BOOM WILL BE SHORT-LIVED, WORLD BANK WARNS

6:30 AM Jan 15, 1996

BOOM WILL BE SHORT-LIVED, WORLD BANK WARNS
Geneva 13 Jan (Chakravarthi Raghavan) -- The current boom in commodity markets which began in 1992 may have already peaked and won't continue for long, and commodity exporting countries should beware and not over-spend or over-commit themselves into the future, the World Bank warns in a just-published booklet, "Managing Commodity Booms - and Busts".

Written by Panos Varangis, Takamasa Akiyama and Donald Mitchell, with a foreword by the Bank Vice-President and Chief Economist, Michael Bruno, the 22-page booklet carries the disclaimer that the findings, interpretations and conclusions are those of the authors and not of the Bank.

The booklet examines experiences of developing countries in earlier commodity boom-bust cycles, and attempts to draw some lessons on management of commodity price volatility.

While cautioning governments against commitments to long-term spending on the basis of the increased revenues and earnings in a boom, the Bank comes out with the prescription to governments to use the earnings to relax capital-account controls and import controls, and for liberalisation of imports -- all of which it says will improve economic efficiency and produce permanent income gains!

The paper though does not say what would happen to the countries when the commodity boom cycle ends and export earnings fall and how the equally long-term commitments of eased (and clearly not easily reversible) capital controls and liberalised imports (of inevitable luxury consumption for upper middle classes) would be maintained and paid for.

In the current boom, in dollar terms, Malaysia registered the biggest gain of $1.76 bilions - with palm oil leading the way with increased earnings of $1.36 billion, followed by rubber and its $340 million.

The other beneficiaries were mainly coffee exporters. Brazil benefited the most, but also Colombia. Another was Indonesia -- with $400 million out of rubber, $300 million out of palm oil and $ 300 million out of coffee. In Africa, Cote d'Ivoire gained -- $250 million on cocoa and $200 million on coffee.

Citing the experiences of Colombia, Kenya and Tanzania in the 70s, and of Nigeria in the late 70s and early 80s on the oil boom, the paper notes that these countries got into trouble by basing their future expenditures on these revenue increases and got into trouble when the bust came.

It talks of the detrimental effects to long-term economic growth of fluctuating GDP and investments, and the need for 'counter-cyclical' fiscal policies and complaints that governments tend to adopt pro-cyclical fiscal policies because of the windfall tax revenues.

But the paper stops short of advocating these Keynesian policies at the time of commodity bust and contraction.

The paper also warns of the effects of soaring foreign exchange earnings during a boom, resulting in excessive appreciation of the currency, making some tradeable sectors less competitive on global markets -- the 'Dutch disease' as it became known from the experience of the Netherlands during the 60s discovery and export boom of North Sea gas.

Governments in past booms, it notes, adopted policies to manage the booms and avoid the Dutch disease -- export taxes, commodity boom bonds, hedging instruments, revenue stabilization funds and international commodity agreements -- and finds fault with all of them.

Export taxes, it says, damaged the booming sector without benefiting other sectors. Often public investment projects were selected on non-economic grounds, and high taxes encourage tax evasion and smuggling. Commodity bonds in foreign currencies, issued by the Central Bank and which commodity exporters were expected to hold (as partial payment for exported coffee), is an export taxation in disguise and an implicit tax.

While hedging can be used to make future revenues more predictable, the paper says that this could be quite costly, would require good credit ratings and is more effective when used to cover commodity prices for a relatively short period of time.

As for revenue stabilization funds, it agrees that a well-designed fund could smooth expenditure adjustments upwards and downwards, but argues that funds often run into difficulties because of unpredictable nature of commodity prices or mismanagement of fund resources.

After thus knocking down these remedies, the paper has some DOs to countries to manage the boom.

Firstly, governments should not commit to long-term spending levels that can't be sustained when the boom fizzles. Secondly, countries should have sound macro-economic policies -- monetary and fiscal policies -- and could even consider reducing external debt with proceeds from the boom.

It then advocates relaxing capital-account controls and restrictions on investing abroad, and reducing import controls. The favourable trade balance situation should be taken advantage of to ease import restrictions.

This, the paper argues, would avoid a real exchange rate appreciation and improve economic efficiency.

"If windfalls are used to finance trade liberalization there will be permanent income gains and trade diversification, and the economy will be in much better shape after the boom than it was before."

The paper also suggests that governments should use the windfall revenues to facilitate diversification and adopt structural adjustment programs to improve efficiency.

Again the paper is silent on how the diversification, particularly vertical diversification (rather than into other commodity productions) can be accomplished within a boom-bust cycle -- when there are many more structural problems including control of this processes, and technology for it, is in the hands of the TNCs and the diversified and higher-value added processed products meet with higher barriers in export markets.