Kenya needs to guard against oil resource curse

Friday November 24 2017

crude oil

This photo taken on July 13, 2014 shows the oil exploration site in Nakukulas village, Turkana County. Kenya will receive a lot of foreign currency when the sale of crude oil to other countries begins. PHOTO | NATION MEDIA GROUP 

By BONI WANJAU
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The resource curse or the Dutch disease is the negative impact on an economy of anything that gives rise to a sharp inflow of foreign currency, such as the discovery of large oil reserves.

This phenomenon was first experienced by the Netherlands in 1960 after the discovery of natural gas, which was previously unexploited.

The foreign currency inflows led to currency appreciation, which made the country’s exports to the rest of the world less price competitive.

While it often refers to natural resource discovery, it can also refer to any development that results in increased inflow of foreign currency, including a sharp rise in natural resource prices, foreign assistance and foreign direct investment.

CRUDE OIL

Due to over-reliance on natural gas, the Netherlands underwent devastating economic trends.

Domestic industries and markets were ignored in favour of the export of natural gas.

This new reliance on a natural resource caused inflation to rise.

Investment fell and flowed out of the country while domestic industries lost their competitiveness in the global market.

Kenya will receive a lot of foreign currency when the sale of crude oil to other countries begins.

TRADE

The Kenya shilling is expected to become strong against the dollar.

As a result, importers will find it easier to buy goods from outside the country at a lower cost.

Exporters will, however, encounter some challenges.

Exporters prefer a depreciated local currency as this may help a country’s exports gain market share when they are less expensive compared to goods priced in stronger currencies.

INCOME
The discovery of oil may shift most labour to the mining sector, which is experiencing a resource boom.

This may cause production to shift towards the booming sector, away from manufacturing and agriculture.

However, this effect can be negligible since the mining sector tends to employ few people compared to the manufacturing and agriculture sectors.

The resource boom brings in increased national income, hence raises demand for goods and services.

The increased demand for goods and services raises their price, which leads to inflation.

AGRICULTURE
Some countries that have discovered significant natural resources have experienced this phenomenon.

High revenue for Nigeria from oil has raised exchange rates and reduced the incentive to risk investment in non-oil sectors such as agriculture and manufacturing.

Since it started exporting oil, Nigeria’s agriculture sector has been collapsing and the country is now entirely dependent on imported food.

Australia has experienced several episodes of mining boom in its economy.

MANUFACTURING

Studies on the impact of mining booms on economic growth indicate that they tend to result in an appreciation of the currency, thus harming the manufacturing and other sectors, while the overall gross domestic product increases.

Algeria is strongly dependent on oil export revenues to fuel its economy.

Following the 1986 oil counter-shock, this country’s manufacturing sector has experienced a persistent decline.

Although it has benefited from high oil prices over the last decades and implemented a myriad of economic reforms, Algeria has failed to develop its manufacturing sector and diversify its economy

INFLATION
As of 2013, Venezuela’s export economy was 34th in the world economy.

Despite this, Venezuela has extremely high inflation rankings.

In 2014, its inflation rate stood at 62.2 per cent. The end of 2015 saw the inflation rate at 141 per cent.

The International Monetary Fund predicts inflation will continue to rise, reaching 204 per cent in 2016

Bulgaria, Croatia, Estonia, Latvia, Lithuania, Hungary, Poland, the Czech Republic, Romania, Slovenia, and Slovakia have benefited from an increase in European Union capital transfers since the demand for European integration.

CURRENCY
At the same time, foreign direct investments have risen, mainly due to the liberalisation of capital movements.

The effects of those funds and the reduction of financial costs can be considered as analogous to the phenomenon known as the Dutch disease.

This means the inflow of financial transfers is also considered a curse.

Despite all the challenges associated with strong currency from high exports of oil, it could be beneficial in other aspects.

As the price of imports falls, this can lead to increased living standards.

EXPORT

Consumers and firms can benefit from lower prices of imported goods.

Most of the firms that rely on imported raw materials will see a fall in costs.

A strong currency makes exports less competitive.

This creates an incentive for exporters to explore ways of improving efficiency of their production lines and, hence, increase productivity.

This is arguably better than always trying to compete through relying on weak currency, which may encourage fewer incentives to be efficient.

Dr Wanjau is an economist and the chief executive of the Kenya College of Sports and Fitness. [email protected]