PRIMARY COMMODITY DEPENDENCE AND DEBT PROBLEM IN LESS DEVELOPED COUNTRIES SWARAY, Raymond B *.

Transcription

1 PRIMARY COMMODITY DEPENDENCE AND DEBT PROBLEM IN LESS DEVELOPED COUNTRIES SWARAY, Raymond B *. Abstract Economists have proffered myriads of causes of the debt problem faced by less developed countries (LDCs). This paper uses the panel data technique to investigate the fundamental causes of the debt problem among primary commody dependent LDCs. The results show a strong link between high levels of indebtedness and unfavourable terms of trade among commody-dependent countries. Further results show that the degree of openness of the LDC s economy also has a significant influence on s external debt level. JEL:C50 Key words: Panel Data, Developed Countries, Primary Commody 1. Introduction The build-up of foreign debt among less developed countries (hereafter LDCs) in the 1970s reached a crisis level in the 1980s when in 1982 Mexico proclaimed an inabily to service her external debts. Since that time many LDCs similarly declared serious debt crises that led to a motley of third world debt rescheduling and debt forgiveness, and total calls debt cancellation that reached a crescendo by turn of the millennium. Economists have put forward a number of reasons for reasons for the debt problem facing LDCs, but ltle or no consensus has emerged about the real causes of the problem. Some economists trace s origin of the debt problem to the oil price shock in 1973 which began wh an increase in the market power of the Organisation for Petroleum Exporting Countries. The oil shock, they believe, contributed to a massive supply of cred into western banks * Raymond, Swaray The Business School, Universy of Hull, Cottingham Road, UK., r.swaray@hull.ac.uk 131

2 and a corresponding balance of payment defic among (especially) oil importing countries thus creating the need for borrowing (see Krueger, 1987; and Jorge and Salazar-Carrillo, 1988). Other group of economists believe that the debt crisis originates from structural problems associated wh underdevelopment and domestic policy lapses in debtor countries (see Ajayi, 1989, Taiwo, 1991). Yet others have identified commody prices and volatily of commody factors fuelling the debt problem and hindering economic development among commody dependent countries (Mundell, 1989; Hausmann, and Gavin, 1995). They particularly stressed s adverse effect on investment, government revenues and national debts. Primary commody dependence has come under the spotlight again a cause to the debt problem. Heavy dependence on primary commodies and problems associated wh low economic growth and foreign debt was mentioned as challenge to Millennium Development goal. The declining trends in prices and high volatily of tradional export commodies have worsened the poverty in LDCs over the last two decades. A review by the IMF and World Bank notes the lower export earnings owing mainly to declining commody prices as a leading causes deterioration of the debt indicators in Heavily Indebted Poor Countries (Gilbert and Tabova, 2004). Inflows of foreign resource, if managed properly and invested in capal generating project, can help LDCs at the stage take off to build productive capacy and kick-start economic growth. The increase in productive potential generates can attract foreign investment and increase in the level of domestic savings. As a result the need for further borrowing will reduce and the outstanding debt will eventually peter. This appears to be the case for the so-called tiger economies in Southern Asia, such as South Korea and Malaysia (Rogoff, 1990). There are a number of reasons for re-examining the relationship between primary commody-dependence and the debt problem among LDCs. Firstly, primary commody prices are highly volatile and the effects of their volatily tend to persist over time (See 132

3 Swaray, R. Primary commody dependence in less developed countries Cashin, Liang, and McDermott, 2000). Secondly, (primary) commody-dependent countries have been facing mounting debt problems over the last two decades (see UNCTAD, 1995). Thirdly, most LDCs in Sub Saharan Africa (SSA) and Latin America presumed agricultural development as a prerequise to industrial development, hence the dominant role of the agricultural sector in a large number of LDCs. Finally, commody prices have been mentioned as one of the main causes of debt problems in LDCs (see Olukoshi, 1989, Mundell, 1989). While we cannot discount the importance of particular causes of the debt problem in LDCs, we did not a priori attach specific causes to the problem. Therefore, we assume that the debt crisis has s origin in a number of factors, no single one of which was sufficient to cause on s own (Sjaastad, 1989). The aim of this paper is to investigate the relationship between primary commody-dependence and foreign debt problems in a sample of 17 countries in SSA, Asia and Latin America. The 1995 edion of UNCTAD Commody Yearbook identified thirty two countries in SSA, fourteen countries in Latin America, and nine in Asia derived more than 50 percent of their export earnings from primary commodies. Fourteen countries on the UNCTAD list are in Latin America; and 9 in Asia. The rest of the paper is organised as follows: Section 2 introduces the models used in the paper. Section 3 discusses the dependent and explanatory variables in the model. Section 4 discusses the data and estimation techniques. Finally, section 5 gives concluding remarks. 2. The model and estimation techniques We pos a direct relationship between external debt problems of a typically undiversified primary commody-dependent LDC and the degree of s dependence on primary commodies. The crux of the model is that the ratio of a LDC s total external debt to export is a function of s terms of trade, the relative price level, the real cost of borrowing, and the extent of s openness to the rest of the world. A stylised panel data model of the relationship is symbolically expressed as follows: 133

4 y ' = α + β + ε, (1) x where y = ( EDT / XGS ), y denotes ratio total external debt outstanding of country i at time t; x and β are k-vectors of nonconstant explanatory variables. The parameter β is assumed to be common across all uns, and ε denotes the error term. The small number of the cross-sectional uns and the fairly large size of time series component of the sample make pooling the data more appealing. Pooled data analyses have been known to yield robust coefficients in data having fair discrepancies in cross-sectional and time series components (Vinod & Ullah, 1981). Let us assume that the data set used in this study consists of N cross-sectional uns, denoted by i = 1,..., N ; and observed at each of T time periods, t = 1,.., T. The problem of using least square method to estimate equation (1) is that the assumption of constant intercept and slope terms would be unreasonable in the pooled model (Pindyck & Rubinfeld, 1998, p. 252). Therefore, we proceed to introduce dummy variables to allow the intercept term to vary overtime and over cross-sectional uns as and symbolise the fixedeffects model as below: y ' = α + x β + z + ε, (2) where z for the i th country, and 0 otherwise. i = 2,... N. Equation (2) is an example of a least squares dummy variable model (hereafter LSDV) (see Green, 1990; Pindyck & Rubinfeld, 1998). The LSDV model perms the intercept to vary by time and by crosssection, and uses the intercept to capture effects unique to crosssections and those that might be unique to time (Sayrs, 1989). It can be estimated by the method of ordinary least squares to yield unbiased and consistent estimates for all parameters in the model (see Green, 1990). 134

5 Swaray, R. Primary commody dependence in less developed countries The pooling technique used in (2) specifically treats the effects of time as if they were surrogate to systematic effects observed in the data over time. Alesina and Roubini s (1992) used the LSDV model to study the systematic effect of timing of elections and changes in governments on dynamic behaviour of GNP growth, unemployment and inflation in 18 OECD countries. The main advantage of combining cross-sectional and time series data is to capture variation across different uns in space, as well as variations that emerge overtime (Sayrs, 1989). The motivation behind the fixed-effects model, among others, similary of economic and structural characteristics among commody-dependent LDCs. Husain and Underwood (1991) show that SSA countries have several common characteristics due to heavy dependence on primary commody exports, heavy reliance of outside aid, large debt burdens (wh large no dollar debts), poor infrastructure and low levels of education. 3. The dependent and explanatory variables A number of indicators have been used to measure the extent of the debt problem in developing countries (see Afxentiou and Serletis, 1996). However, the total external debt to export of goods and service (including workers remtances) ratio called the total debt to exports ratio clearly indicates a commody-dependent LDC s capacy to service their debts out of commody exports earnings. High external debt to export ratio could stymie the LDCs economic performance and negatively affect private investment and savings through two main channels. First, the resources used to service these countries debt could crowd out public investment, which due of complementary between public and private investment discourages private investment. Second, large external debt ratio could indicate a debt overhang whereby economic agents anticipate higher tax liabilies to service s debt (Eaton, 1987; Borensztein, 1990a, 1990b). In effect, a deterioration in terms of trade as a result of decline in commody prices could lead to a reduction in export earnings, disposable income and tax receipts. 135

6 We use the following four explanatory namely terms of trade, cost of borrowing (i.e. interest rates), relative price level, and the degree of openness of commody-dependent LDC economies. The first explanatory variables, the terms of trade depicts the potential of the country s export sector (i.e. the predominant primary commody in the case of commody dependent countries) to service outstanding debts and forestall the need for future cred. Over two-thirds of the export earnings of commody-dependent LDCs in SSA, Asia and Latin America come from their primary commody sector, the prices of which are largely determined in the world market (UNCTAD, 1995). A fall in the prices of these commodies, as was the case in the 1980s, other things remaining the same, could result to a decline in their export earnings which may increase the likelihood of borrowing abroad. The terms of trade of a country can also determine the channel through which fuels (oil) price shocks can affect the debt burden. For example, oil exporting countries can realise an improvement in their terms of trade in the years of oil price increase. On the contrary, can indicate how fuel price increases would lead to deterioration in the terms of trade oil importers. Therefore, we expect a negative relationship between the terms of trade and debt burden of LDCs. The second explanatory variable, the relative price level, influences the debt problem through two common channels. First, the differential between domestic price level and export prices gives an indication of the competiveness of the export sector which may affect the supply of exports (Paul and Mote, 1970). Second, the differential between the domestic price level and foreign price level may affect imports and exports potential. The greater the differential, the greater the demand for imports, and the lower the demand for exports. Thus, a devaluation of the local may improve the performance of exports and discourage import of manufactures, thus lessening the debt burden. However, devaluation fuels inflation in the domestic economy that may off set potential improvements in net export. Prior to the mid 1970s, the costs of borrowing (i.e. interest rates) on external loans were kept low and stable and LDCs borrowed 136

7 Swaray, R. Primary commody dependence in less developed countries mainly at concessionary rates from official sources. They countries were, thereafter, required to borrow largely from private credors at higher nominal rates of interest in the in financial markets. For example the years 1970 to 1980 saw a decrease in the ratio of total debt to concessionary loans by 48 per cent; and an increase in the average interest rates by 4 per cent this trend continued into the 1990s. We incorporate this in the model to test the extent to which the rise in interest rates, adjusted for inflation affects the debt burden of commody-dependent LDCs. Domestic policy deficiencies in LDCs may be manifested in various forms, including corruption in governments, defective project appraisal, and defective investment incentives that makes domestic industries mainly dependent on foreign inputs. The model uses the degree of openness of the domestic economy as is measured by the ratio of imports plus exports to the country s GNP (or GDP). The real effect of the degree of openness of the economy depends on how the nature of exposure of the domestic economy to the international economy is handled. For those LDCs that effectively allocate foreign capal to future wealth generating projects can improve their overall debt posion in the medium- to long-run. Countries that focus on the importation of consumer goods or fail to effectively utilize imported capal goods will experience a worsening the debt suation (Taiwo, 1991). 4. Data The 1995 UNCTAD Commody Yearbook lists 59 developing countries which derived at least 50 percent of their export earnings from three main primary commodies or less. This study uses the UNCTAD list to identify those countries that derived at least 75 percent of their export earnings from less than four main primary commodies. The 75 percent selection crerion resulted in 29 countries-- about 74 per cent of countries on the UNCTAD list. The sample consists of a disproportionately large number of countries from the SSA that any other region of the world. We proceeded to obtain country-data on the dependent and explanatory 137

8 variables in this study World Debt Tables ( ), IMF International Financial Statistics (1998 and June 1999), World Tables (1997) World Development Index (1998). Seventeen countries had complete up-to-date data on all the variables, and only countries wh complete were used in this study. It was not possible to obtain data on some of the variables beyond 1997 therefore the time series component of the data did not extend beyond Of the 17 wh complete data, 12 are from SSA, 3 from Latin America 2 from Asia The empirical results We began the empirical analysis wh un root tests on the pooled data using the Augmented Dickey Fuller (ADF) test. The results of the ADF tests are reported at the bottom Table 1. The ADF tests show that interest rate and relative price variables were stationary at levels, which implies the absence of un roots. However, the test show total debt to exports ratio, terms of trade and the degree of countries openness had un root and integrated to the order one or I(1) (Gujarati, 2002). Equations (1) is a restriction of (2), therefore we conducted an F-test on the validy of the restriction (Pindyck and Rubinfeld, 1998, p. 253). Table 1 also contain the results of the fixed-effects model used in this paper. The coefficient of the terms of trade variable is negative and highly statistically significant. This indicates terms of trade of commody-dependent LDCs, has a strong influence on their debt posion. The relationship is such that, other things being equal, an increase in LDCs total debt indicator may result from deterioration in the terms of trade of the countries in the sample. This result is in line wh Rao s (1991) view that developing countries face great difficulties in raising external finance and servicing their external debts, due in large part to sharp fluctuations in the prices of primary commody exports. The terms of trade of these countries are 1 The countries include Burundi, Burkina Faso, Cameroon, Congo, Ethiopia, Gabon, Malawi, Niger, Nigeria, Rwanda, Uganda, Zambia, Ecuador, Venezuela, St. Vincent and Grenadine, Myanmar, Yemen. 138

9 Swaray, R. Primary commody dependence in less developed countries vulnerable to short-run fluctuations in the world demand for their primary exports on the one hand, and to import price shocks from, especially petroleum products on the other hand. Table 1: Pooled Regression Coefficients, Linear restriction and Augmented Dickey- Fuller Test Indep. Variables Dep. variable = EDTX Linear Restriction Tests Coefficients Variables F- Conclusion Statistics Constant (0.254) Tot ** Tot ** Reject null (-4.716) PR (0.030) PR Do not reject null INT (-1.070) INT Do not reject null OP ** OP ** Reject null (48.113) R Z Do not reject null F DW Augmented Dickey- Fuller Tests EDTX TOT PR INT OP ** * ** ** ** 1 st Diff 1 st Diff. Level Level 1 st Diff. Note: Individual country dummy variable coefficients are not reported due to statistical insignificance of the LR of Z. Values in the parenthesis are t- values. The impact of relative prices on total debt ratio is posive. However, the coefficient of this variable is statistically insignificant. Likewise, the coefficient of the cost of borrowing is not significant. Therefore, I was unable to conclude that relative prices and cost of borrowing played a significant role in the debt problem of primary commody-dependent countries. 139

10 The openness of the LDCs economies to the international communy was found to have a significantly posive influence on the total debt to export ratio. The posive relationship wh the total debt dependent variable is in line wh the fact that foreign trade is an important factor in debt negotiations and borrowing on concessionary terms. LDCs that are open to the international economy can borrow foreign capal and use to influence their debt suation. Table 1 also contain results of the fixed-effect model as well as linear restriction tests and summary conclusions. The tests simply imposed zero restrictions on each of the putative explanatory variables in the model, and all the dummy variables as a group. The result further confirms that terms of trade had a strong influence on the debt burden. Similarly, the test confirmed that the countries openness to international economy had a strong influence on their foreign debt problems. We are unable to reject the hypothesis for relative price and interest rate variables. Moreover, we are unable to reject joint test of hypothesis equaly of country dummy variables. This result supports Husain and Underwood (1991) and Claessens and Qian (1993) on the similary of debt and socio-economic variables among commody-dependence on SSA countries. 6. Conclusion This paper has examined the relationship between primary commody dependence and debt problems in a sample of LDCs wh dominant primary commody sectors. We use the pooled time series approach to evaluate the relationship between the LDCs debt indicators and a range of exogenous variables, including terms of trade, domestic vis-a-vis foreign price level, the cost of borrowing and the degree of openness of the economies to the international communy. The fixed-effects model used in this paper is particularly advantageous in capturing variations across countries. The empirical results in this paper show that a significant increase in debt burden of commody dependent countries resulted from deterioration in their terms of trade. These findings are in line wh 140

11 Swaray, R. Primary commody dependence in less developed countries studies that, among other things, point to the sharp fluctuations in commody prices as one of the factors responsible for difficulties that commody dependent countries face in raising external finance and servicing their debts. Further results show that the degree of openness of the local economy to the rest of the world to have a major influence on s external debt problem. However, relative price indices and the cost of borrowing do not appear to have significant impact of the LDCs debt suation. Refere nces Afxentiou, P. C. and Serletis, A. (1996) Growth and Foreign Indebtedness in Developing Countries: An Empirical Study Using Long-Term Cross-Country Data, The Journal of Developing Areas, 31, Ajayi, E. A. (1989) Nigerian Debt management Experience, Bullion, Publication of the Central Bank of Nigeria, 13(2), pp Alesina, A & Roubini, N. (1992) Polical Cycles in OECD Countries, Review of Economic Studies, 59, pp Borensztein, E. (1990a) Debt Overhang, Cred Rationing and Investment, Journal of Development Economics, 32, pp Borensztein, E. (1990b) Debt Overhang, Debt Reduction and Investment: The Case of Philippines, IMF Working Paper 90/77, IMF Washington. Cashin, P. Liang, H. & McDermott, J. (2000) How Persistent Are Shocks to World Commody Prices? IMF Staff Papers, 47(2), , Washington: International Monetary Fund. Cleassens, S. & Qian, Y.(1993) Financial Risk Management in Sub- Saharan Africa, in: Claessens, S. & Duncan, R.C. (eds) Managing Commody Price Risk in Developing Countries, The World Bank, Johns Hopkins Universy Press. Eaton, J. (1987) Public Debt Guarantees and Private Capal Flight, World Bank Economic Reviews, 1, pp Gilbert, C. L. and Tabova, A. (2004) Commody Prices and Debt Sustanabily, GRADE Discussion Paper No. 4, Dipartimento di Economia, Universa Degli Studi Di, Trento, Italy. Green, W. (1990) Economic Analysis, MacMillan Publishing Company, New York 141

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