Staggering from inflation and mounting deficits in Liberia: Non-parametric Analysis
By: Musa Dukuly (PhD) and C. Gyude Bedell (MBA)
Despite the forecast of Africa’s strong economic growth beyond 2013, Liberia’s economy could face tougher economic times ahead, underpinned by pervasive structural constraints (lack of electricity, water supply, poor road network). This is indicative that the economy could present a mysterious passage for economic agents to cope and contain with critical macroeconomic pressures. Though the exchange rate shows relative stability for most parts of 2012, other exogenous constraints seem to put the market on a risky growth path. Fighting commodity inflation and bridging the fiscal deficit that average 5% and 46.5million over the last three and five years respectively are an uphill challenge. To this effect, Liberia’s macroeconomic imbalances build up continuously.
In a small open economy like Liberia, it is anticipated that exchange rate induces inflation. Paradoxically, the exchange rate remains relatively stable, but the inflationary trend, in particular food, is on the “high” horizon. Food and commodity inflations are critical macroeconomic policy concerns because they are the main absorber of liquidity by economic agents. Consequently, economic agents are struggling to maintain payments of diverse service fees (school, rent, medical, transport, etc) while homeowners/developers are faced with further increased costs for construction materials. This inflationary surge does not only lower the real money balance to constraint consumer spending, but it also undermines the monetary value of Liberia’s tax revenues. However, the fiscal authority’s zero tariff policy on rice importation is laudable for slightly easing food inflation.
In addition, the monetary policy on taming inflation has been appropriately strategic, instead of pursuing the orthodox approach of contractionary monetary policy. The crust of the issue is that though inflation seems to be driven by some weak economic fundamentals, external shocks (high fuel price, low demand for exports, etc) and supply side constraints remain the main drivers. These shocks are emanating from surge in globally rising price of fuel, drought that had affected food supply, thereby necessitating higher food imports and eventually exerting pressure on the inflation.
Given the external shocks, it was anticipated that the monetary authority would raise interest rate as the right mechanism of easing the macroeconomic problem. The strategic decision of not raising interest rate was just right. Keeping interest rate low/steady was definitely the right policy response as opposed to the frequently adopted “copy and paste” solution of the IMF. Venturing to raise interest as a recipe to curb the inflationary shock would have constrained private sector credit and propagated additional effects on the fragile economic growth.
Infusion of foreign exchange to contain the exchange rate pressure and extension of low cost credit to viable businesses in Liberia, especially SMEs are indication of effective utilization of monetary instrument. The Treasury bill regime (in the pipeline) is an additional monetary instrument that could further ease the fiscal deficit. These create the conditions for the attainment of monetary stability through stable exchange rate and single-digit inflation, though on the high side. Interestingly, the recent monetary authority’s swift move of allocating 5 million USD to increase extension of credit to small scale and other businesses is appropriate for relieving the imbalance to enhance the real engine of the economy (i.e, private sector growth).
Aside from other external shocks, the widening trade deficit exposes our economy to further macroeconomic risks. Trade deficit has swollen to the peak where last year imports were running at twice the level of exports. This means that far more people sought to buy dollars. Combination of monetary intervention and capital inflow is helping to ease the exchange rate pressure. In reference to the Central Bank of Liberia’s annual bulletin (Vol.13, No.3, July-September, 2012), Liberia’s exports have risen slightly, but not in excess of imports. Last year, Liberia imported more than twice as much in goods/services than it exported. However, supporting the trade deficit via other capital inflows is vital to further spur exchange rate stability. Interestingly, this would ensure that the stability of the exchange rate vis a vis the demand for United States Dollars (USD) is not as badly out of balance as the supply.
Based on predictable uncertainty in global economy, it seems the problem of inflation could be in Liberia for the better part of this year until structural constraints (electricity, improved roads, water supply) are addressed for the term of trade (export/import) to improve via a thriving real sector. Liberia’s relative currency stability achieved due to sound monetary prudence is not sustainable in the medium to long term until it is matched by a significant drop in inflation. In fact, the current monetary strategy enables experts to predict that the exchange rate may not still hover around existing rate in most parts of 2013. However, with the tightening monetary policy, it is extremely unlikely for the rate to hit the “90 Liberian Dollars” level against the USD in 2013.
From the fiscal front, Government planned spending has galloped by more than 25% in reference to the last fiscal budget. At the same time, Gov’t spending is pressured by its rising recurrent against increased expenditures on infrastructure, even as revenues dwindle. The planned spending of almost 50% of GDP is a potential risk to economic growth if appraised development projects are not efficiently handled to ensure that the relevant budgetary allocation trickle to sectors with pervasive multiplier effects. Countries where tax collection, capital markets and institutions are weak, fiscal imbalances are often at the root of reinforcing inflation (Agenor and Montiel, 2008).
The country’s more than 650 million USD budget estimates for 2012/2013 is risked from being met, with predictable divergence between planned and actual revenues. The forestry and other sectors are facing dwindle in performance of revenues. Reduction in government revenue due to unanticipated constraints evokes pressure for monetizing the fiscal risk. But the ballooning in government spending on recurrent and capital (infrastructure) would see the trade and fiscal deficits over shooting the economy in the next five years before easing. Prompt fiscal adjustment through cuts in recurrent expenditure is necessary for narrowing the fiscal gap. This requires that strict expenditure control be accompanied by revenue measures and robust tax administration regime. Over the last five years, the deficits have averaged 46million USD, which is almost 5% of GDP.
In the context of the diverse macroeconomic imbalance, it seems monetary and fiscal coordination could just be the win-win solution to tackle inflation and the deficits in the short run. The monetary should not persist with deficit financing of the budget in the absence of tangible solution to avert unanticipated erosion in tax revenues. Persistent financing of the deficit through monetary expansion may reinforce fiscal risk, potentially increase price and progressively erode CBL’s reserves. However, if coordination pursues the channel of direct domestic debt forgiveness/flexible debt rescheduling to mitigate the deficit, fiscal space could widen for low costs credits to continue with the huge growth inducing projects. About 93% of the total Government domestic debt (281 million USD) is owed to the CBL whose money reserve is more than 35% of GDP and more than 50% of the 2012/13 fiscal budget.
To conclude, the deficits and inflation present a stiff macroeconomic model for economic stakeholders and the potential for high economic growth could be stalled in the short term occasioned by wide range of ongoing development programs. The prospects of narrowing the fiscal and trade deficits in 2013 are only possible through effective and coordinated monetary and fiscal policies. Otherwise, the deficits may prop up inflation and tumble successive sector to tighten squeeze from construction, through extractive, manufacturing and service. As 2013 gets underway, the economy is set to be very tough for sales, profits and jobs, even as Liberia contends with ongoing socio-economic development programs. Swift macroeconomic policy response is for monetary authority to discount/waive portion of its domestic debts owe by government and for the government to also ensure fiscal adjustments by cutting its own spending (especially recurrent) as well as to keep future year-on-year budget increment around feasible range.