News Archive March 2016

tralac’s Daily News Selection

The selection: Wednesday, 30 March 2016

Featured alerts, commentary:

South Africa’s February 2016 trade data will be released tomorrow. Bloomberg consensus sees a compression of the deficit to -R4.3bn.

The Commonwealth Trade Expert Group is meeting in Delhi, discussing 'Revitalising global trade and multilateralism'

Joshua P Meltzer: 'New trade deals challenge Africa to step on to the global stage' (The Guardian)

Rwanda: Trade deficit grows in first two months of 2016 (New Times)

According to a statement from the central bank yesterday, the country’s trade deficit widened to $297.2m (about Rwf232.4bn) largely due to an increase in formal imports that rose by about 7.2%, as well as a 9.7% decrease in the value of Rwanda’s exports. The international trade developments were among the focus of discussions during yesterday’s quarterly financial stability committee and monetary policy committee meetings chaired by the National Bank of Rwanda governor, John Rwangombwa.

South Africa: Poultry crowd rubs salt in own wounds (Business Day)

The South African Poultry Association is trying to get the South African International Trade Administration Commission to institute an agricultural safeguard on EU chicken. An agricultural safeguard is not dissimilar in effect to the antidumping duty that is no longer imposed on US bone-in chicken, except that it operates in three-year cycles. The association is essentially looking to institute protectionist action in the form of a 37% import tariff on EU bone-in chicken. [The author, David Wolpert, is CEO of the Association of Meat Importers and Exporters SA] [Call for steps against duty-free European chicken] [AGOA sword will keep hanging above SA]

Kenya's tea sector: value chain capacity assessment project launch (ACBF)

The assessment will undertake a comprehensive review of capacity assets, needs and options for strengthening capacity of key targeted institutions responsible in the value-chain of the tea product. The review will also identify structural and institutional factors including agents that can influence change resulting from a capacity development investment to improve the performance of the product. These factors will include the conduciveness of the socio-political environment, efficiency of prevailing policy instruments, effectiveness of organizational arrangements, as well as technical skills and knowledge. The assessment is expected to be finalized by the end of May 2016. [Further details: KIPPRA]

Recent papers published by the COMESA Monetary Institute:

Challenges of dollarization in COMESA: Governors noted the following recommendations from the study [extract] : i) Successful de-dollarization requires implementation of an appropriate mix of sound macroeconomic policies, market-based incentives, and micro-prudential measures including: ii) There is need for countries to avoid policies that may lead to stagflation and severe macroeconomic disruptions which precipitates the need for dollarization.

Enhancing the effectiveness of fiscal policy for domestic resource mobilization in the COMESA region: In the COMESA region, as elsewhere, fiscal policy can and should be used effectively to foster growth, reduce short term fluctuations of economic activity and maintain economies close to their potential growth paths. The necessity to carry out these tasks is emphasized by the following conclusions [extract]: i) Domestic revenue to GDP ratios remain low for most member countries (figure 2) attributed to among others low per capita income and growth, institutional problems and weak governance. Addressing these challenges provides a case for fiscal policy in domestic resource mobilization. [COMESA Committee of Governors of Central Banks: meeting report, 19 November 2015]

AfDB President rounds up Asian tour in Beijing with firm commitments for support (AfDB)

Most of the cooperation commitments discussed at the meetings will be concretized at the Bank’s 2016 Annual Meetings in Lusaka, Zambia. The Bank’s staff involved in Japan, Korea and China will be very activate in the coming days refreshing MOUs and writing the terms of new cooperation agreements, a member of the delegation said.

African Institute for Economic Development and Planning: progress report (UNECA)

Now that the strategic framework has been defined globally, time has come for an contextualized action in 2016, to translate these agenda into national, subregional and regional objectives. IDEP will therefore reorganize itself in order to adapt its offer to a changing environment and - as previously - pursue its support to member States in setting up training programmes in full compliance with the requirements of their transformative agenda.

Training of trade counsellors from IGAD livestock exporting countries to GCC countries (IGAD)

The IGAD Centre for Pastoral Areas and Livestock Development, in collaboration with FAO SFE, organized the training of trade counselors in Addis Ababa, 21-24 March. The activity was funded by an Italian-funded project. The limited exports has partly been due to limited coordination between the trade counsellors, exporters and chief veterinary officers. The gap has been in terms of real time market information and dissemination on import requirements as well as commodity prices and limited promotional and linkage efforts. The workshop made the following recommendations: [Zuma consolidates ties in the Gulf region (IOL)]

Nigeria: trade diplomacy, foreign policy perspectives (Daily Trust)

Q to Minister of Foreign Affairs, Geoffrey Onyeama: After one year, what should Nigerians expect from the ministry? 'We are faced with severe economic challenges. What can we, as a ministry, do? We decided on economic diplomacy as the framework in which we want to operate. We have identified two areas. First, we are looking at a strategy of targeting a number of African countries to have with them an agreement for the free movement of business people within Africa in order to enlarge the economic space for Nigerian businessmen. The second is to develop a matchmaking data base where Nigerian business persons can upload information about themselves, businesses and what they want to sell to the world and this would be accessible through our 119 foreign missions.'

Nigeria's promise turns to peril as investors head for the exits (Bloomberg)

Nigeria’s appeal has faded as the price of oil, source of 90% of export earnings, has crashed. Growth slumped to 2.8% last year, the slowest since 1999, and will decelerate to 2% in 2016, according to Morgan Stanley. In dollar terms, the economy in 2019 will still be 17% smaller than its 2014 peak of $542bn. Only two years ago, McKinsey & Co. said Nigeria had the potential to grow 7.1% annually until 2030 and build a $1.6trn economy. [Nigerian lawmakers want wireless giant MTN's fine doubled to eye-popping $10bn (M&G Africa)]

Total readies Shs13 trillion for oil pipeline development (Daily Monitor)

French oil major Total S.A has said it will finance the development of the $4b (Shs13 trillion) crude oil export pipeline from Uganda’s Albertine Graben to Tanzania’s Tanga port at the Indian Ocean. Mr Javier Rielo, the Total East Africa vice president, on Monday, assured Tanzanian President John Magufuli that “the company will begin construction of the pipeline project to transport oil from Uganda to Tanga as soon as possible, for funds to implement the project exist.”

Is the WTO a World Tax Organization? A primer for WTO rules for policy makers (IMF)

This paper examines the extent to which World Trade Organization rules impinge on policy makers’ freedom to formulate tax policies. It provides an overview of both the economic rationale for WTO rules concerning taxation and the provisions of the main WTO agreements concerning border taxes and internal taxes (direct as well as indirect). It also points out some tax anomalies and inconsistencies in these rules, and how the rules have evolved as a consequence of the interpretation of the WTO agreements by its Dispute Settlement Body and the latter’s rulings in connection with several disputes over taxes affecting trade. [The author: Michael Daly]

International regulatory co-operation: the role of international organisations (OECD)

In order to strengthen the information base on this topic and shed light on the contribution of IOs to IRC, the OECD carried out in 2015 a survey covering the governance, operational modalities and tools of IOs, as well as their rule-making disciplines and assessment of implementation and impacts. For most IOs, the main benefits provided by their IRC activities come from increased transparency of regulatory frameworks, knowledge flow and peer learning through exchange of information. Secondly, they promote efficiency gains and reduction of regulatory burdens through the sharing of tasks and increased coherence across regulatory requirements. The economic benefits, such as reducing regulatory burden or fostering economies of scale, come last.

Local nexus and jurisdictional thresholds in merger control (OECD)

Background paper by the Secretariat: Three years later, this paper seeks to provide a detailed overview of merger control thresholds and local nexus criteria in various countries, and to compare them with international recommendations on the topic. The paper is structured as follows: chapter 2 will provide some background on the topic of merger control thresholds and local nexus criteria; chapter 3 will describe the various types of notification thresholds and local nexus criteria adopted in different countries; chapter 4 will compare current practices to international guidelines, and identify the main developments since the Recommendation was adopted in 2005; and, finally, chapter 5 will summarise and analyse the main findings. [Annex to the Background Paper]

Related: Best practice roundtables on competition policy: June 2016, OECD, Public interest considerations in merger control: background paper

Over-The-Top (OTT) Services and regulation (tralac)

A close connection is developing between the rules of international trade on market access, domestic regulation and network neutrality. This is increasingly subject to trade negotiations. However, a comprehensive classification of the different facets of OTT services is yet to be developed. [The author: JB Cronje]

Going beyond goods: measuring services for export competiveness (World Bank)

Many governments are interested in how services support their country’s exports and economy at large. Answers to such questions are typically left unanswered because systematic data is not readily available on how services contribute to exports across developing countries and sectors. The Export of Value Added Database was developed to fulfill this need. What sets the EVA Database apart is the wide coverage of developing countries: over 70 of the economies included are low- and middle-income.

Egypt, World Bank sign $5m grant to ease regulatory environment for investors (World Bank)

Asian Development Outlook 2016 (ADB)

Growth is slowing across much of developing Asia as a result of the continued weak recovery in major industrial economies and softer growth prospects for the People’s Republic of China (PRC). This will combine to push growth in developing Asia for 2015 and 2016 below previous projections, says a new Asian Development Bank report. In its new Asian Development Outlook (ADO) 2016, ADB forecasts GDP growth of 5.7% in 2016 and 2017 for the region. In 2015, GDP growth was 5.9%. ADO is ADB’s flagship annual economic publication. [Downloads]

Related, regional perspectives: The benefits of regional electricity cooperation and trade: lessons from South Asia (World Bank), ADB, JICA establish $1.5bn fund to invest in private infrastructure (ADB), With RCEP commitment, India marks big shift in trade policy (Livemint), Roberto Azevêdo speech: 'Brazil in the global trading system: achievements and future challenges' (WTO), DG Azevêdo welcomes Brazil’s ratification of WTO trade facilitation deal (WTO)

Swaziland has to borrow $422.1m - official (StarAfrica)

Challenges for EAC to phase out 'Caguwa' by 2019 (New Times)

Mozambique/Swaziland: new bridge to boost trade (StarAfrica)

Tanzania: Ruvu gas find could be worth up to $11bn (IPPMedia)

East Africa: 'Chambers can issue Certificates of Origin' (editorial comment, East Africa Business Week)

Oil prices and the global economy: it’s complicated (IMF)

London Stock Exchange launches Africa Advisory Group to boost African capital market development

GREAT Insights: Partnerships with business for development (ECDPM)

The role of UNCTAD in the follow-up and monitoring process of the 2030 Agenda for Sustainable Development

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tralac’s Daily News Selection

30 Mar 2016
The selection: Wednesday, 30 March 2016 Featured alerts, commentary: South Africa’s February 2016 trade data will be released tomorrow. Bloomberg consensus sees a compression of the deficit to -R4.3bn . The Commonwealth Trade...
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tralac in the news ~ African countries should diversify exports to adapt to changes in China

The ongoing changes in China’s economy may be an opportunity for African countries that now mainly export raw materials and oil, to adapt and diversify exports and move up the value chain, according to analysts.

China, Africa’s main trading partner, has registered an economic slowdown and the authorities want the “engine” of growth in the coming years to be domestic consumption rather than investment, which will affect external demand, particularly in sub-Saharan Africa, according to an analysis by the Trade Law Centre for Southern Africa (tralac).

“As Chinese domestic demand changes from investment goods for domestic consumption and, implicitly, to services, exporters of food and services can gain from the change,” said the March analysis of the China Africa Trading Relationship.

This will offset the impact of reduced demand for African imports and the fall in commodity prices, which will have a negative impact on global prices of such goods, affecting the terms of trade.

“It is therefore imperative for African countries to diversify exports and move up the value chain,” says the document.

Angola, for which oil is the main export and the basis of its economy, is among the countries where efforts to diversify exports are most visible, following the fall in revenue related to the oil price drop since mid 2014.

The increase of Chinese trade with Africa – to USD221.5 billion in 2014, more than 20 times that recorded in 2001 – was driven “by the large bill on oil imports, mainly from Angola,” the Trade and Law Center said.

Figures from UN Comtrade (United Nations Commodity Trade Statistics Database) for 2014 put Angola as the second largest source of Chinese imports in Africa, with 27 percent of the total, behind South Africa (39 percent), and 5th largest destination for exports with 6 percent.

After the last Forum on China-Africa Cooperation (Johannesburg, 4-5 December 2015), economist Mark Bohlund in an article for Bloomberg Intelligence, noted that the slowdown in China would be another “jolt” for African countries.

The fall in oil prices, he argues, is more of a result of increased production in the United States than a reduction of imports by China – whose economy continues to grow, from a higher base.

The drop in investment levels, he said, mainly reflects the devaluation of some mining assets and “investment financed by debt is much more important for Africa than FDI and should continue to grow as China expands the scope of projects financed in Africa.”

“Chinese investment in infrastructure in sub-Saharan Africa is more likely to increase than decrease,” taking into account the Chinese central bank’s transfers to the Export Import Bank of China ($45 billion) and the China Development Bank ($48 billion) in July 2015 to finance the New Silk Road strategy, said Bohlund.

The Chinese authorities have been arguing that even in the current context of slowdown, Africa investment and will continue and even become more important.

Li Yifan, the Chinese Ambassador to Ethiopia told the Reuters news agency on 15 March that African countries may even be “the ideal place” for business investment of companies that “have driven the expansion of Chinese infrastructure in the last 30 years,” at a time when the domestic economy is slowing and they are increasingly looking to foreign markets.

“Despite all the doubts, I can share that in China the relevant government departments, development banks, and insurance companies are addressing their African partners to make this great plan a reality,” said Li.

» Read the China Africa Trading Relationship, March 2016 update

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Is the WTO a World Tax Organization? A primer for WTO rules for policy makers

This paper examines the extent to which World Trade Organization (WTO) rules impinge on policymakers’ freedom to formulate tax policies. It provides an overview of both the economic rationale for WTO rules concerning taxation and the provisions of the main WTO agreements concerning border taxes and internal taxes (direct as well as indirect).

It also points out some tax anomalies and inconsistencies in these rules, and how the rules have evolved as a consequence of the interpretation of the WTO agreements by its Dispute Settlement Body and the latter’s rulings in connection with several disputes over taxes affecting trade.

As WTO Members will undoubtedly want to avoid having their tax policies successfully challenged in the WTO, the paper provides some guidance concerning the design of tax policy.


Despite more than six decades of multilateral trade liberalization unleashed by the General Agreement on Tariffs and Trade (GATT) in 1947, protectionist policies persist in many international goods markets. Perhaps the greatest challenge regarding the design of multilateral trade rules is the concern that trade liberalization commitments with respect to one policy instrument, such as tariffs, may be vitiated by other protectionist instruments unconstrained by such rules. Consequently, multilateral trade and other agreements must address a wide range of potentially protective measures, including tax measures other than tariffs.

Tariffs and other indirect taxes, whether levied at the border or internally, have long been subject to the binding multilateral rules embodied in the GATT. However, in recognition of the fact that tax measures can be used as substitutes for other types of protection and government assistance or regulation, direct as well as indirect taxes have come under increased scrutiny at the World Trade Organization (WTO). This recognition is reflected in several of the agreements negotiated under the Uruguay Round, notably those concerning subsidies and trade-related investment measures (TRIMs). These agreements reflect the realization by national governments that multilateral rules need to play an increasingly important role in regulating the use of tax as well as non-tax measures, especially where these measures affect the international movement of goods, services, capital, technology and persons.

As a consequence of these agreements, the range of tax measures challenged by WTO Members has widened considerably beyond the more traditional trade taxes. Since 1995, taxation has been the cause of over 40 of the 500 disputes that have been initiated with Members’ requests for consultations submitted to the WTO’s Dispute Settlement Body (DSB), which is now arguably the world’s most prolific international dispute resolution system. Roughly half of these disputes have resulted in the establishment of panels and consequent rulings by the DSB. The DSB’s rulings against Indonesia’s National Car Programme and especially against the United States concerning the latter’s Foreign Sales Corporation (FSC) scheme, which, at the time, led to the largest retaliation award ever authorized in a dispute at the WTO, are particularly noteworthy. These rulings confirmed, if there were ever any doubt, that, generally speaking, direct as well as indirect taxes (including, of course, not only tariffs), are subject to WTO rules, notwithstanding efforts by tax authorities to secure specific exemptions for certain direct tax measures in these agreements. The FSC ruling also reconfirmed the traditional distinction under multilateral trade rules between direct and indirect taxes, especially with respect to how such taxes should be treated under the border tax adjustment and subsidy rules of the WTO. It would not be surprising if other WTO-inconsistent tax measures were identified in the future, leading to further disputes among WTO Members. WTO rules can therefore be expected to continue to be an important factor in shaping tax policies, as Members will undoubtedly want to avoid having their tax policies successfully challenged in the WTO.

This paper provides an overview of the extent to which taxation is subject to WTO rules, which embody the fundamental principles of non-discrimination, predictability and transparency. Section II provides a synopsis of the possible economic rationale for these principles (and thus the main provisions of the GATT/WTO agreements), which can be ignored by readers already familiar with the basic theory of trade policy instruments. Section III focuses attention on the basic rules of the GATT/WTO agreements as well as several other provisions that are especially relevant for tax policymakers. Section IV examines how these rules have been interpreted by the DSB in a few selected cases concerning tax measures. Section V contains some concluding remarks. The Annex provides some guidelines concerning WTO rules for tax policymakers.

Economic Rationale for WTO Rules

Before providing an overview of the extent to which GATT/WTO rules encompass taxation, this section considers the possible economic rationale for the main rules and their underlying principles, namely non-discrimination, predictability and transparency. The broad aim of these rules is to regulate, if not remove, distortions to trade. These distortions contribute to economic inefficiency, by, for example, reducing consumer choice, raising prices to consumers, including downstream processors, and disrupting global supply chains, thus impeding economic development. Attention here is focused mainly on the GATT because the fundamental principles and consequent obligations embodied in this agreement form the basis for the other WTO agreements, such as the General Agreement on Trade in Services (GATS). In some respects, however, WTO tax rules appear to be anomalous or, indeed, inconsistent with economic theory concerning trade taxation.

Notwithstanding the considerable progress made in dismantling barriers to trade as a result of multilateral negotiations under the auspices of the GATT/WTO, protectionist policy measures are still widely used by WTO Members for various reasons, compelling or not. These may include: shifting the terms-of-trade in a country’s favour; protection of specific domestic “infant” industries; correction of “market failure”; conservation of natural resources; assistance to downstream processing of such resources; food security; or as a counterbalance to domestic or other countries’ trade distortions (in accordance with the theory of Second Best). In some mainly developing countries, they are also still an important source of tax revenues. Among the various protectionist measures available concerning trade in goods are tariffs (non-discriminatory or discriminatory), quantitative restrictions (quotas), voluntary export restraints, export taxes, discriminatory tax policies, and subsidies, including tax incentives. Some of these (and other measures) may have similar or equivalent economic effects, particularly concerning their deadweight efficiency losses, while others can have very different effects. There may also be inherent similarities or differences concerning their transparency, predictability, susceptibility to rent-seeking, ease of administration, etc.

The rest of this section provides an analysis of these non-tariff measures in comparison with a tariff, irrespective of whether government intervention to restrain trade makes economic sense or not. It also highlights some well-known instances of economic equivalence as regards different measures. At the same time, it identifies protectionist tax policy measures that do the least damage. After all, damage limitation is often a major challenge for tax, if not other, policymakers. In doing so, it is shown that, by and large, WTO rules do encourage “efficient protection,” particularly as far as goods markets are concerned (Sykes, 2001). A comparison of tax measures suggests that non-discriminatory tariffs and domestic subsidies, including those in the form of tax relief, tend to involve relatively “efficient protection” and that these measures are less constrained by WTO rules. More damaging forms of protection are, to a large degree, discouraged, if not prohibited.

This material was prepared at the request of the IMF; Mr. Daly is a member of a panel of fiscal experts advising the IMF’s Fiscal Affairs Department. The analysis and policy considerations expressed in this publication are those of a member of the author and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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Oil prices and the global economy: It’s complicated

Oil prices have been persistently low for well over a year and a half now, but as the April 2016 World Economic Outlook will document, the widely anticipated “shot in the arm” for the global economy has yet to materialize. We argue that, paradoxically, global benefits from low prices will likely appear only after prices have recovered somewhat, and advanced economies have made more progress surmounting the current low interest rate environment.

Since June 2014 oil prices have dropped about 65 percent in U.S. dollar terms (about $70) as growth has progressively slowed across a broad range of countries. Even taking into account the 20 percent dollar appreciation during this period (in nominal effective terms), the decline in oil prices in local currency has been on average over $60. This outcome has puzzled many observers including us at the Fund, who had believed that oil-price declines would be a net plus for the world economy, obviously hurting exporters but delivering more-than-offsetting gains to importers. The key assumption behind that belief is a specific difference in saving behavior between oil importers and oil exporters: consumers in oil importing regions such as Europe have a higher marginal propensity to consume out of income than those in exporters such as Saudi Arabia.

World equity markets have clearly not subscribed to this theory. Over the past six months or more, equity markets have tended to fall when oil prices fall – not what we would expect if lower oil prices help the world economy on balance. Indeed, since August 2015 the simple correlation between equity and oil prices has not only been positive (Chart 1), it has doubled in comparison to an earlier period starting in August 2014 (though not to an unprecedented level).

Oil Chart1 IMF March 2016

Past episodes of sharp changes in oil prices have tended to have visible countercyclical effects – for example, slower world growth after big increases. Is this time different? Several factors affect the relation between oil prices and growth, but we will argue that a big difference from previous episodes is that many advanced economies have nominal interest rates at or near zero.

Supply versus demand

One obvious problem in predicting the effects of oil-price movements is that a fall in the world price can result either from an increase in global supply or a decrease in global demand. But in the latter case, we would expect to see exactly the same pattern as in recent quarters – falling prices accompanied by slowing global growth, with lower oil prices cushioning, but likely not reversing, the growth slowdown.

Slowing demand is no doubt part of the story, but the evidence suggests that increased supply is at least as important. More generally, oil supply has been strong owing to record high output from members of the Organization of the Petroleum Exporting Countries (OPEC) including, now, exports from Iran, as well as from some non-OPEC countries. In addition, the U.S. supply of shale oil initially proved surprisingly resilient in the face of lower prices. Chart 2 shows how OPEC output has recently continued to grow as prices have fallen, unlike in some previous cycles.

Oil Chart2 IMF March 2016

Moreover, even in the United States, a net oil importer where demand has been fairly strong, cheap oil seems not to have given a substantial fillip to growth. Econometric and other studies suggest that only part of the recent decline in oil is due to slowing demand – somewhere between a half and a third – with the balance accounted for by increasing supply.

So there remains a puzzle: where in the world can the positive effects of lower oil prices be seen?

To address this question, the forthcoming April 2016 World Economic Outlook compares 2015 domestic demand growth in oil importers and oil exporters to what we expected in April 2015 – after the first substantial decline in oil prices. The lion’s share of the downward revision for global demand comes from oil exporters – despite their relatively small share of global GDP (about 12 percent). But domestic demand in oil importers was also no better than we had forecast, despite a fall in oil prices that was bigger than anticipated.

Understanding why the naked eye cannot detect positive spending effects requires a closer look at the composition of demand in oil exporters and importers.

Domestic demand in oil exporters

In 2015, domestic demand in oil exporters was indeed much weaker than we had forecast a year before. This negative surprise reflected both weaker consumption and especially weaker investment. Rich oil exporters can draw on their reserves or sovereign wealth funds, and most of them have, but they have also been cutting government spending sharply. Poorer countries, of course, have much lower borrowing capacity, and risk crises if foreign debt levels get too high. Most have sharply lower current account surpluses or higher deficits, and their sovereign spreads have risen. In these countries domestic spending can fall sharply, in a nonlinear fashion – sometimes through the impact of large exchange rate depreciations that make imported goods more expensive. Public investment has fallen especially fast – most capital goods are imported, and when fiscal adjustment is needed, capital spending is typically the first item to be cut. And of course, factors unrelated to oil prices have also being weighing on economic activity in a number of oil exporters – ranging from domestic strife in Iraq, Libya, and Yemen to sanctions in Russia.

Of course, low oil prices make exploration and extraction activities less profitable in the private sector, leading to lower capital expenditures there as well. According to Rystad Energy, the fall in global capital expenditure in the oil and gas sector amounted to about $215 billion between 2014 and 2015 – about 1.2 percent of global fixed capital formation (or just below 0.3 percent of global GDP). Even some oil importers have been hit hard, notably the United States, which accounts for a significant part of the global drop in energy-related investment.

Domestic demand in oil importers

Advanced oil importing economies have indeed seen some positive effects on consumption – for instance, in the euro area – but the impact has been somewhat less than anticipated. And investment growth has fallen short of expectations – also reflecting the unexpectedly large decline in U.S. energy-related investment mentioned above. The situation for oil importers in the emerging and developing world is varied. These countries typically have more limited pass-through from international to domestic fuel prices compared with advanced economies; some have reduced fuel subsidies. True, governments’ improved fiscal positions should eventually result in lower taxes or increased public spending, but the process could take time and is subject to various frictions and leakages. Overall, domestic demand growth for these oil importers was broadly in line with expectations – despite difficult macroeconomic conditions in a few countries that are exporters of other commodities.

Surprising macroeconomics at the zero interest-rate bound

There is another factor potentially impeding a pickup of demand in oil importers.

Compared with previous price cycles, falling oil prices this time coincide with a period of slow economic growth – so slow that the major central banks have little or no capacity to lower their monetary policy interest rates further to support growth and combat deflationary pressures.

Why does this matter? In the 1970s and 1980s, a large economics literature, summarized by Michael Bruno and Jeffrey Sachs more than three decades ago, showed how oil-supply-driven price increases lead to stagflation – a combination of higher inflation and slower growth. Stagflation is a direct result of higher costs for producers who use energy, costs that lead them to reduce output, shed labor, and raise prices to cover higher costs.

Even though oil is a less important production input than it was three decades ago, that reasoning should work in reverse when oil prices fall, leading to lower production costs, more hiring, and reduced inflation. But this channel causes a problem when central banks cannot lower interest rates. Because the policy interest rate cannot fall further, the decline in inflation (actual and expected) owing to lower production costs raises the real rate of interest, compressing demand and very possibly stifling any increase in output and employment. Indeed, those aggregates may both actually fall. Something like this may be going on at the present time in some economies. Chart 3 is suggestive of a depressing effect of low expected oil prices on expected inflation: it shows the strong recent direct relationship between U.S. oil futures prices and a market-based measure of long-term inflation expectations.

Oil Chart3 IMF March 2016

Being near the zero bound also can imply a “perverse” response to higher oil prices. When central banks are battling deflation pressures, they are unlikely to raise policy interest rates aggressively to counter an uptick in inflation. As a result, oil price increases, symmetrically, can be expansionary by lowering the real interest rate.

Of course, it would be wrong to conclude that central banks can enhance the benefits of current low oil prices by raising their policy interest rates. On the contrary, all else equal, that action would harm growth by raising real interest rates. Our claim is simply that when an oil importer’s macroeconomic conditions warrant a very low central bank interest rate, a fall in oil prices could move the real interest rate in a way that runs counter to the positive income effect.

The way forward

Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets. The possibility of such negative feedback loops makes demand support by the global community – along with a range of country-specific structural and financial-sector reforms – all the more urgent.


Oil prices and the global economy: It’s complicated

30 Mar 2016
Oil prices have been persistently low for well over a year and a half now, but as the April 2016 World Economic Outlook will document, the widely anticipated “shot in the arm” for the global economy has yet to materialize. We...
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