12:03 PM Apr 21, 1993

WORLD BANK HEDGES BETS WHILE PROJECTING OPTIMISM

Geneva 21 Apr (Chakravarthi Raghavan) -- An end to the long-term trend of decline, and even a slight upward movement in real non-oil commodity prices and thus terms of trade of commodity exporting countries has been projected by the World Bank's economists and econometrists in their report published last week "Global Economic Prospects and the Developing Countries".

This is a major premise or assumption behind the Bank's optimistic projection that developing countries would do better over the next decade (1992-2002), and that sub-Saharan Africa would register positive growth rates after a decade of falling output.

The Bank itself, though, has warned of some serious downside risks in its prognostications and has said that in the case of Africa in particular the prospects were particularly fragile.

A detailed perusal of the report, issued on the eve of the Interim and Development Committee meetings in Washington of the International Monetary Fund and Development, and released (with a media barrage) in Washington last week, but which became available here only Monday, however shows that there is not only the downside risks of external factors but questionable assumptions behind the projections.

The somewhat glaring one is in relation to commodity prices.

According to the Bank's economists, the index of non-oil commodity prices, deflated by the manufactured unit values, while subject to short-term market fluctuations, have shown a declining trend of an annual 1.5 percent per annum over a period spanning 44 years. Interestingly, the Bank and Fund economists in the 1980s used to debunk this Prebisch view in the UNCTAD.

However, the bank economists project a reversal of this trend and an upward price rise trend (in real terms) of an annual 0.7 percent over period 1992-2000 or a 2.2 percentage point turn around (Fig 6-1, page 58).

This reversal of the price trend is crucial for the Bank's positive projections, not only in terms of commodity export earnings but the effective real interest rates at which they would borrow.

There is now a general consensus view that the disastrous performance of the sub-Saharan African countries in the 1980s was due to no small extent to the collapse of their commodity price exports and earnings.

A number of studies have also blamed the collapse of the commodity prices and earnings on the Fund-Bank stabilization and structural adjustment policies as a result of which to repay their debts these countries were encouraged or forced to export which, to them, primarily meant export of primary commodities.

Also, the individual country-desks of the World Bank, using the upward trend in commodity prices that prevailed between 1979 and early 1980s, encouraged individual countries to diversify and expand their commodity production and exports.

But the Bank economists forgot all about the theory of 'fallacy of composition', and despite the availability of a large array of computerised databases, did not envisage the effect on prices in the world markets of all countries with more or less diversifying (horizontally) into similar commodities and increasing exports.

As a result, while all the African countries increased their volume of exports, the prices fell much faster, and they ended up with less earnings than before.

The Bank which preaches the theology of the market, and lent money to countries that followed its advice, nevertheless did not follow the principles of the market for itself.

Any creditor lending money to a project that fails, and turns the borrower bankrupt,has to pay the penalty by writing off his loans. Even sovereign borrowers in the last few years have been able to get the banks to write down their debts.

However, though the policy advice was faulty, and the countries came to grief, the Bank and the Fund did not write off their loans but the countries have had to repay and are still doing so.

In its base-line scenario in the report, the Bank has projected a growth rate of developing country GDP of 5.3 percent a year or more than one percent above that of the 1980s and 1970s, but 0.5 percent below the rate of the 1960s. The optimistic forecast for the developing world as a whole, the report underlines, is based on a marginally improved international economic environment, stronger developing country policies and a restoration of access to external finance after restructuring.

For sub-Saharan Africa, the Bank economists have projected a GDP growth "thanks to the projected break in the declining trend in real commodity prices". The baseline growth projected is of an annual 3.7 percent over 192-2002, but with a 2.1 percent population growth, per capita growth is put at 0.6 percent, still a positive one compared to the negative growth and per capital in the 1980s.

Export growth for these countries is predicted to increase in response to more liberalized trade regimes, but the economists also add that "the current composition of exports with its heavy reliance on commodity goods, along with the lack of adequate supporting infrastructure, will limit Africa's ability to raise its export potential rapidly".

The international economic environment for developing countries, the report further adds, is expected to be better in the 1990s than in the 1980s, despite lower prospective growth in the high income countries, because world trade is expected to grow faster, real interest rates to be lower and "real commodity prices to stop declining".

In an earlier chapter "The international economic environment for developing countries", the Bank economists in their report have said "the outlook for this environment in the 1990s is in some respects worse, from a developing country viewpoint, than the 1980s situation and in some respects better."

"Long-run growth in the industrial countries is expected to be slow, because of slow productivity growth. World trade, however, is projected to rise faster than OECD-country growth, in part because of trade between developing countries and in part because of the impact of regional arrangements.

"Long-term real interest rates are projected to remain high largely because of poor savings performance in some major industrial economies, but the trend of real commodity prices is projected to end its long-run decline, because of a continuing shift by developing countries out of primary production."

While forecasting a continuation of high real interest rates, particularly long-term rates, reflecting considerations of both a cyclical and structural nature, the Bank economists have said that "if, as projected here (in the report), the terms of trade of developing countries reverse their historical decline and stabilize, or rise a little, the effective real interest rates paid by many developing countries will fall substantially even if interest rates in the G-7 stay high"

Thus a rise in real commodity prices appears crucial for the bank's base-line scenario as well as the more optimistic projections, both for developing countries as a whole and even more for sub-Saharan Africa.

Primary commodities, the bank economists underline, still represent about half the export proceeds of developing countries (the figure is much higher for sub-Saharan Africa alone).

"Over the whole forecast period, the prices of primary commodities are expected to be approximately stable in real terms, ending the downward trend of the last twenty years" (table 6-5), the bank says.

"The baseline forecast," the economists add, "calls for some increase in food and beverage prices from deeply depressed levels, but prices of other commodities are unlikely to show any sustained recovery in real terms. Also, the price of oil remains approximately constant in real terms.".

"Major factors underlying these projections," the economists add, "first, a continuing long-run decline in the production of perennial crops, especially coffee and cocoa, where production costs often exceed world prices, and new plantings have fallen; and, second, in the latter half of the decline, a decline in petroleum production by both OPEC and non-OPEC producers".

The report goes on to project crude oil prices remaining nearly constant in nominal terms for the next few years and, thus, decline in real terms - from 76 in 1992 to 71.1 in 1995. While OECD industrial activity is expected to pick up after 1994, oil supplies should be ample to forestall price increases for some time. But over the latter half of the decade prices are expected to show an upward trend in real terms as production begins to decline and petroleum consumption increases --with increased use of motor transport as the main reason for this growth.

While nonfuel primary commodity prices have fallen sharply in real terms since early 1980s, and prices of all major commodity groups have fallen, the bank notes that the largest decline was in the beverage group.

But in 1993, the economists project beverage prices to improve, though more than offset by declines in constant-dollar prices of cereals, agricultural raw materials and metals. From 1994 onward, the aggregate non-fuel index is expected to increase, although only slowly -- from 86.6 in 1993 to 94.2 in year 2000. Increases in beverage prices will be supported by upturns in all other groups, with the exception of vegetable fats and oils, the bank economists add.

But the catch behind these assumptions are spelt out in summary in the next paragraph:

The two "main assumptions" behind this optimistic projection of turnaround in the trend in real prices, is spelt out in the report as"..that there will be a sustained upturn in economic activity in the industrial countries and that production growth in the perennial crops, particularly cocoa and coffee, will decline in some countries..."

The economists then go on to add: "However, events could turn out to be different and the expected upturn in prices not take place. Planning based on commodity prices should recognize the large degree of uncertainty associated with them. For its sensitivity analysis of projects and programs, the World Bank uses wide ranges in its commodity price forecasts. For example, for constant dollar forecasts of coffee, cocoa, and petroleum prices, the range of prices three years ahead with a 70 percent probability of occurrence is typically plus or minus 25 percent or more of the projected most likely price. Commodity prices can be expected to remain volatile".

Perhaps their view about production growth of perennial crops continuing to decline might mean that the Bank and its national desks would not commit the folly again of thrusting commodity policy advice ignoring the 'fallacy of composition'. But whatever happens the delphic-oracle like predictions and projections would enable the economists at some future point to cite one or other portion to show they had envisaged it.