This Selected Issues paper aims at discussing the impact of the oil windfall on Chad, with a focus on growth, poverty, competitiveness, and fiscal policy challenges posed by the oil revenue outlook. The paper discusses the reforms needed to remove structural factors that constraints the non-oil sector growth, in particular on civil and military services and the microfinance sector. The paper argues that Chad’s current growth potential is seriously limited by low levels of both human and physical capitals and by weak institutions and governance.

Abstract

This Selected Issues paper aims at discussing the impact of the oil windfall on Chad, with a focus on growth, poverty, competitiveness, and fiscal policy challenges posed by the oil revenue outlook. The paper discusses the reforms needed to remove structural factors that constraints the non-oil sector growth, in particular on civil and military services and the microfinance sector. The paper argues that Chad’s current growth potential is seriously limited by low levels of both human and physical capitals and by weak institutions and governance.

III. Assessing Competitiveness in Chad in Light of Oil26

A. Introduction

1. Chad is one of the poorest countries in the world. When oil began flowing in 2003-04, there were strong expectations that it would be a panacea for this land-locked desert nation. Revenues were to be tightly controlled by a Petroleum Revenue Management Law (PRML), passage of which the World Bank required as a condition of its participation in developing the sector. Leaving aside the controversial question of the use of oil revenues, oil exports have radically altered the profile of Chad’s economy. What has this meant for the rest of the economy and Chad’s non-oil export sector? This paper is a preliminary exploration of the impact of oil on Chad’s competitiveness.

2. The basic theory of Dutch disease, as applied to a fixed exchange rate regime, is that if inflows from exports (such as oil) are not held as reserves, used solely on imports, or adequately sterilized, they will increase the domestic money supply and ignite inflation. The ensuing inflation premium causes a change in relative prices and appreciation of the real exchange rate. Applying a theory of one price, another interpretation might be that oil production would increase efficiency and lower prices within the export sector as a whole. As a result, the nontradables sector becomes more costly and pays higher wages, so entices labor away from the traditional export sectors.

3. This paper concludes that there are some signs of real exchange rate appreciation in Chad, although the period for which data are available is very short and data quality is poor (Box 1). Because Chad is a member of the Central African Economic and Monetary Community (CEMAC), the Chadian authorities have limited flexibility in changing monetary and fiscal policies to neutralize real exchange rate appreciation. Structural policies are therefore crucial to maintaining competitiveness. In the end, the most important and effective policies to retain or boost competitiveness will be those that facilitate an increase in productivity in the non-oil economy.

4. The paper is structured as follows. Section B reviews Chad’s external sector for the period 1994-2004 and how the composition and direction of trade changed with oil production. Section C discusses measures of the real exchange rate and CEMAC-wide competitiveness. Section D discusses possible policy responses to increases in the real exchange rate, and Section E draws conclusions.

B. The External Sector Through 2004

5. In the last four years, external sector developments have been dominated by the coming online of oil production. In 2002-03 when the Chad-Cameroon pipeline was being constructed, the current account balance plummeted to a deficit of 99 percent of GDP. With production coming on line in the second half of 2003 and in full swing in 2004, the current account balance sharply reversed itself, moving to a surplus by 2005 (Figure 1).27 As was to be expected, services imports increased with oil exports.

Figure 1:
Figure 1:

Chad’s Current Account balance 1994-2005

CFAF billions

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

Data Limitations in Chad

The insights in this paper are constrained by data limitations, in terms of both quality and quantity. BOP data are available only on an annual basis. The first full year of oil production, 2004, is also the most recent year for which disaggregated export data are available. Only preliminary 2005 balance of payments data are available. There are no data available on productivity and real wages.

Moreover, data collection methodologies are not reliable. Because Chad’s balance of payments data are compiled from surveys of large exporting companies rather than customs data, they are subject to errors and frequent revision. Huge revisions of the 2002 balance of payments data were made in 2005 based on new information provided by the oil consortium. The revisions showed that there had been large errors and omissions and large swings in short-term capital flows in the crucial pipeline construction years.

It appears from the recent data revisions that oil-related imports increased sharply in 2002, but all other import categories declined markedly in that year only. This raises a question whether non-oil import figures might have been revised to reduce the size of the change in the aggregated number. For example, in 2002, a more extensive multi-country survey was conducted on intra-CEMAC livestock trade; as a result, Chad’s livestock export numbers were almost tripled in 2003. The Bank of Central African States (BEAC), which produces balance of payments data for Chad, chose not to revise the estimates of livestock exports retroactively.

Data on the direction of trade, especially in recent years, are inconsistent with the figures provided by trading partners. Also, the significant 2002 revisions are reflected in current account data but not in the data on the composition or direction of trade. This paper mostly uses partner country trade data.

6. The coming online of oil has radically altered export composition, direction, concentration, and weight in GDP (Figure 2). Chad’s traditional exports—cotton, livestock, and gum arabic—have been overshadowed by oil in recent years. Exports as a percentage of GDP increased from 10 percent in 2002 to 64 percent in 2005. Non-oil exports as a percentage of non-oil GDP have stayed relatively constant at around 14-16 percent. Cotton exports did fall as oil production came on line, but this was because international and local prices were falling. The cotton sector has suffered from significant infrastructure problems, including the near-bankruptcy of the state cotton company. The apparent increase in livestock exports at the same time occurred because new estimating methodology doubled the size of exports but was not applied retroactively.

Figure 2:
Figure 2:

Chad, composition of exports, 1994-2004

CFAF billions

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

7. Data on the direction of trade confirm that oil exports have changed its orientation. Trade within CEMAC and sub-Saharan Africa appears to be low, but data drawn from Chad’s trading partners, do not reflect recent large balance of payments revisions or the new calculations of livestock exports, which are almost exclusively directed to the CEMAC region and Nigeria. Before oil was found, most exports went to the European Union; now, oil exports show a major reorientation to North America and Asia (Figure 3).

Figure 3:
Figure 3:

Chad: share of exports to regions, 1994-2004

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

8. Chad’s non-oil imports are concentrated in equipment, intermediary goods, consumption goods, and energy (Figure 4). Except when the pipeline was being constructed, imports have held at around 18-20 percent of GDP. Continued strong imports for non-oil equipment and intermediary goods suggests that demand for inputs for traditional export sectors has not waned because of oil production. The buoyant rise in all categories of imports may indicate stronger domestic demand.

Figure 4:
Figure 4:

Chad, Composition of Imports, 1994-2004

CFAF billions

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

9. Before the pipeline and oil production facilities were constructed, Chad’s imports were predominantly from the EU. Imports from the U.S. and Canada in 2001-03 were primarily oil-related. While the share of imports from these countries has since declined, it is likely to remain somewhat higher than in the pre-oil era as long as oil is flowing. Imports from within CEMAC have increased at the same time, probably reflecting increased informal trade.

B. Measures of Competitiveness.

10. The real effective exchange rate (REER) is the most straightforward method for assessing competitiveness. It generally measures purchasing power in a country compared with its trading partners by using relative prices and the nominal exchange rate. 28 If the law of one price holds—that is, the price of tradables equalizes between countries—the real exchange rate can also be calculated as a ratio of the price of non-tradables to tradables in the home country. 29 In other words, if the price of non-tradables goes up relative to tradables—the real exchange rate rises and competitiveness is lost. In the theory of Dutch disease, natural resource windfalls cause a shift in resources from the nontradables to the tradables sector, making the former relatively more costly and implying an appreciation in the real exchange rate and a loss of competitiveness. In that case productivity growth would be the only way to stay competitive. In practice, the theory of one price usually does not hold, even for goods that seem to be purely tradable, owing to transport costs, official trade barriers and noncompetitive market structures.30

11. The Fund’s database shows that Chad’s REER appreciated by over 10 percent from before the 1994 devaluation through fall 2005. The change is composed of a fairly large nominal appreciation and a less pronounced increase in relative prices (Figure 5).

Figure 5:
Figure 5:

Chad’s Exchange Rates and Relative Prices, December 1993-September 2005

(Effective weightings as of 1990; December 1993=100)

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

Source: IMF Information Notice System

12. The radical change in Chad’s external trade should in theory put more weight on the US dollar/euro relationship in determining the country’s competitiveness, since the CFAF is pegged to the euro. A new REER series had to be constructed to reflect the change in Chad’s direction of trade. Although the weights for the Fund’s REER measures were changed from 1990 to 2000, the latter year still predates the radical shift in Chad’s direction of trade. For this paper, the REER was reconstructed using weights that give more prominence to relative prices for North America than for other regions.31 While changing the weights gives US dollar movements against the euro a higher weight in the nominal effective exchange rate, there is little change for relative prices because U.S. and euro-area inflation generally move in tandem. Indeed, applying the new weights relative to the old over the same period indicates that the nominal effective exchange rate has a more profound effect on REER movements than relative prices.32

13. Using the modified weighting scheme with a heavier weight for the US dollar, the increase in the REER since Chad’s oil production has come on line appears to be driven almost exclusively by changes in the nominal effective exchange rate. Using a modified weighting scheme and rebasing the series to 100 in July 2003, from January 2003-August 2005 the REER increased by 3.7 percent, reflecting a 3.7 percent increase in the nominal exchange rate and no change in relative prices over the period, although there was considerable vacillations within the period 33 (Figure 6). This suggests that the weakness of the U.S. dollar relative to the euro could be the main source of Chad’s loss of competitiveness rather than the oil sector.

Figure 6:
Figure 6:

Chad Exchange Rates and Relative Prices, Modified Weights

July 2003-August 2005

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

14. Assuming that the law of one price holds to some extent, another way to assess competitiveness is the internal exchange rate—the price of non-tradables relative to tradables in the country itself. The internal exchange rate also seems to have increased in Chad since oil came on line. A REER was constructed by classifying detailed CPI categories as tradable or non-tradable and creating weighted index for each. Oil itself was excluded Figure 7 shows that prices of nontradables have been increasing more than those of tradables. A main source of inflation in Chad has been food shortages, especially of cereals, but since cereals are included in the tradables index, they are not responsible for the movement of non-tradables.

Figure 7.
Figure 7.

Real Exchange Rate using Disaggregated CPI

Dec. 2003-December 2005

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

15. Similarly, terms of trade data excluding oil show a sharp drop in the price of exports relative to the price of imports (Figure 8).34 This reflects both a strong drop in export prices and a moderate increase in import prices. Since they are combined with nominal exchange rate appreciation, these movements are difficult to interpret, but the drop in export prices could reflect movements in cotton commodity prices.

Figure 8:
Figure 8:

Chad’s terms of trade for non-oil tradables, 1994-2004

Citation: IMF Staff Country Reports 2007, 028; 10.5089/9781451836462.002.A003

16. According to IMF regional surveillance of CEMAC earlier this year, evidence on the evolution of competitiveness in CEMAC members is mixed.35 The mission team found that trends in REER differed significantly among members of the monetary union. While in general exchange rate-based measures point to declines in competitiveness, recent increases in export volumes, market penetration ratios, and export market shares of different regions tell a different story. The terms of trade have also improved, mainly because of higher oil prices and increases in export volumes. However, the report does note a slowdown in the growth of non-oil exports, and in view of the limited horizon on Chad’s production of oil, the mission recommended a focus on non-oil sector competitiveness. The authorities agreed that expansion in oil sectors had led to growing domestic cost pressures, including higher costs of labor and services particularly in Equatorial Guinea and Chad. But structural rigidities undermine the competitiveness of the non-oil export sector, with business climate indicators showing major obstacles to private sector development for such reasons as limited access to bank credit, high cost of collateral, inadequate legal systems, and labor market rigidities.

17. In terms of Dutch disease, the CEMAC mission noted that heavy reserve inflows were not being adequately sterilized by the regional central bank (BEAC). As a result, the region suffers from substantial excess liquidity and sharp increases in inflation and bank lending in some member countries. The authorities felt in turn that the liquidity situation did not carry a serious threat of inflation.

C. Possible Policy Responses to Declining Competitiveness

18. The government of Chad has not much room to maneuver in making decisions on an appropriate macroeconomic policy response to the oil windfall. In theory, a loss of competitiveness due to oil sector inflows could be addressed through a variety of policy actions to avoid absorbing the windfall, such as using the foreign exchange to finance higher imports or spending the foreign currency counterpart in the economy. However, the Petroleum Revenue Management Law (PRML) implies in fact that there should be additional spending for investment in priority sectors and dictates that, when absorption capacities are weak, a large share of windfalls in the next few years should be saved.36

19. As for absorption, monetary policy is determined by the regional central bank. To the extent the government spends oil revenues domestically according to the PRML, it increases the money supply and sterilization is needed to bring the money supply back in line and avoid igniting inflation. But even the BEAC has few tools for intervention; they consist mainly of reserve requirements and the provision of short-term remunerated deposits for commercial banks. It also must consider the entire CEMAC region. The BEAC is not doing much to sterilize strong reserve inflows. Moreover, because the CFA franc is pegged to the euro, the nominal exchange rate is exogenously determined and cannot serve as an adjustment mechanism. In theory, if the exchange rate were to float freely, the nominal exchange rate would adjust to compensate for movements in relative prices between countries. If the nominal exchange rate adjusts completely and immediately, real exchange rates would stay in equilibrium, and aggregate purchasing power would be identical in each country.

20. This leaves structural policy as the sole adjustment mechanism. The best way to ensure long-term competitiveness is to increase productivity in the non-oil sector. In fact, the importance of external competitiveness measures is dwarfed by structurally stagnant non-oil productivity in Chad. A recent Diagnostic Trade Integration Study (DTIS) for Chad mentions as potential sectors for further export development cotton, livestock, fishing (Lake Chad), and crops beyond gum arabic, such as spiruline, peanuts, sesame and karite. In addition to meeting the preconditions of macroeconomic stability and durable security, Chad must also overcome numerous obstacles, within the country, outside it, and at the borders, in order to exploit the full growth potential of these sectors.37

21. Perhaps the first priority is to remove obstacles to productivity increases and growth within Chad itself.

  • The lack of basic infrastructure and public services in Chad is extreme. The transport network is woefully inadequate, causing delays and raising transport costs to prohibitive levels. Even in the capital, virtually all roads are made of dirt (deeply-pitted mud in the rainy season). In the rural cotton areas, the roads are often not passable and transport trucks wear out quickly. Because 98 percent of Chadian households do not have access to the electricity grid, they must go without electricity. For those better-off households and businesses that do have access, the grid’s capacity is so feeble that they must generate their own backup electricity using high-cost diesel fuel.

  • The cotton sector is in a precarious state; the state-owned cotton company is in virtual bankrupt. Serious reform will be needed to keep the cotton sector afloat. While the livestock sector is healthy, its potential for growth is limited because there are formal structures for information-sharing or promotion.

  • To foster investment it is imperative that Chad improve the investment climate and governance generally. Chad recently was ranked among the most corrupt countries in Transparency International’s list and was near the bottom in terms of being a good place to do business in a recent business climate survey.

22. More efficient customs operations would help productivity in Chad’s tradables sector. Problems include ad-hoc exemptions, discretionary application of the rules, and corruption. Also, better data collection on the tradables sector would be useful for measuring improvements.

23. Constraints outside the country are also obstacles to trade. Chad’s landlocked status requires exports to pass through Cameroon to the seaport at Douala. Because transit times are long and costly, Chad needs to work closely with other countires in the region to improve these conditions. Also problematic are typical barriers to trade facing developing countries: distortionary cotton subsidies in industrialized countries and entry barriers to world markets, such as high product standards. The best hope for reducing these barriers are the Doha Development Round negotiations and, bilateral agreements, like the European Partnership and the U.S. African Growth and Opportunity Act. The Chadian authorities have signed all the necessary conventions in order to benefit from these initiatives.

D. Conclusion

24. Chad’s long term competitiveness can only be ensured if it tackles deep-seated obstacles to growth and productivity improvement. Indications that the coming online of oil production may be creating Dutch disease, which will have short-run impacts on the real effective exchange rate, only makes such reforms more imperative. The country has limited means for using the normal policy tools needed to address short-term, with potentially long-term ramifications, oil-induced erosions in competitiveness.

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26

Prepared by Laure Redifer

27

Balance of payments data for 2005 are still estimates by the BEAC (Banque des Etats de L’Afrique Centrale).

28

Producer prices, GDP deflator, and unit labor costs are some ways other than consumer prices to measure relative price changes. Only the CPI and the GDP deflator are available for Chad.

29

P = PNTα PT1-α. Domestic prices are composed of both the nontradables and tradables sectors. RER= e P/ P*. The real effective exchange rate is equal to domestic prices relative to international prices adjusted by the nominal exchange rate. According to the theory of one price, P* =e PT if prices in the nontradables sector adjust to international prices adjusted by the nominal exchange rate. Then RER= e(PNTα PT1-α)/e PT = (PNT/ PT)α. The real exchange rate is the price of nontradables relative to tradables.

30

Obstfeld and Rogoff (1999) and Froot and Rogoff (1995).

31

This was done using the Fund’s effective exchange rate facility. However, since the direction of trade of imports was affected less than the direction of exports (it was only affected profoundly while the pipeline was being constructed), the weights were not changed dramatically.

32

Using the Fund’s effective exchange rate facility to recalculate effective exchange rates and relative prices and giving a higher weighting for the US (45 percent) and Asia shares of trade relative to Europe (45 percent) reveals more REER appreciation. Comparing new and old weightings for January 2001-August 2005 shows a 23 percent increase in the REER (10 percent using the old weightings) composed of a increase in the nominal effective exchange rate of 15 percent (10 percent using the old weightings) and an increase in relative prices of 7 percent (5 percent using the old weightings). The recalibration forces the relationship to add properly.

33

Using the old weighting system, the REER depreciated 1.6 percent between July 2003 and September 2005.

34

The terms of trade data used are from the Fund system. Staff estimates of the terms of trade, based on roughly- imputed price series, do not indicate that non-oil export prices are decreasing relative to non-oil import prices.

35

Central African Economic and Monetary Community—Staff Report on Common Policies of Member Countries, Country Report No. 06/317, 6/20/06.

36

The CEMAC mission advised not to count these resources as official reserves so that they could be invested in longer term assets to generate higher returns.

37

See Cadot et. al

Chad: Selected Issues and Statistical Appendix
Author: International Monetary Fund
  • View in gallery

    Chad’s Current Account balance 1994-2005

    CFAF billions

  • View in gallery

    Chad, composition of exports, 1994-2004

    CFAF billions

  • View in gallery

    Chad: share of exports to regions, 1994-2004

  • View in gallery

    Chad, Composition of Imports, 1994-2004

    CFAF billions

  • View in gallery

    Chad’s Exchange Rates and Relative Prices, December 1993-September 2005

    (Effective weightings as of 1990; December 1993=100)

  • View in gallery

    Chad Exchange Rates and Relative Prices, Modified Weights

    July 2003-August 2005

  • View in gallery

    Real Exchange Rate using Disaggregated CPI

    Dec. 2003-December 2005

  • View in gallery

    Chad’s terms of trade for non-oil tradables, 1994-2004