Macro Adjustment: Now or Never

As author John Steinbeck reminds us in his masterpiece, East of Eden, human nature is such that we forget quickly, but it should not and does not have to be that way when managing an economy. African economies in particular are significantly affected by booms and busts, which are created by fluctuations in commodity prices, exchange rates and interest rates.

Can we afford to forget about the impact an oil price of over 100 dollars per barrel has on oil-consuming economies in Africa and only focus on oil-producing countries who are benefiting? Can we afford to forget about the impact an oil price below 30 dollars per barrel has on oil-producing countries in Africa and only care about the oil-consuming economies who are benefiting?

Given the susceptibility of African economies to these major shifts, this human tendency towards forgetfulness must, instead, become one of education and lessons learned.

These same questions apply in the fixed income market (ForEx and interest rates) and the impact its volatility has on African economies. Now is not only the time to sound the alarm on commodity price volatility and its impact on African economies, but for African economies to take charge and protect their economies by fully embracing sound risk management principles.

According to the International Monetary Fund (IMF), Africa’s growth rate fell from five per cent in 2014 to 3.8pc in 2015; its lowest in 17 years. Clearly, many African economies have been hit hard by the volatility of commodity prices, which is a recurring problem. The question now is what can be done about it.

Every African country’s development plan ought to include a detailed financial risk analysis for the medium and long terms. That analysis should clearly identify the major risks to which a given economy is subject. Once identified, these risks have to be quantified as much as possible.

This risk quantification step is key because, in commodity-producing countries, for example, just looking at their daily production figures and equating that to their commodity risk exposure is just not accurate. In the case of oil-producing countries, a risk tolerance analysis could mean finding out at what oil price level, by how much, and for how long does the economy hurt.

It could also mean finding out at what oil price level the economy stops generating enough dollar revenues, which could then lead to external debt servicing problems. In the case of oil-importing countries, where oil subsidies are still in place, the question could be, “At what price level do subsidies become unsustainable for the yearly government budget?”

The concept of risk tolerance is one that has been implemented with some level of success by the private sector, especially international banks. I strongly believe that African governments could benefit tremendously from integrating risk tolerance analyses into their macroeconomic studies.

These analyses should help a given country know exactly what kind of shocks it can sustain or not. The shocks deemed unbearable should be the ones that lead to the formulation and implementation of a detailed risk management strategy.

Some may argue that for some economies, going through the steps above is now a bit too late. I disagree.

In fact, for oil-producing countries, the above analyses should at least encourage getting a strategy in place now and implementing it as soon as oil prices recover to reasonable levels. Moreover, for oil-consuming countries, it is absolutely crucial that they put these measures in place now and actually implement a hedging strategy that will lock in these low oil price levels for the medium term.

There were many experts who expected a 100-dollars price for a barrel of oil to be the norm; and now we are hearing that prices should stay around 30 dollars for a prolonged period.

But who knows? Indeed, in a 2001 IMF paper titled, “Hedging Government Oil Price Risk” by James Daniel, a Mexican government official states, “We said, listen, given the uncertainty and given the volatility, it can go to 40 dollars (a barrel) or it can drop to 10 dollars. We have a budget here, a budget that we have to cover […] We didn’t do it to be ahead. The government does not speculate in that sense. Doing nothing is speculative. It does look good now that we are ahead compared to doing nothing. Some days we do not do as well. But we sleep well.”

The words above are in fact full of wisdom for African economies exposed to commodity price risk. Some of them have in fact put in place successful sovereign commodity risk management programmes. But many still live without it.

I am not advocating that African countries just focus on hedging insurance alone to manage their risks. What is advisable is that African governments use a diverse set of tools to manage risks.

We have now seen the damage commodity price volatility inflicts on African economies. As a result, governments cannot sit idly by and not insulate their economies against commodity price risk. It does not have to be that way.

 


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