African EM less vulnerable than LatAm to price declines

By Helmo Preuss

A sharp decline in commodity prices would cause the public finances to deteriorate in many emerging market (EM) countries‚ with the loss of revenues greatest in the Middle East and parts of Africa‚ but low levels of public debt mean that there is little immediate threat to fiscal sustainability in these countries.

By contrast‚ a decline in commodity prices would pose a bigger problem for the authorities in Latin American countries such as Mexico and Venezuela‚ Capital Economics Emerging Markets Economist David Rees said on Tuesday.

“As the global economy is set to disappoint over the coming years‚ we expect the price of most industrial and agricultural commodity prices to fall by 15% to 20% next year. Our forecasts are for Brent crude oil to fall to around $85 per barrel next year (from $110 currently) and copper to fall to around $5‚000 per tonne (from some $8‚150 currently)‚” he said.

“One obvious channel through which net commodity exporters in the emerging world would be hit is via the public finances. For example‚ in the Middle East and parts of Africa‚ oil revenues account for 75% to 90% of total public sector revenues. As a result‚ the loss of public revenue could amount to 10% to 15% of GDP.

“Elsewhere‚ in Latin America and Emerging Asia‚ wider tax bases mean that commodities account for 25% to 50% of public revenues. As a result‚ any loss of government revenue would be closer to 1% to 3% of GDP. There is‚ of course‚ more to the story than meets the eye.”

“For a start‚ while the loss of revenue would be greatest in the Middle East and Africa‚ conservative management of commodity revenues over the past few years means that most countries would be able to withstand the losses. According to our calculations‚ the public sector budgets in many Middle Eastern and African countries would still balance with an oil price of around $80 per barrel. As a result‚ those countries would in fact still be accumulating savings (or reducing debt)‚ albeit at a slower rate than in recent years.

“What is more‚ very low public debt levels‚ along with large savings in sovereign wealth funds (SWFs)‚ mean that the public finances in many countries are secure for the foreseeable future. That is particularly true in the Middle East where SWF savings often exceed 100% of GDP.”

“In addition‚ the governments in several countries pay large energy subsidies. As a result‚ while the public finances may suffer from a loss of revenues if commodity prices fall‚ those losses may be partially offset by reduced spending on subsidies. But there are several emerging markets where low commodity prices could raise concerns about the sustainability of the public finances. In Russia‚ a recent increase in public spending means that an oil price of around $120 per barrel is now needed to balance the budget. So while the low level of public debt and the existence of (albeit quite small) SWF savings afford the government some room for manoeuvre‚ lower oil prices would force a significant fiscal consolidation over the medium-term.”

“More immediately‚ concerns are likely to focus on Venezuela. Profligate spending means that the budget only balances when oil is around $120 per barrel while‚ in contrast to Mexico‚ public debt has been rising sharply in recent years. The key difference‚ however‚ is that the newly elected Mexican government has demonstrated an appetite to implement the reforms to tackle its reliance upon oil revenues while the re-election of Hugo Chávez as President of Venezuela suggests that the government’s dependence on oil will increase over the coming years‚” Rees concluded.