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LAC can avoid 'natural resource curse' through savings, good policies - World Bank report

Published:Wednesday | September 15, 2010
The World Bank report floated the idea of an exchange rate Peg to Export Price as a new policy lever that would accommodate shocks from volatile movement in commodity prices. In the case of bauxite/alumina-producing Jamaica, the peg would be to aluminium. - File

Lavern Clarke, Business Editor

CORAL GABLES, Miami:

Commodity export is about a US$400 billion industry for the seven largest economies in Latin America and the Caribbean (LAC), but the region has a poor history of managing the wealth such exports generate, leading to a cycle of boom and busts.

Now a World Bank report released Monday, which suggests that LAC is poised once again to profit from its resources, is saying that governments can avoid what it calls the "natural resource curse"— a bust — by saving some of the wealth on the upswing in exports, and through targeted investment in social services, human capital, infrastructure, and other areas of their economy to diversify the export base.

The report 'Natural Resources in Latin America and the Caribbean: Beyond Booms and Busts?' was launched at a press conference in Miami on Monday.

In LAC, commodities, including agriculture products, minerals and hydrocarbons, account for 24 per cent of fiscal revenues. Some 97 per cent of regional GDP is generated by net commodity exporting countries, while the region is projected to grow by about five per cent this year, compared to three per cent for advanced economies.

World Bank senior economist Augusto de la Torre, co-author of the report, said LAC countries have a history of wasted "commodity bonanzas", but that with good policies that encourage innovations and diversification, their economies could still grow even when exports hit a downturn.

Torre cited Brazil's ethanol sector, a spin-off from its sugar industry, as the type of innovation or value creation required.

Commodity price volatility

The natural resources report also raises the issue of commodity price volatility, including its impact on exchange rate policy. It floated the idea of an exchange rate Peg to Export Price (PEP) as a new policy lever that would accommodate shocks from volatile movement in commodity prices.

"The proposed PEP regime targets the leading commodity of a country in question," the report said. In the case of bauxite/alumina producing Jamaica, it added, the peg would be to aluminium.

The PEP suggestion is contained in a paper authored by Harvard's Jeffrey Frankel in 2009 — done as a side paper to the natural resources report — looking at possible nominal variables that can be anchors for monetary policy in commodity-exporting countries.

Another co-author of the report, World Bank senior economist Emily Sinnott, told The Gleaner that the PEP paper was not a prescription but meant to spark discussion at the national level on the policy levers available, beyond producer price and consumer price indices in determining real exchange rates, especially for intermediate/managed float regimes.

The natural resources report also suggests that countries should set up a 'natural resource fund' or stabilisation fund in which savings from export revenue would accumulate, but which operates as a Government account rather than a separate institution.

Trinidad and Tobago, an oil and gas economy, accumulates 60 per cent of revenue in excess of budget amounts in its Heritage and Stabilisation Fund.

Different circumstances

But Torre, when pressed by The Gleaner on what should be the optimal level of savings from commodity revenues, said it was not easily determined as circumstances in each country were different, and the "debate was not easy to settle" on how best to deploy windfall revenues.

Some countries use commodity revenues to bring down their debt to GDP ratios, added Sinnott, who also co-authored the report.

How to manage a "commodity bonanza" is often driven by internal politics, according to Torre.

Chile's fiscal responsibility law setting up a stabilisation and saving fund in 2006, for example, was politically unpopular when it was introduced, he said, but later became an advantage to the president when copper prices slowedand its savings were there to cushion the economy.

For net commodity exporters like Jamaica, Sinnon said they tend to deploy subsidies to buffer the economy on the downswing, but that protecting the vulnerable was seen as a less expensive option.

She also suggested using insurance products to hedge against large price changes, particularly in the energy market, as practised by Panama.

LAC countries are in a strong position to profit from their natural resources, assuming that demand from China and other emerging markets continues to rise, according to Torre.

Dropping demand

The United States is still the largest destination market for regional commodities, but demand is on the downswing, dropping from 44 per cent in 1990 to 37 per cent in 2008, the latest data available according to the World Bank.

China accounts for 10 per cent, but that is an upswing from 0.8 per cent. China also buys one-fifth of Brazil's total commodity exports.

Torre said the World Bank was optimistic about economies in the LAC region, saying they were impressive in the quality of their central banks, had turned the corner on debt-management and other fiscal issues. They are also trading more among each other, said Sinnott.

The natural resources report was released ahead of the two-day 2010 Americas Conference at the Biltmore Hotel in Coral Gables.

lavern.clarke@gleanerjm.com