Burkina Faso: Selected Issues
Author: International Monetary Fund
Publication Date:
28 May 2008
eISBN:
9781451803952
Language:
English
Keywords:
ISCR; CR; mining company; terms of trade shock; export price; income cost; terms of trade deterioration; petroleum price; purchasing power; Import prices; Imports; Purchasing power; terms of trade change; cotton price
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This paper assesses the link between public investment and economic growth in Burkina Faso. It also evaluates Burkina Faso's external competitiveness by using a comparison of REER to its equilibrium levels and a survey-based assessment of overall competitiveness. The report attempts to quantify the impact of rainfall and terms-of-trade shocks on the Burkinabe economy and draws policy measures to lessen external shocks. The report assesses that industrial mining has become a source of foreign exchange and government revenue, which requires transparent management and accountability.

Abstract

This paper assesses the link between public investment and economic growth in Burkina Faso. It also evaluates Burkina Faso's external competitiveness by using a comparison of REER to its equilibrium levels and a survey-based assessment of overall competitiveness. The report attempts to quantify the impact of rainfall and terms-of-trade shocks on the Burkinabe economy and draws policy measures to lessen external shocks. The report assesses that industrial mining has become a source of foreign exchange and government revenue, which requires transparent management and accountability.

III. Vulnerabilities Related to Rainfall and Terms of Trade Variations32

A. Introduction

87. This paper attempts to quantify the impact of rainfall and terms of trade shocks on the Burkinabè economy and draws conclusions about policy measures to lessen the impact of such external shocks. Rainfall is a powerful determinant of economic activity in an agricultural economy like Burkina Faso. The terms of trade, which determine the country’s relative purchasing power, in Burkina Faso are driven mostly by cotton and oil prices. The country is vulnerable to drought, rainfall variation, and related natural phenomena such as locust infestation and desertification. The recent crisis in the cotton sector and strains from higher world prices for oil are potent reminders of just how vulnerable the economy is to shocks to the external terms of trade (prices of exportables relative to importables).

88. In a country that depends heavily on agriculture, supply shocks from rainfall variation affect a large proportion of the population. Smoothing such shocks geographically or intertemporally can be difficult, especially for subsistence farmers who depend on surface rainfall, lack adequate storage facilities, have poor communications and transportation links, and lack access to credit. At the macro level adverse rainfall shocks may lead to lower growth, higher prices, less export revenue, increased imports, a drawdown of international reserves, and a redirection of government spending toward emergency relief.

89. Terms of trade shocks also affect the economy in a variety of ways:

  • Other things being equal, a terms of trade shock affects the trade balance; at unchanged volumes a favorable shock improves it.

  • It also leaves the country with more real income because the same volume of exports allows the country to purchase more goods, which in turn raises demand for both tradables (importables) and nontradables. Consequently, improvement in the trade balance may be tempered and accompanied by an appreciation of the real exchange rate.

  • Terms of trade shocks may alter intertemporal consumption choices. The extent of the reallocation will depend on the persistence or permanence of the shock. For example, a temporary increase in oil prices may be more easily absorbed by a widening trade deficit and a loss of reserves than a permanent increase.

90. We report stylized facts about Burkina Faso’s vulnerability to rainfall variation and shocks to the terms of trade, and we estimate their impact on key macroeconomic variables. Because the effects of such shocks are complex and data limitations are severe, we chose a parsimonious approach consisting of estimating simple relations between the exogenous shocks and such variables as the trade balance, growth, and inflation. This approach is easily interpretable, although it is also likely to pick up indirect effects from omitted macro variables that could bias the analysis.

91. Section B describes stylized facts of rainfall variation and presents the effects on output and prices. Section C discusses variation in the terms of trade, putting Burkina Faso’s recent experience in an international perspective. It also gives details on the costs of terms of trade changes and sets out evidence of the impact of terms of trade shocks on the trade balance and prices. Section D draws conclusions and provides some policy recommendations.

B. Rainfall Variation

Stylized facts

92. Like its sahellian neighbors, Burkina Faso’s rainfall (Figure III.1) is characterized by low annual amounts, significant variation from year to year, significant regional variation, and strong seasonality. The rainfall data in Figure III.1 are interpolations of satellite grid point data.33 The top panel of the Figure III.1 depicts the average monthly rainfall for Ouagadougou, Bamako (Mali), and Niamey (Niger) for 1979–2005; the bottom panel shows monthly rainfall for those cities from December 2002 through July 2006.

Figure III.1.
Figure III.1.

Rainfall in Ouagadougou, Bamako, and Niamey, 1979-2005

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: http://disc2.nascom.nasa.gOv/Giovanni/tovas/rain.GPCP.2.shtml.

93. Rainfall patterns display significant regional variation; localized pockets of drought may occur even when rainfall for the country as a whole has been good.34 For Ouagadougou, average monthly rainfall for 1979–2005 was a mere 79.8 ml, but as the top panel of Figure III.1 makes clear, this average number masks substantial year-to-year variation; the standard deviation is 9.4 for the sample period. For example, average monthly rainfall was only 72.9 ml in 2002 but was 99.3 ml in 2003. With a 35 percent increase in rainfall, it is not surprising that harvests in 2003 were much better than in 2002. Typically, rainfall diminishes as one moves further north. For example, average monthly rainfall in Niamey was 45 ml for 1979–2005, about 35 ml less than in Ouagadougou.

94. The highly seasonal rainfall pattern determines the rhythm of agriculture, especially for subsistence farming. The seasonality of rainfall is clearly captured in the bottom panel of Figure III.1: the rains usually in May through September, and November through February are dry months. Deviations from the typical pattern may adversely affect crop yields. For example, the late start of rains in 2007 is estimated to have significantly reduced both the cotton and the maize crops.

The impact of rainfall variation on output and prices

95. To quantify the effect of rainfall shocks on growth and inflation, we estimate a three-variable vector autoregression (VAR) model with one lag, using annual observations for 1980 through 2005. We use the detrended values of the logs of real GDP and CPI; the rainfall data are the log of average monthly rainfall per year.35 Figure III.2 summarizes results of this VAR estimation by showing impulse responses, cumulative impulse responses, and variance decompositions.36

Figure III.2.
Figure III.2.

Burkina Faso: Response of Real GDP and Prices (CPI) to Rainfall Shocks, 1980–2005

(Percent, VAR specification, annual data)

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.

96. The impulse responses trace the intertemporal reaction of a variable (here: output and prices) to an initial shock to rainfall of, with the magnitude of the rainfall shock equal to one standard deviation. The cumulative impulse responses measure the cumulative effect of the intertemporal reaction of the variables of interest to the initial rainfall shock. Finally, the variance decompositions calculate the fraction of the overall variation in a variable that is due to movements of the other variables.

97. The main results confirm several intuitive points:

  • A positive rainfall shock (equal to one standard deviation; about 10 ml) initially pushes output above trend by almost 2 percent and prices below trend by about 1 percent.

  • The effect of the positive impulse on output is persistent, though eventually it dies out and output returns to trend.

  • The change in prices is also drawn out, but the cumulative response function suggests a permanently lower price level effect;

  • Finally, variance decomposition suggests that rainfall variation explains almost half of the output and CPI variation in output.

98. To check the robustness of the results of rainfall on prices, we also ran a monthly regression model with data on rainfall, gasoline prices, and CPI prices. The regression model uses a VAR setup with detrended data, and the sample period runs from February 1998 through April 2007. Twelve lags account for seasonality. The estimated impact of rainfall on prices is shown in Figure III.3. The findings confirm that prices fall in response to a positive rainfall shock. The monthly results also show that the response of prices appears to kick in after 6-12 months and that the effect seems to be permanent (seen most clearly in the cumulative responses). The delayed response of prices is confirmed by the variance decompositions: the effect of rainfall shocks on prices Starts to builds up about six months after the shock. The variance decompositions also confirm the important contribution of rainfall to price Variation (almost 20 percent).

Figure III.3.
Figure III.3.

Burkina Faso: Reponse of Prices to Rainfall Shocks, 1998-2007 (April)

(Percent, VAR specification, monthly data)

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.

C. Shocks to the Terms of Trade

99. A positive terms of trade shocks provides a country with more real income since the same volume of exports allows the country to purchase more goods. The reaction to the shock depends on whether the change is thought to be permanent or temporary. For example, a temporary increase in cotton prices would narrow the trade deficit and tend to increase reserves without fundamentally changing economic behavior. A permanent increase in cotton prices, however, raises permanent income and consumption, thus offsetting a part of the improvement in the trade balance. Also, a permanent shock may increase demand and thus production of nontradables, which could lead to an appreciation of the real exchange rate.

Stylized facts

100. Variation in cotton prices has been the most important explanatory factor for the observed large Swings in the terms of trade:

  • The terms of trade have been declining since after the devaluation of 1994, and large year-to-year swings have been quite common (see Figure III.4). In 7 out of 12 years, there were Swings of more than 10 percent in seven out of twelve years, even exceeding 20 percent in 2003 and 2005 Swings of more than 20 percent.

  • Both export and import price changes contribute to changes in the terms of trade. Often, these factors reinforce each other, as they did in 2003 and in 2005. However, with few exceptions large Swings in the terms of trade are due to changes in export prices.

  • Cotton prices are largely responsible for changes in export prices (Figure III.5). This is not entirely surprising given the dominant role of cotton in Burkina Faso’s Overall exports—about 60 percent in recent years.

  • Changes in petroleum prices contributed substantially contributed to changes in import prices (2002 and 2003 are exceptions), but had a limited impact on the terms of trade.

Figure III.4.
Figure III.4.

Burkina Faso: Terms of Trade, 1995-2006

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Sources: Burkinabè authorities; and IMF staff estimates.
Figure III.5.
Figure III.5.

Burkina Faso: Contribution to Changes in the Terms of Trade, 1995–2006

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: Burkinabè authorities; and IMF stattestimates.

101. The terms of trade are relatively more volatile in Burkina Faso than in its neighbors (Table III.1). In 2005, for example, only in Benin was the deterioration nearly as dramatic as in Burkina Faso. Burkina Faso, Benin, and Mali are the only countries in the comparison that depend on a Single product for more than 50 percent of export revenues, and Burkina Faso seems to be unique in that its main crop explains nearly all the movements in export prices (Table III.2). Senegal is at the other end of the spectrum, presumably because its export base is more diversified. On the other hand, regarding import prices, the contribution from petroleum prices to Burkina Faso’s experience is fairly similar to that of neighboring countries (Table III.3).

Table III.1:

Terms of Trade of Selected African Countries, 2000-06

article image
Source: IMF African Department country desks.
Table III.2:

Decomposition of Export Prices of Selected African Countries, 2000–06

article image
Source: IMF staff calculations.
Table III.3:

Decomposition of Import Prices of Selected African Countries, 2000–06

article image
Source: IMF staff calculations.

The cost of terms of trade changes on the economy

102. We introduce three concepts to measure the economic impact of changes in the terms of trade. The annual impact can be quite large; up to 5 percent of GDP in gains or losses for the economy in terms of consumption possibilities gained or lost. The first measure of the impact is the import cost of changes to the terms of trade, which is calculated as the product of the percentage change in the terms of trade and last period’s import-to-GDP ratio:

Importcostin %of GDP ≡ - % Δ ( termsoftrade ) * ( imports / GDP ) ≈ - [ % ▵ ( exportprices ) * ( imports / GDP ) - % ▵ ( importprices ) * ( imports / GDP ) ]

103. Import cost captures the extent to which a country is poorer when the terms of trade deteriorate by showing how much more net income it needs to purchase the same quantity of imports, and the extent to which it is richer when the terms of trade improve because the same purchases take less net income. Import cost increases in import prices and in imports-to-GDP (the same increase in import prices is more costly when the country had higher imports to begin with). It decreases in export prices, since exports generate additional income.

104. Although the import cost measure is intuitively appealing, it does not take into account the effect of terms of trade changes on net exports.37 To account for this effect, we introduce the income cost measure:

Incomecostin % of GDP ≡ - [ % ▵ ( exportprices ) * ( exports / GDP ) - % ▵ ( importprices ) * ( imports / GD ) ]

105. Income cost is also expressed as a percentage of GDP, and the export-to-GDP and import-to-GDP ratios are those of the previous period. It essentially measures the impact on the trade balance of a change in the terms of trade, holding constant any volume effects (with the sign inversed). Note that the income cost measure is identical to the import cost measure if the import-to-GDP and export-to-GDP ratios are the same—that is, if the trade balance is zero. Also, if most variation in the terms of trade comes from export prices and the country runs a trade deficit, income cost will typically be smaller in absolute value than import cost.

106. A third measure captures the notion that the purchasing power of exports falls when the terms of trade deteriorate and an economy can compensate for the loss by increasing the volume of exports (see Dornbusch and Helmers 1988). This measure, which applies to the purchasing power of exports, is calculated as the product of the terms of trade and the export volume:

Purchasing power of exports ≡ Terms of trade * Export volume

107. The import cost and the income cost have been considerable in Burkina Faso since the devaluation of 1994 (Figures III.6). Our calculations indicate that the import cost of terms of trade changes has generally fluctuated between about –4 and +4 percent of GDP (recall that positive values are costs and negative ones are gains). The severity of the terms of trade deterioration in 2005 is confirmed by an import cost of 4.4 percent of GDP. We also note that there are several years of impressive gains; 2003 had a record gain of 4.2 percent of GDP. The calculated income cost measure is qualitatively similar to the import cost measure but is typically smaller (except in 2000, when the large deterioration in the terms of trade came mostly from import prices). Since devaluation the income cost has varied between -2.7 percent and +4.6 percent of GDP. The 2005 terms of trade deterioration translated into an income cost of about 3 percent of GDP. This, however, is still smaller in absolute value than the cumulative income gains enjoyed in 2003–04 and the 4 percent of GDP income loss of 2000.

108. There were also large movements in the purchasing power of exports since devaluation period (Figure III.7). The purchasing power of exports declined by 8.6 percent in 2005; the increased volume of exports was able to mitigate but not fully compensate for the adverse impact from the terms of trade deterioration. This contrasts with 2002, where deterioration in the terms of trade was more offset by the volume increase of exports.

Figure III.6.
Figure III.6.

Burkina Faso: Import Cost and Income Cost of Changes in the Terms of Trade, 1995-2006

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.
Figure III.7.
Figure III.7.

Burkina Faso: Terms of Trade Shocks and Purchasing Power of Exports, 1995–2006

(Percentage change)

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.

109. Although Burkina Faso has generally experienced larger terms of trade swings since 2000, some of its neighbors (particularly Côte d’Ivoire, Ghana, and Togo) have had to cope with larger import and income costs (Text Table III.1 and Table III.4). Cumulatively Burkina Faso’s terms of trade improved about 10 percent over 2000–06, with a corresponding cumulative income gain of about 1.4 percent (in spite of the large deterioration in 2005). Among neighboring countries Niger had the largest improvement (about 23 percent) in its terms of trade for the period, with a cumulative income gain of 2.1 percent. In contrast, Benin, Côte d’Ivoire, Mali, and Togo saw a terms of trade deterioration; Togo suffered the highest income cost (5.4 percent cumulatively). Finally, Burkina Faso recorded the largest cumulative gain—130 percent—in the purchasing power of exports for 2000–06, followed at a distance by Mali with about 50 percent and Ghana with about 30 percent.

Text Table III.1:

Cumulative Cost of Terms of Trade Changes of Selected African Countries, 2000–06 1

article image
Source: IMF staff calculations.

Cumulative values calculated using the percentage change in the terms of trade, import prices, and export prices (between 2000-06), and the average imports-to-GDP and exports-to-GDP ratio over 2000–06.

Table III.4:

Cost of Terms of Trade Changes of Selected African Countries, 2000–06

article image
Source: IMF staff calculations.

Cumulative values calculated using the percentage change in the terms of trade, import prices, and export prices (between 2000–06) and the average imports-to-GDP and exports-to-GDP ratio for the period.

The impact of terms of trade changes

110. Because the intuitive measures just discussed do not capture intertemporal effects, they cannot substitute for intertemporal econometric estimations. Unfortunately, for Burkina Faso it is hard to estimate the reaction of the trade balance to shocks in the terms of trade because the sample size of the post-devaluation period is short. We therefore proceed cautiously by estimating three simple bivariate vector error correction models (VECM), each with one lag. The two variables are the trade balance as a percent of GDP and the terms of trade, export prices, and import prices. The impulse responses and the variance decompositions of each of the three specifications are shown in Figure III.8.

Figure III.8.
Figure III.8.

Burkina Faso: Response of the Trade Balance to Shocks to the Terms of Trade, 1995–2007

(Three VECM specifications, annual data)

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.

111. Despite the short sample period, the results confirm the basic conjecture about term of trade shocks: a positive shock to export prices improves the trade balance, and a positive shock to import prices causes it to deteriorate. Specifically, a typical one-standard-deviation shock to the terms of trade affects the trade balance by about ½ percent of GDP. Though the reaction of the trade balance persists into the second year, the effect soon dies out. The variance decompositions suggest that terms of trade shocks explain about 20 percent of the variation in the trade balance; this goes up to about 26 percent for a separate decomposition of export and import price shocks.

112. Finally, we report the effects of petroleum price shocks on CPI prices (Figure III.9) using the three-variable VAR with monthly data on rainfall, petroleum prices, and CPI prices, with twelve lags to capture seasonal effects. The effect of world petroleum prices on CPI prices is significant. In fact, the impulse responses in Figure III.9 show that CPI prices appear to react in two waves, with the first-wave response capturing the direct effect of price changes at the pump (left panel of Figure III.9). Indeed, the government has in place a system of automatic price adjustment that allows for the direct pass-through of world petroleum prices to domestic prices. After about one year, a second-wave response to prices begins. It may be that the cost structure of some goods and services is affected by petroleum prices, but that the prices of those products change infrequently.

Figure III.9.
Figure III.9.

Burkina Faso: Response of CPI to Petroleum Shocks, 1998-2007 (April)

(Percent, VAR specification, monthly data)

Citation: IMF Staff Country Reports 2008, 169; 10.5089/9781451803952.002.A003

Source: IMF staff estimates.

D. Conclusion

113. Burkina Faso is vulnerable to external shocks. Rainfall variation may explain as much as half of the observed cyclical variation of output and prices. The country is also subject to large swings in its external terms of trade that affect the trade balance, prices, and incomes. Although petroleum prices contribute, these swings are largely due to variation in world cotton prices. Unsurprisingly, the big drop in world cotton prices in 2005 had a large cost for Burkina Faso in terms of lost income, for which increased volumes could not fully compensate. Though neighboring countries also experienced significant changes in their terms of trade, Burkina Faso is especially vulnerable because it is so dependent on a single commodity for export revenue. Indeed, by the end of 2006 the share of cotton in overall exports had increased to more than 60 percent, and the purchasing power of exports had increased by 130 percent.

114. There are some possible policy options for responding to rainfall variations, though less so for terms of trade shocks. The important rainfall variations present in Burkina Faso imply high risk premiums that may make investments in agriculture less attractive and permanently restraining the movement of the sector beyond subsistence. Moreover, subsistence farmers have few instruments at their disposal to lessen the impact of these shocks. However, possible medium-term policy responses would be to increase food storage facilities to be able to supply deficit regions with additional food. It would also be important to improve water storage, irrigation, and roads, install early warning methods, and broaden access to credit. These measures would allow farmers to better adjust to the variations in rainfall and would thus lessen the impact of rainfall variations on agricultural output. Regarding terms of trade shocks the main policy response would be to facilitate adjustment to permanent changes, and to smooth temporary changes including through improved access to credit.

References

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  • Dornbusch, Rudiger, Stanley Fischer, and Paul Samuelson, 1977, “Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods,” American Economic Review, Vol. 67, No. 5, pp. 823 –39.

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  • Mendoza, Enrique, 1995, “The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations,” International Economic Review, Vol. 36, No. 1, pp. 101 –37.

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  • Végh, Carlos, 2007. “Non-traded Goods and Relative Prices,” in Végh, Open Economy Macroeconomics in Developing Countries (forthcoming; Cambridge, MA: MIT Press), available at http://www.econ.umd.edu/~vegh/book/book.htm

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32

Prepared by Chris Geiregat.

33

The rainfall data were acquired using the GES-DISC Interactive Online Visualization and Analysis Infrastructure (Giovanni),) part of NASA’s Goddard Earth Sciences (GES) Data and Information Services Center (DISC).

34

Unfortunately, we were not able to obtain time series data on rainfall by region in the various regions of Burkina Faso.

35

We also included a dummy for 1994, to absorb the outlier of the 1994 devaluation on inflation. Throughout the study, variables were detrended using the Hodrick-Prescott filter.

36

The impulse responses and variance decompositions were obtained via a Cholesky decomposition, with rainfall ordered first. The confidence bands are drawn based on plus and minus two standard deviations, thus encompassing 95 percent of possible outcomes.

37

Imagine a country with a trade deficit and both import and export prices increase by the same percentage. Since the terms of trade are not affected, the import cost measure would be zero. However, the additional income generated from exports would not be enough to compensate for the additional cost of imports.

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Cover IMF Staff Country Reports
Burkina Faso: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2008: Issue 169
Publisher:
International Monetary Fund
ISBN:
9781451803952
ISSN:
1934-7685
Pages:
71
DOI:
https://doi.org/10.5089/9781451803952.002
  • View in gallery

    Rainfall in Ouagadougou, Bamako, and Niamey, 1979-2005

  • View in gallery

    Burkina Faso: Response of Real GDP and Prices (CPI) to Rainfall Shocks, 1980–2005

    (Percent, VAR specification, annual data)

  • View in gallery

    Burkina Faso: Reponse of Prices to Rainfall Shocks, 1998-2007 (April)

    (Percent, VAR specification, monthly data)

  • View in gallery

    Burkina Faso: Terms of Trade, 1995-2006

  • View in gallery

    Burkina Faso: Contribution to Changes in the Terms of Trade, 1995–2006

  • View in gallery

    Burkina Faso: Import Cost and Income Cost of Changes in the Terms of Trade, 1995-2006

  • View in gallery

    Burkina Faso: Terms of Trade Shocks and Purchasing Power of Exports, 1995–2006

    (Percentage change)

  • View in gallery

    Burkina Faso: Response of the Trade Balance to Shocks to the Terms of Trade, 1995–2007

    (Three VECM specifications, annual data)

  • View in gallery

    Burkina Faso: Response of CPI to Petroleum Shocks, 1998-2007 (April)

    (Percent, VAR specification, monthly data)

Rainfall in Ouagadougou, Bamako, and Niamey, 1979-2005

Burkina Faso: Response of Real GDP and Prices (CPI) to Rainfall Shocks, 1980–2005

(Percent, VAR specification, annual data)

Burkina Faso: Reponse of Prices to Rainfall Shocks, 1998-2007 (April)

(Percent, VAR specification, monthly data)

Burkina Faso: Terms of Trade, 1995-2006

Burkina Faso: Contribution to Changes in the Terms of Trade, 1995–2006

Burkina Faso: Import Cost and Income Cost of Changes in the Terms of Trade, 1995-2006

Burkina Faso: Terms of Trade Shocks and Purchasing Power of Exports, 1995–2006

(Percentage change)

Burkina Faso: Response of the Trade Balance to Shocks to the Terms of Trade, 1995–2007

(Three VECM specifications, annual data)

Burkina Faso: Response of CPI to Petroleum Shocks, 1998-2007 (April)

(Percent, VAR specification, monthly data)