Managing commodity export cycles

Managing commodity price movements
When all commodity prices are extremely volatile it is dangerous to follow the principle that revenue from temporary price increases should be saved, whereas income from permanent increases can be spent. Even under more stable conditions, temporary price increases may be erroneously assumed to be permanent; and classifying a particular shift as "permanent" or "temporary" in a volatile environment is even more uncertain. The cost of assuming a temporary price increase to be permanent is probably higher than that of assuming a permanent increase to be temporary, since it is often difficult to rein back spending that increased during a supposedly permanent boom - especially if boom revenue was leveraged through borrowing into even higher spending. Delays in adjustment to a fall in export prices lead to further debt accumulation. When the adjustment finally comes, it is more difficult because not only does a country have to deal with lower commodity revenue but it is also faced with increased debt service and reduced flows of new lending.

A more prudent strategy is for the public sector to save a large portion of its commodity revenue whatever the current price environment. These additional savings may be used to: (a) increase a country's net foreign asset position (either through repaying debt or accumulating foreign deposits); (b) reduce public domestic debt; (c) raise public domestic investment.

The use to which the savings are put determines how quickly the government can respond to changed circumstances. Foreign assets, although not without risk, are highly liquid and thus can be sold quickly when times are difficult times. Botswana protected itself against downturns in the diamond market by increasing its foreign exchange reserves to cover two years' worth of imports. Repayment of debt reduces exposure of the public sector to unstable revenues and avoids the monetary pressures caused by reserve accumulation at the central bank. Reducing net debt to the central bank also reduces monetary expansion by offsetting the increase in foreign exchange reserves. Public investment suffers from the defect that it is difficult to reverse - new investment spending is hard to stop for projects under way, and it is usually difficult and time-consuming to sell physical assets once they have been acquired. Additional public investment financed by commodity revenue should therefore be limited to highly profitable projects.

It would be wise policy to try to facilitate both public and private saving during booms. If governments save a high proportion of boom revenues, this can help the country to save enough in good times to provide resources for consumption in bad times. However, since governments have often spent too much in booms, it may be better in many cases to allow private producers to retain more of the boom revenue, so that they can themselves save during good times to prepare for bad times. Apparent inadequacy in private saving may be due more to controls on financial markets, such as low deposit interest rates, than to any inherent defect in private savings behaviour.
Type Classification:
D: Detailed strategies
Related UN Sustainable Development Goals:
GOAL 8: Decent Work and Economic GrowthGOAL 12: Responsible Consumption and Production