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World Bank advises on rebuilding buffers as soft oil prices seen to persist in 2015

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Lower oil prices provide a timely opportunity for Nigeria and many other developing economies to diversify and rebuild fiscal buffers to support economic activity in case of a growth slowdown, the World Bank says in the new edition of its Global Economic Prospects, released yesterday.

Developing countries are faced with weaker export prospects, an impending rise in global interest rates and fragile financial market sentiment, the World Bank warns, as it sees oil likely to remain cheap for some time.

The bank projects that oil prices are expected to persist in 2015 and will be accompanied by significant real income shifts from oil- exporting to oil-importing countries.

For many oil-importing countries, lower prices contribute to growth and reduce inflationary, external, and fiscal pressures.

However, weak oil prices present significant challenges for major oil-exporting countries, which will be adversely impacted by weakening growth prospects, and fiscal and external positions.

“The rebuilding of fiscal buffers will provide the room required to support activity during times of economic stress. The need for additional fiscal buffers is more pronounced now in an environment of uncertain growth prospects, limited policy options, and likely tighter global financial conditions,” said Ayhan Kose, director of development prospects at the World Bank.

If lower oil prices persist, they could also undermine investment in new exploration or development. This would especially put at risk investment in some low-income countries, or in unconventional sources such as shale oil, tar sands, and deep sea oil fields, the World Bank notes in the report.

This year’s Global Economic Prospects go beyond prediction and deepens understanding of the current global economic predicament.

The report documents how well-designed and credible institutional mechanisms such as fiscal rules, stabilisation funds, and medium-term expenditure frameworks are instrumental in fostering growth and restoring depleted fiscal buffers.

“For policy makers in oil-importing developing countries, the fall in oil prices provides a window of opportunity to undertake fiscal policy and structural reforms, as well as fund social programmes,”  Kose warns.

“In oil-exporting countries, the sharp decline in oil prices is a reminder of significant vulnerabilities inherent in highly concentrated economic activity and the necessity to re-invigorate efforts to diversify over the medium and long term.”

The decline in oil prices reflects a confluence of factors, including several years of upward surprises in oil supply and downward surprises in demand, receding geo-political risks in some areas of the world, a significant change in policy objectives of the Organisation of  Petroleum Exporting Countries (OPEC), and appreciation of the U.S. dollar.

Although the relative strength of the forces driving the recent plunge in prices remains uncertain, supply related factors appear to have played a dominant role.

The World Bank is concerned that in countries with elevated domestic debt or inflation, monetary policy options to deal with a potential slowdown are constrained. In the foreseeable future, these countries may need to employ fiscal stimulus measures to support growth.

But more worrying is the fact that many developing countries, including Nigeria have less fiscal space now than they did prior to 2008, having used fiscal stimulus during the global financial crisis. And in recent years, private debt levels have risen substantially in some developing countries.

“With oil likely to remain cheap for some time, oil-importing countries should lower or even eliminate fuel subsidies and rebuild the fiscal space needed to carry out future stimulus efforts. On the policy front, both the size and the quality of fiscal deficits matter, as do spending decisions,” Kaushik Basu, Senior Vice President and Chief Economist at the World Bank suggests.

“Emerging market economies would do well to invest in infrastructure and support social schemes vital to poverty reduction. Such policies can raise future productivity and reduce the fiscal deficit in the long run.”

A key finding from the analysis in the report is that in countries where debt and deficits have widened from pre- crisis levels, each fiscal dollar spent will support activities that contribute to consumption and boost national income by roughly a third less, than in the run-up to the global financial crisis.

The global institution observes that because the so-called fiscal multiplier effect is weaker now for many developing countries, they need to rebuild budgets in the medium-term, at a pace determined to country-specific conditions.

For a number of oil-importing countries, lower oil prices offer a chance to improve fiscal positions more quickly than might have been possible before mid-2014, the World Bank notes in the report.

Onyinye Nwachukwu