Interview with AfDB Chief Economist, Louis Kasekende-Escalating Oil Prices Pose a Challenge to Many African Economies

14/03/2008
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Interview with AfDB Chief Economist, Louis Kasekende-Escalating Oil Prices Pose a Challenge to Many African Economies

Speaking about the declining value of the "greenback" against all other major international currencies, the AfDB Chief Economist said that the weakening dollar would impact countries differently depending on the weight of the dollar in foreign exchange denominated flows, especially buyers of US exports and competitors. Given that 85 per cent of the continent’s exports are outside the region, in particular with countries whose currencies have strengthened against the dollar, African exports denominated in US dollars present an opportunity for higher export earnings.

Question: What, in your view, are the effects of the declining dollar on African economies?

Answer: The weakening of the dollar would impact countries differently depending on the weight of the dollar in foreign exchange denominated flows, mainly buyers of US exports and competitors. Most African countries export primary commodities that are priced in US dollar terms. Given that 85 per cent of Africa’s exports are outside the region, in particular with countries whose currencies have strengthened against the dollar, African exports denominated in US dollars present an opportunity for higher export earnings. However, countries that hold their reserves in dollars would lose because the value of reserves would decline in real terms. Furthermore, countries would suffer transaction losses whenever they shift from dollar denominated holdings to other currencies such as the Euro.

Questions: Oil prices are permanently on the rise and this looks like good news for oil-producing African economies. But given that oil payments are denominated in US dollar; can we say these countries are losing a good part of their revenue because of the dollar’s free fall?

Answer: As you know, the price of a barrel of crude oil has risen from about $18 to $23 in the 1990s to cross the $100 mark on January 3, 2008. Today a barrel of crude oil trades at over $106. There are two parts to the oil story. One is the impact of the high price of crude oil, and the other is the one you have focused on. Regarding the first, it is important to note that although, in real terms, the price of oil is still lower than it was in the late 1970s and early 1980s, the recent upsurge can have dramatic consequences on oil-importing countries. In particular, the impact will be more severe in countries that are overly dependent on oil and/or have limited access to international capital markets, leading to high import bills. Also, for those that received debt relief, the gains could be wiped out. Africa has 38 net oil-importing countries and increasing oil prices may not be good news for them.

For the net oil-exporting countries, a weak dollar is a mixed blessing. Because oil (and other commodities such as gold) is priced in dollars, a weak dollar makes them attractive to non-US investors, thus driving up their prices. Thus, in principle net oil exporters (as well as metal) exporters stand to benefit from the significant influx of foreign revenue, which they could harness for their development, for instance, to accelerate the rate of the implementation of their poverty reduction strategies and the attainment of the Millennium Development Goals (MDGs). However, as I have mentioned earlier, these countries are challenged to preserve the value of their reserves, given that most hold their reserves in dollar denominated assets. These countries are, at the same time, challenged to manage the oil windfalls for the benefit of the whole population, as well as future generations, and cushion their economies against any macro-economic distortions. Nevertheless, it is also important to note that the rise in crude oil prices is significantly higher than the corresponding drop in US dollar, although there is indeed a close link.

Question: The greenback’s decline makes American products cheaper abroad. Over the last decade, efforts have been made to encourage African countries to take advantage of their cheap labor to produce high-quality exports. With the crumbling dollar, do you think African businesses, especially farmers, can successfully penetrate the US market?

Answer: There are a number of factors preventing African goods from penetrating the American market. Firstly, the productivity levels in Africa are relatively lower than those of most countries in other regions, making African economies uncompetitive. Secondly, a number of developed countries use a combination of tariff and non-tariff barriers to limit market access. The depreciation of the dollar, therefore, reinforces these constraints on market access. We should therefore not argue that the strengthening of the dollar on its own would boost African trade with the US.

Question: American sub-prime mortgages are spreading a lot of economic pain across the globe. Given that almost all economies are integrated, do you think African economies have been affected by America’s economic woes resulting from the mortgage crisis?

Answer: African financial markets are weakly integrated with global markets and this insulates them from the first-round effects of the sub-prime problem. However, Africa will suffer from any contractionary effects on the economies of developed countries. Africa’s recorded improved economic performance over the past 5-10 years has been largely on account of favourable global economic conditions. These have sustained high commodity prices, especially for oil and metal products. Any tapering off arising from weaker global economic conditions in commodity prices would reduce Africa’s growth prospects.

Interview Conducted by Joachim Arrey, External Relations and Communication Unit, the African Development Bank Group


Speaker

Name: Louis Kasekende Title: AfDB Chief Economist