Blog 2

Financing for Development in Resource-Rich Countries

Degol Hailu, Senior Advisor, UNDP

May 2015

For the past 10 years, prices of hydrocarbons, metals and minerals have been on the rise. Oil prices have risen from $50 per barrel in 2004 to $99 in 2007 and $115 in 2013. In the same period, the non-energy commodity-price-index increased by 112%. These price hikes were largely the result of demand for natural resources.

High commodity prices meant resource-rich countries could invest in social services. For instance, between 2002 and 2012, average per capita public expenditure on health of the 25 countries with highest shares of oil, gas and mineral exports increased by 65% from $112 to $219. Similarly from 2000 to 2010, average public expenditure on education increased by 11.86% compared to the decade before.

However, the recent fall in commodity prices is threatening the availability of funds for development. Over the year ending in January 2015, The Economist’s commodity-price-index fell by 9.9% in dollar terms, with metal prices falling by 10.1%. Oil prices per barrel have fallen by 51.2%.

The decline in commodity prices is attributed to many factors. Among which are slow growth in the global economy, the shale-gas boom in the US, anticipation of interest rate increases in major economies and the decision by OPEC not to collectively raise the price of oil.

So what should resource-rich countries do? Should they accept more aid?

Securing more aid is improbable given the difficult fiscal positions many donors face. 

Should they borrow instead? Many countries are fast reaching the debt sustainability threshold. Examples are Ghana and Gambia: two resource-rich economies with net debt-GDP ratios of 53% and 82%, respectively, in 2013. In 2000, these figures stood at 98% and 125%, respectively. Significant gains were made in debt reduction and accumulating more of it is not wise.

The promising option is capturing a bigger share of resource rents, i.e. the tax on profits generated from the exploitation of a country’s natural resources. This requires capacity to negotiate good contracts and enforce them. A good contract contains fair concession and royalty as well as tax agreements. Enforcement is necessary to close loopholes that lead to illicit flow of funds.   

For example, mining tax exemptions in Sierra Leone  cost the government US$598 million, equivalent to 58% of total domestic revenues collected or 140% of international aid receipts. Similarly, stronger safe guards against tax evasion in Zambia could have raised additional copper revenues equivalent to as much as 3.7% of GDP.

Governments are also in fear of “scaring away” the private sector. This has led to a ‘race to the bottom’: a situation in which resource-rich countries harmfully compete to offer the most generous terms and conditions. This is the result of uncoordinated tax policies.

It is a well-known cycle that commodity prices will soon recover. Hence, when the development community gathers in Addis Ababa in July, three actions important to consider are: 1)supporting the development of contract negotiation and enforcement capacity, 2) reaching an international agreement to curb tax evasion and avoidance, and 3) assisting countries to formulate collective taxation regimes.