy hinted at in a press conference held to announce the crude oil trial extraction, could be calamitous. Significant injections of capital into the economy, by way of the government’s coffers, can lead to highly reactive policy decisions, and there will be less appetite for affecting structural reforms that demand political capital or risk.

It can lead to governments with a devolved incentive to be accountable. With a lesser need for individuals and businesses to pay taxes or grow the tax base, the less likely the government would be obliged to abide by its side of the deal, which is to ensure that the rule of law is upheld.

The nation’s need for cash cannot be underestimated. Faced with a population a fifth of which is under the poverty line, high youth unemployment, and poor infrastructure, the government has for over a decade tried to right the ills with as much investment as is necessary. By splurging on infrastructure development, it has sought to create employment opportunities while at the same time affect investments in transport, education and energy.

This has been harder than expected though given that even as expenditure grew, revenue has been muted. It has given rise to the current macroeconomic predicament, including a double-digit inflation rate.

At such a crossroad, the tendency to settle accounts with a significant capital injection will be almost forgivable if it was not so irresponsible. It would merely delay the economic recession that will be waiting just around the corner until such time as the foundation of a healthy economy – competitive markets, and capable institutions – are established.

Bar structural and policy reforms, new capital will give rise to the economic ills the nation currently suffers from as the problem of poor allocation of resources would not have been addressed.

Such a gloomy end to what should be a novel source of wealth and prosperity can be forestalled if the government is able to ensure that significant revenues – from the export of natural resources or foreign currency generated from privatisation – enters the economy slowly.

The revenues ought to be held in sovereign wealth funds similar to that of the Australian Government Future Fund or Government Pension Fund in Norway. An establishment of such a fund must be followed up with robust legal frameworks on how much, where and when the revenues can be saved, or withdrawn to ensure transparency and effective investment.

Concurrently, strengthening institutional capacity and instituting an adequate level of checks and balances in government is in order.

Not immediately spending the significant amounts of capital that could enter the economy will mean that the government would have to depend on its usual sources of revenue, such as grants and taxes. Unavoidably, it would make it impossible to cover annual debt interest, recurrent budgets as well as invest in infrastructure. This will leave the government with an austere fiscal policy that cuts back on infrastructure spending as the last alternative at this critical juncture in the economy.

Such a decision would exhaust the EPRDF’s newly secured political capital. But the EPRDFites have also to note that taken sooner than later, structural and policy reforms would ensure the efficient and responsible use of the nation’s new resource from the outset.

Published on Jul 07,2018 [ Vol 19 ,No 949]



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