Report No. 47321-GH Ghana Economy-Wide Impact of Oil Discovery in Ghana November 30, 2009 PREM 4 Africa Region Document of the World Bank Vice President: Obiageli K. Ezekwesili Country Director: Ishac Diwan Sector Director: Sudhir Shetty Sector Manager: Antonella Bassani Task Team Leader: SCbastien Dessus Acknowledgments The report was prepared by a team led by SBbastien Dessus (Chapter l), comprising Denis Medvedev and (Chapter l), Bryan Land (Chapter 2), Katherine Bain and Smile Kwawukume (Chapter 3), Marcello Andrade, Carlos Calvacanti and Michael Stevens (Chapter 4), Vivien Foster and Maria Vagliasindi (Chapter 5), Christopher Costain (Chapter 6), Chris Jackson and Derek Byerlee (Chapter 7). Glaucia Ferreira, Faye Hartbottle and Ayisha Terewina helped prepare this document. Overall guidance was provided by Ishac Diwan and Antonella Bassani. Brian Pinto, Kapil Kapoor and Alexander K y e i peer reviewed this report. Comments, inputs and suggestions were also received from Sunil Mathrani, David Santley, Ventbra Bengoechea, Art0 Kovanen, Ross Worthington, Tuan Minh Le, Phillip Keefer, Stepehen Ndewga, Andrew Norton and Catherine Gamper. Comments and suggestions from the Ministry o f Finance and Economic Planning were coordinated bv Amoako Tuffour. ... 111 Republic o f Ghana Economy-Wide Impact o f Oil Discovery in Ghana Table o f Content EXECUTIVE SUMMARY ............................................................................................................... vi1 1. OVERVIEW .................................................................................................................................. 1 A. INTRODUCTION ........................................................................................................................... 1 B. INSTITUTIONALAND PUBLIC FINANCIAL MANAGEMENT CHALLENGES.................................... 4 C. MACRO-ECONOMIC CHALLENGES .............................................................................................. 7 D. PRODUCTIVITY. COMPETITIVENESS. AND SOCIAL CHALLENGES ............................................. 11 E. TRADE-OFFS A WAY FORWARD ......................................................................................... AND 16 2 . REVENUE PROJECTIONS ...................................................................................................... 19 A. INTRODUCTION .......................................................................................................................... 19 B. JUBILEE PHASE BASE I CASE.................................................................................................... 20 C. IMPACTS BASE OF A LARGER RESOURCE ................................................................................. 23 3 . POLITICAL ECONOMY DIMENSIONS ............................................................................... 26 A . INTRODUCTION ......................................................................................................................... 26 B. THEROLE POLITICS AND INSTITUTIONS IN DETERMINING IMPACT OF OIL ON A OF THE COUNTRY ........................................................................................................................................... 26 c . APPLYING POLITICAL AND INSTITUTIONAL DETERMINANTS THE TO GHANA.......................... 27 D. TAILORING INTERNATIONAL EXPERIENCE DESIGNING IN INSTRUMENTS FOR GOOD MANAGEMENT OF OIL RENTS TO GHANA......................................................................................... 30 4 . PUBLIC FINANCIAL MANAGEMENT ................................................................................. 35 A . THE ARRIVAL OF OIL REVENUE MAGNIFIES ALREADYEXISTINGPUBLIC FINANCIAL MANAGEMENT CHALLENGES............................................................................................................ 35 B. STRATEGIC BUDGETING THROUGH MORE EFFECTIVE A MTEF ............................................... 35 C . DEVELOPING GIFMIS........................................................................................................ THE 38 D. MANAGING PUBLIC SECTOR WAGEBILL .......................................................................... THE 38 E. PUBLIC INVESTMENT ................................................................................................................ 39 5 . INFRASTRUCTURE ................................................................................................................. 40 A. FINANCING GAP........................................................................................................................ 40 B. KEY POLICY ISSUES .................................................................................................................. 43 6 . INVESTMENT CLIMATE ........................................................................................................ 45 A. GHANAALREADYH A S M A N Y OF THE SYMPTOMS OF DUTCH DISEASE .................................. 45 B. GHANAHAS DEVELOPED NOT A COMPETITIVE MANUFACTURING SECTOR ........................... 45 C. GHANA'SLACK COMPETITIVENESS APPEARS TO STEM FROM POOR PRODUCTIVITY .........46 OF D. LABOR MARKETS NOT COMPENSATE FOR L O W PRODUCTIVITY ........................................ DO 48 E. REGULATIONS ON ONGOING BUSINESS OPERATIONS ARE NOT CONSIDERED BN I G ..........50 I DN F. FOREIGN INVESTMENT H A S FAVORED COMMODITIES AND SERVICES ..................................... 50 G. ACCESS FINANCE I S COMPETITIVE ...................................................................................... 5 1 TO H. INCREASING THE DOMESTIC SUPPLY RESPONSE I NON-TRADABLE N SECTORS ....................... 53 I. OVERCOMING THE INFRASTRUCTURE CONSTRAINT ................................................................. 53 J. IMPROVING FACTOR MARKETS ................................................................................................ 53 iv 7. AGRICULTURAL COMPETITIVENESS .............................................................................. 56 A. INTRODUCTION ......................................................................................................................... 56 B. OIL AND A CHANGING MACRO-ECONOMIC ENVIRONMENT AGRICULTU ...................... FOR RE 56 c. IMPACTS OF EXCHANGE RATE MOVEMENTS AND THE EXTENT THE TRADABLE OF SECTOR ... 5 8 D. MAINTAINING THE COMPETITIVENESS OF AGRICULTURAL VALUECHAINS ............................ 60 E. POLICY OPTIONS FOR IMPROVING COMPETITIVENESS ............................................................. 62 F. IMPROVING THE INVESTMENT CLIMATE FOR COMMERCIAL AGRICULTU ............................ RE 66 G. CONCLUSION ............................................................................................................................. 67 L i s t of Tables: Table 1. 1: Real Annual Permanent.Income. Various Assumptions ......................................................... 8 Table 1.2: Widening Recurrent Deficits Contributed to a Deteriorated Fiscal Balance ........................ 10 Table 1.3: Spending O i l Revenue Would Hurt Agricultural Output and Exports ................................. 14 Table 1.4: An O i l Boom Could Induce Significant Redistribution Effects ........................................... 14 Table 2.1 : Jubilee Phase I Base Case - $75/bbl ..................................................................................... 21 Table 3.1 : Political Economy Classification o f Oil Exporters ............................................................... 34 Table 4.1 : Budget Deviations and Deficits Have Been Widening ......................................................... 35 Table 5.1 : Indicative Infrastructure Spending Needs in Ghana ............................................................. 41 Table 5.2: Infrastructure Financing Flows to Ghana ............................................................................. 41 Table 5.3: Measures to Address the Infrastructure Financing Gap........................................................ 42 Table 6.1 : Doing Business Indicators .................................................................................................... 50 Table 6.2: Inward FDI Stock as a Percentage o f GDP .......................................................................... 51 Table 6.3: Analysis o f Commercial Bank Lending to Enterprises ........................................................ 53 Table 6.4: Public Sector Wage Premiums Are High and Growing ....................................................... 55 Table 7.1 : Returns to Public Investment in Agriculture and Impacts on Poverty Reduction ................64 L i s t o f Figures: Figure 1.1. Peaking in 201 1.16. O i l Extraction Could Add U S $ l Billion to Ghana's Budget ...............1 Figure 1.2: Without Reforms. O i l Could Lower Per Capita Incomes in the Long Run......................... 12 Figure 1.3: Key Reforms Would Greatly Magnify the Developmental Impact o f O i l .......................... 18 Figure 5.1 : Historic and Potential Future Links Between Infrastructure and Growth ........................... 40 Figure 6.1 : Since 2004. GDP Growth Has Been Concentrated in the Non-Tradable Sectors ...............45 Figure 6.2: Labor Productivity i s Particularly Low in Ghana's SMEs .................................................. 47 Figure 6.3: Median Capital Intensity i s Lowest for Ghana.................................................................... 47 Figure 6.4: In Ghana Relatively Fewer Firms Export............................................................................ 48 Figure 6.5: Median Labor Productivity i s Relatively L o w in Ghana..................................................... 49 Figure 6.6: Manufacturing Constitutes Only a Small Fraction o f Ghana's GDP .................................. 49 Figure 6.7: Access to Land i s Difficult in Urban Areas ........................................................................ 54 Figure 7.1: The Composition o f Cocoa Marketing Costs in 1995-98 and 2006-08 ............................. 61 L i s t o f Boxes Box 2.1 : Some Parameters Affecting Pre-tax Petroleum Economics .................................................... 22 B o x 2.2: The Fiscal Regime for the Jubilee Field ................................................................................. 23 B o x 3.1 : S2o TomC's Oil Fund .............................................................................................................. 32 . B o x 6.1 : Global Competitiveness Index ................................................................................................ 46 B o x 7.1 : Nigeria and Chile in a Resource Boom ................................................................................... 58 B o x 7.2: Price Transmission and the Extent o f Tradability ................................................................... 59 V Box 7.3: Exchange Rate Appreciation and Forward Cocoa Sales ......................................................... 61 Box 7.4: Can Ghana Increase Value Addition In Cocoa?...................................................................... 61 Box 7.5: Subsidies versus Investments.................................................................................................. 65 Box 7.6: Exploiting the Agricultural Potential o f Northern Ghana ....................................................... 66 Box 7.7: Extendingthe Benefits o f Private Investments through Outgrower Schemes ........................ 67 List of Annexes Annex 1: The Computable General Equilibrium (CGE) Model ............................................................ 69 vi EXECUTIVE SUMMARY Ghana's o i l will start to f l o w in 2011, maybe even before, and most o f its known reserves will be extracted in the immediate years after. The promise o f o i l generates expectations o f all sorts, the more so as Ghana currently grapples with a macroeconomic crisis o f significant proportions. Ghana's reserves are relatively modest by international standards, and will thus not radically transform Ghana's economy into one where o i l becomes the major sector. Nonetheless, they are already large enough to deeply affect the future o f the non-oil economy, positively or negatively. As liquidity constrained, Ghana's economy could expect high development returns from oil. But without sufficient preparation, risks o f misuse o f o i l revenue are considerable, to the extent that it could even lead to a decline in per capita incomes in absolute terms after the initial boom years. The political capture o f o i l rents could also revert some o f the important progress made in Ghana in terms o f governance and executive accountability. Hence the huge premium and responsibilities put on Ghana's successive authorities to wisely manage the o i l wealth. In Ghana, like in any country facing a similar challenge, the fundamental issue i s the acceptance and ability o f ruling political forces to renounce the discretionary power provided by windfall revenues. Indeed, political calendars might not align themselves well to the sequence o f reforms required t o ensure that the spending o f the o i l rent is o f sufficient quality. Various options are technically possible to limit discretionary use, but their effective implementation i s all predicated on consensus building among political forces, and o n the recognition that the threat o f letting other parties take advantage o f a discretionary use o f funds (and i t s consequences on institutional stability) could be potentially more harmful than the benefit it could derive from such funds. Given the now high likelihood o f democratic power transition in Ghana, the current administration could find interest in limiting future governments' discretionary use o f o i l revenue. Building the right environment for ensuring a pro-developmental use o f o i l revenue comprises many dimensions. First and foremost i s transparency in o i l revenue and i t s allocation, through disclosure o f contracts and i t s full inclusion in the budget process. In turn, increased transparency should open the door t o design a home-grown institutional response to the risk o f political capture. Various experiences from the rest o f the world can inspire Ghana, but none o f them will become effective if not fully and broadly owned locally. Second i s the need to raise Government's ability to manage such additional o i l revenue and channel it towards projects with high social returns, through restored fiscal sustainability and improved capacity in public financial management, macro-economic and debt management and cost-benefit analysis. Third is the need to remove bottlenecks in the real economy which could generate rents and induce suboptimal investment decisions. The report identifies the following set o f actions as critical preparatory steps for an effective pro-poor use o f o i l revenue: 9 Increase transparency o n oil revenue. Transparency could be improved as Ghana adopts and implements a Freedom o f Information Act; and stipulates/enforces accountability mechanisms regarding: (i) publication o f reports on revenue and their use, and (ii) the the disclosure o f bidders' identity and bidding documents. The Extractive Industries Transparency Initiative would support such actions. vii > Restore fiscal sustainability. High fiscal deficits threaten macro-economic stability, and using o i l revenue to finance them would only postpone the adjustment while missing an important development opportunity. The needed adjustment will call in particular for tackling long standing issues in public sector and energy, while strengthening public financial management capacities. Restoring fiscal sustainability would also go against borrowing externally o n non concessional terms beyond reasonable limits, given associated risks for debt sustainability. P Remove bottlenecks in non-tradable sectors. Dutch disease effects would be mitigated by removing constraint to competition and domestic supply response in non-tradable sectors, including: high barriers to entry into formal sectors (starting a business, labor regulation and minimum wages, access to finance, urban land tenure), and lacking infrastructure (water, electricity) for urban SMEs. The latter would benefit from higher consideration to Public Private Partnership options, leaving greater financial capacity for the Government to finance projects with high social returns. P Introduce stabilization mechanisms f o r managing oil price volatility. The first mechanism would consist in restoring the pass through o f international prices into gasoline and utilities tariff, along with establishing targeted mechanisms to protect the poor. A second mechanism to shield the budget from o i l price volatility and reserves uncertainty would consist in establishing an O i l Fund, from which predictable transfers would be made t o the budget. P Increase the provision o f agricultural public goods. The agricultural sector might be the most affected by an oil-related boom and bust cycle. Given the high social return and pro-poor impact o f investing in agriculture, greater than ever attention should be paid to support the provision o f various public goods for agriculture, including feeder roads, research, extension services, water and power supplies, storage capacities, irrigation for smallholders, and safety standards. Many o f these actions are currently contemplated by the Government t o raise the quality o f spending the o i l rent and some o f them are already being implemented. But most o f them will also take time to be completed, which calls for sequencing and the prioritization o f measures aimed at raising transparency and restoring macro-economic stability, as o i l extraction will peak in the very next years. In the face o f it, adopting a mechanism to ensure the channeling o f a stable and predictable amount to the budget in these years would minimize risks implied by possible delays in structural reforms. 1 See World Bank (2009h) for a detailed discussion on the possible content o f these reforms. viii 1. OVERVIEW A. INTRODUCTION 1.1 Ghana recently found crude oil off the shores of its Western Atlantic Coast. Jubilee field's estimated reserves: as o f October 2009, amount to 490 million barrels o f high-quality oil and justify commercial exploitation should barrel oil prices exceed US$30. At i t s peak (mid 201 1- mid 2016), some 120,000 barrels o f oil per day could be extracted - making Ghana a net oil exporter for a short while,3 and the overall period o f activity could span over two decades. Based on the fiscal regime in place,4 and a price assumption o f US$75 per barrel,5 the World Bank's central estimate puts potential government revenue at U S $ l .O billion on average per year between 201 1 and 2029. B y way o f comparison, government revenue in 2008 reached US$3.7 billion (excluding grants) and GDP US$16.1 billion. Such level o f proven reserves puts Ghana at par with neighboring Cameroon (400 million' barrels) and above Cate d'Ivoire (100 million barrels), but much below Nigeria (36,200 million barrels). Figure 1.1: Peaking in 2011-16, Oil Extraction Could Add US$1Billion to Ghana's Budget Qoss Revenue I Government Revenue Government Revenues at different oil prices US$ millions (real) Bbmn I 35001 I 3500 ! 3000 2500 2000 1500 "....-.. - . - 1000 500 *, 500 0 Source: World Bank staff calculations 1.2 The oil revenue estimate i s subject to a large sensitivity. A number o f parameters could modify this central estimate. Given fixed costs o f extraction, highedlower oil prices would Certified proven reserves were still amounting to 278 million barrels by October 2009. However, GNPC's central estimate (P50) was also at 490 million barrels, and most observers were considering the level of certified proven reserves for Jubilee Phase 1 as severely underestimated. As this report tries to assess the economy wide impact of oil discovery, the use GNPC's central estimate - rather than certified level - i s preferred, acknowledging the uncertainty attached to this number. A sensitivity analysis on reserves i s presented in Chapter 2. 3 IMF(2009) projects that Ghana's oil supply (fiom Jubilee Phase I will enjoy an exportable surplus between 201 1 ) and 2016, before domestic demand re-exceeds supply. The regime in place applies to the consortium in charge of the Jubilee field exploitation. The consortium comprises Tullow Oil, Kosmos Energy, Anadarko Petroleum, Sabre Oil and Gas, and the EO group, all o f which are small- scale operators. The fiscal regime comprises the following elements: a 5 percent royalty for oil revenue; a 10 percent tax on petroleum revenue net of royalty and operational expenses (i.e., the oil rent); a share of the oil rent growing with the rent amounts; and 35 percent income tax. Source: World Bank (2009a). The price i s expressed in real terms and i s assumed to span over the 20-year period of extraction (that is, between 201 1 and 2029). disproportionally affect revenue. At US$50 per barrel, government revenue would go down to an average o f US$0.4 billion per year; at U S $ l 00 per barrel, government revenue would conversely go up to an average o f US$1.6 billion per year. Besides, higher cost o f extraction could also significantly impact revenue. A 25 percent overrun in cumulated capital costs (estimated at US$3.4 billion over the period 2009-12) would reduce government revenue by 14 percent. A two-year production peak (instead o f a five-year peak) could also reduce government revenue to US$0.4 billion per year. O n the other hand, additional reserves could be discovered in 2009 as drilling goes on in the Jubilee Field, with the potential to double o i l production (and increase even more revenue if facilities already in place could be used to exploit these new reserves). 1.3 Changes in the equity structure could also affect the stream o f Government revenue. Following the initial exploration phase and the confirmation o f commercial reserves, the Government o f Ghana, through i t s national company, the Ghana National Petroleum Corporation (GNPC), could find interest in acquiring supplementary shares in the consortium. This could give additional voice to the Government to promote national interests (e.g. local content, environment preservation, greater control over investment and operation decisions), and, should stakes be underpriced, be financially rewarding over the medium term. At the same time, borrowing for it would reduce net public o i l revenue in the initial years (given the need to service the related debt and contribute to capital expenditures), and have important implications for overall public debt sustainability.6 It would increase Ghana's exposure t o o i l risk, while also reducing opportunities to use borrowed capital in other venture. 1.4 Gas comes along w i t h oil. Gas would be produced in association with o i l at a rate o f one thousand cubic feet o f gas per barrel o f oil. Thus, at peak Phase 1 Jubilee production, Ghana could produce 120 million cubic feet o f gas per day. Given Ghana's non-flaring policy, Jubilee production facilities include capacity to re-inject gas. However, plans underway to build pipelines and processing facilities would result in streams o f dry processed gas for use in power generation and natural gas liquids (NGL) for export and domestic use. At current world market NGL prices and a dry gas price o f US$2 per thousand cubic feet, gross revenues would be roughly US$260 million per year, that is, less than a tenth o f o i l gross revenue. In turn, the combination o f corporate taxation and an assumed 50 percent equity ownership for GNPC in the gas infrastructure would generate US$120 million per year for the Government. To this figure could be added an implicit rent o f US$140 million originating from the difference between a dry gas market value o f US$6 per thousand cubic feet (as measured by the delivered price o f gas from the West Africa Gas Pipeline, WAGP) and that o f US$2 reflecting the cost o f extracting, transporting and processing the gas 1.5 I n the medium term, gas exploitation could encourage the development o f several downstream activities. Unlike o i l and NGL, dry gas cannot be easily stored and exported. But with the availability o f a gas pipeline, several downstream activities could be undertaken, the most immediate being electricity generation through the conversion o f existing and planned power stations from o i l to gas, which would generate significant cost reduction. At this stage, derived j o b creation should remain modest. Further value added could be generated by supplying gas to industries needing a direct heating source, such as cement, food processing, smelting, etc. LNG, methanol or other large-scale gas conversion and export projects would require much larger gas reserves than currently assessed - at least double, given the large fixed As reported by the press in November 2009, the value o f Kosmos's shares would broadly correspond to Ghana's total external public debt by end-2008, US$4 billion. -2 - capital costs needed to develop these activities over a long period o f time in highly competitive global markets. At that stage, the impact o f j o b creation could be more substantial, depending o n the nature o f industrial choices retained.7 In all events, the intended use o f the gas rent would require transparent decision making, as for any other public resource. While the rent could be passed to electricity consumers' - Ghanaian households and/or f i r m s and foreign clients if electricity is exported, other choices could be made. This could for instance include transferring the rent to the consolidated fund, or leaving it t o GNPC which could charge for gas supply at market values. 1.6 Unlike gas, oil discovery will primarily impact the economy through the budget. As located off-shore and demanding equipments and expertise not yet available in Ghana, the extraction o f o i l will not generate significant backward linkages (in terms o f demand for domestic inputs and upstream activities) in the short to medium term. And unlike gas, forward linkages and related downstream activities are also expected to be minimal, but through their impact on the budget. O i l revenue will be shared among the Government and the foreign companies in the consortium, with the assumption that the latter will repatriate all their revenue abroad. From an analytical perspective, this report thus chooses to retain the Gross National Product (GNP) as the measure o f national welfare in its quantitative analyses, rather than a GDP that i s inflated with o i l exports but whose proceeds would not stay in Ghana. 1.7 Oil discovery brings promises and raises expectations, given Ghana's high development needs, and aspiration to quickly join the group o f middle income countries. The combined manifestos o f the two major parties running for presidential elections in late 2008 expressed intentions to apply o i l revenue to priority areas o f infrastructure, agriculture and food processing, ICT, education, health, rural development, housing, water and sanitation, among others. In the shorter term, o i l revenue as it comes on board in 2011 could also help Ghana address its large fiscal and external imbalances, and cushion the negative impact o f the current global economic crisis. By end-2008, Ghana's fiscal and external deficits represented respectively 14.5 and 18.7 percent o f GDP. 1.8 But oil revenue also brings the so-well known challenges associated with it, in terms o f institutional and macro-economic absorptive capacities. These challenges are o f various natures, but reinforce each other. A first set o f challenges concern the capture o f o i l resources by groups or individuals to satisfy their personal interests rather than the public good. The second set o f challenges relates to the management and use o f a volatile, uncertain and exhaustible source o f revenue. From a narrow economic perspective, these challenges can all be seen as that o f converting o i l revenue into high social return investment projects which will effectively raise the long-term growth rate o f the economy, rather than financing immediate consumption. Such challenges potentially raise concerns about Ghana's ability to protect the strong growth and poverty alleviation momentum engendered since the early 1990s. 'Preliminary calculations suggest that the arrival o f gas in 2012 (from Jubilee Phase 1) could roughly generate 20- 30 thousand jobs (against a labor force o f 9 million by that time) in the years after through derived demand for labor in various sectors. A doubling o f available gas resources from 2015 onwards could generate another 25-35 thousand new jobs afterwards, depending on the pace o f reforms needed to improve Ghana's economic environment, see Section l.E. * From an equity perspective, a case could be made for instance to subsidize electricity connections (through rural electrification projects for instance) rather than subsidize the price o f electricity, which only benefit to those already connected. 1.9 This overview discusses the Ghana-specific nature o f these challenges and explores possible options to address them. In doing so, it builds on seven thematic chapters which look at different aspects o f the question: (1) o i l facts, (2) political economy, (3) public financial management, (4) infrastructure, (5) private sector development, (6) agriculture, and (7) poverty.' While the overview tries to bring together the findings o f these different chapters, further details and discussions o n each o f these topics can be found in o f the chapters themselves. It concludes that while o i l revenue will not be large enough to radically transform Ghana, it could, if improperly managed, impose enough stress on non-oil sectors to severely undermine Ghana's medium t e r m development prospects. Hence the huge premium and responsibilities put o n Ghana's successive authorities to wisely manage the o i l wealth to promote the development o f the non-oil sectors. B. INSTITUTIONAL AND PUBLIC FINANCIAL MANAGEMENT CHALLENGES 1.10 With the exception o f a few industrialized countries, the governance record o f most oil exporters i s at best mixed - and thus possibly worrisome for Ghana. The recent example o f Chad, who denied its initial commitments on the use o f o i l proceeds, illustrates how challenging it can be to design solid institutional mechanisms in this regard. Oil-related civil conflicts in Nigeria also point to possible risks o f social destabilization. Rent-seeking and corruption, political patronage, lower entrepreneurship and capacity for investment, and increased authoritarianism and c i v i l conflict are common problems that confront countries that have discovered oil. 1.11 Nonetheless, Ghana benefits from a strong institutional basis. Ghana can be considered as a young democracy with several strengths: there i s no dominant single party in Ghana, parties are quite well institutionalized, traditional leaders provide some restraint o n the capacity o f the Executive to pursue its own self-interest, and extra-institutional interventions (for instance from the military) are rare in comparison to other neighboring countries (World Bank, 2007). These, and other quantifiable governance indicators," explain why Ghana does so well on the World Bank's Country Performance Indicator Assessment (CPIA), where it ranked 5th among the 75 low-income countries in 2007. The successful democratic transition from December 2008 i s another important expression o f the maturity o f Ghanaian institutions at their highest level. Risks o f institutional failures are thus reduced in comparison with other countries endowed with poorer institutions, and the range o f policy options to address the risk o f governance failure is probably wider. 1.12 At the same time, the review o f Ghana's institutional framework points to serious r i s k s o f political capture o f oil revenue. Ghana's young democracy can also be considered "factional." World Bank (2007) shows how the political incentives in Ghana produce a high level o f clientele and patronage politics. Ghana spends more, on average, on targeted expenditures, such as the public sector wage bill, energy subsidies, and earmarks - the very reason o f widening public deficits in the recent years (see Table 1.2 below), and less for the provision o f public goods, such as the rule o f law, quality o f education or the lengths it goes t o The overview and report focus only on the use of o i l revenue, leaving aside contractingirevenue sharing and environmental issues. lo Worldwide Governance indicators (World Bank, 2009b) also rank Ghana among the very f r s t African countries in terms of voice and accountability, regulatory quality, control o f corruption, rule of law and government effectiveness. For all these indicators, Ghana recorded significant progress between 1998 and 2007. -4- fight corruption. Besides, Ghana exhibits large and increasing social polarization (urban vs. m a l , south vs. north) and the role o f ethnic identity seems to be increasing with ethnic grievances rising. Finally, Ghana displays l o w levels o f civic counterweight, for which a number o f studies show that information i s the most binding constraint to more executive accountability through vertical means. l1 1.13 I n the face o f such challenges, the fundamental issue i s the acceptance and ability o f ruling political forces to renounce the discretionary power provided by windfall revenues. Indeed, political calendars might not align themselves well to the sequence o f reforms required to ensure sufficient quality o f spending the o i l rent. Various options are technically possible to limit discretionary use (e.g. fiscal responsibility rules, o i l funds, efficient public financial management systems). But their effective implementation are all predicated on consensus building among political forces and on the recognition that the threat o f letting other parties take advantage o f a discretionary use o f funds (and its consequences on institutional stability) could be potentially more harmful than the benefit it could derive from such funds (Bourguignon and Dessus, 2009). In the face o f it, improved economic transparency is a sine qua non condition, and probably the best vehicle for initiating momentum for reform, especially in vertical political structures where programmatic parties are absent, as in Ghana. The fact that the current macro- economic situation came as a surprise to the new government'2 reflects the extent o f progress which can s t i l l be made in terms o f economic transparency and commitment to sound budget execution and public financial management principles. l3 1.14 Given the now high likelihood o f democratic transition in Ghana, the current administration could find interest in limiting future governments' discretionary use o f o i l revenue through improved transparency. Minimizing risks o f political capture calls for the establishment o f an early consensus among all stakeholders (including agricultural producers) on the management o f oil, and a clear institutional framework with embedded accountability and transparency mechanisms to deal with o i l companies and oversee the channeling o f these funds to the budget. In contrast, technical solutions - such as the creation o f special institutions for the management o f o i l resources - are deemed to fail to deliver their intended objectives, unless emanating from a civil society which can be mobilized against misuse and for better quality o f spending through greater transparency. The latter could be achieved as: (i) Ghana adopts a Freedom o f Information Act; and (ii) stipulates/enforces accountability mechanisms regarding the publication o f reports on revenue and their use, and the disclosure o f bidders' identity and bidding documents. Improved transparency could then pave the way for strengthening social accountability mechanisms, at a juncture where the absence o f absolute majority at the Parliament also gives the authorities greater incentives to seek consensus. From an operational perspective, social accountability could be reinforced by: (i) expanding the national dialogue on o i l initiated in 2008, focusing on the design o f the institutional framework for transparently '' Confused intergovernmental arrangements that limit potential entry points, weak enforcement capacity o f the state which leads citizens to put little value in participating since there i s no ultimate recourse, a plethora o f uncoordinated instruments that do not add up to much impact at the national level and, finally, a weak and poorly organized civil society that has little influence on policy debates or their oversight also contribute to the weakness o f Ghana's civic counterweights and executive accountability. l2 On January 19,2009, soon after Presidential elections, the Economic Subcommittee o f the Government Transition Team declared the Government o f Ghana "broke," when discovering the extent o f macro-economic deficits. This statement came in contrast to the promises made during the election campaign. 13 The decision to relax commitment controls for the Energy Ministry in late 2007 significantly contributed to the build-up o f arrears and outstanding commitments discovered by mid-2009. -5- managing o i l revenue; and (ii) capacity building for effective Parliamentarian oversight o f o i l issues and technical management within the Government. 1.15 At the extreme, a citizen fund could be envisaged, but this would imply renouncing the ambition of Government to uses oil revenues for the collective good, rather than simply transferring a portion o f the rents to individual citizens. Although challenging from a logistical perspective, the direct distribution o f the o i l rent to citizens in the form o f cash handouts could be envisaged in Ghana, would possibly receive popular support and could provide the needed constituency for good governance o f this new resource (Moss and Young, 2009). This solution, however, is only optimal if one considers the risks o f misuse and poor governance as high in Ghana, and if one i s convinced that a direct transfer will solidify the social contract between the Government and its citizens, as it i s argued has been the case in Alaska. For, in order to adopt a direct transfer model, there must be a strong case that the Government i s not capable o f managing the resources, o n behalf o f i t s citizens, and cannot provide Ghana with some o f the collective goods it needs so badly to meet i t s common, development goals, notably in the infrastructure and basic services sectors. Clearly, as this report points out, there is much that needs to be done - both immediately and in the long-term - to ensure that Government does indeed have the capacity and the incentives for managing well these rents. If this can be accomplished, the rents could then be put towards collective goods that will likely have a greater development impact than enhancing individual welfare through a direct transfer. 1.16 Another related risk i s the inability of the administration and budget processes to simply control the amounts and effective allocation of funds to their designated use. Large and growing budget execution deviations illustrate Ghana's difficulties to enforce i t s budget law. Unless addressed rapidly, risks o f o i l revenue being diverted from i t s designated use will remain high, and Ghana could even enter in a cycle where mismanaged o i l revenue could undermine progress achieved in broad public financial management in the last years. However, earmarking o i l revenue to specific projects would not solve the problem, but would rather increase budget rigidity and reduce people and Parliament oversight on public resource allocation. It would also lessen the possibility to encourage program performance through an effective medium-tern expenditure framework (MTEF). 1.17 Prime attention should be given to payroll management. In the recent years, the greatest source o f budget deviation has originated from un-budgeted increases in public employees' individual remunerations. As already argued above, these practices are driven by political motivations, and thus need to be addressed politically, with a view t o avoid the risk that c i v i l service capture the o i l rent for itself. From a practical perspective, ongoing negotiations o n the payroll reform provide the opportunity to review the payroll in light o f related service delivery and fiscal affordability, and explore ways to improve public sector productivity (capacity building, wage levels and structure, etc.). Once done, technical solutions envisaged to improving payroll management (aligning budget and wage negotiation processes, strengthening oversight o f records regarding the entrance, exit and the transfers o f employees, upgrading the payroll management and control software - IPPD-2, as part o f an upgraded GIFMIS) would then become much more effective. 1.18 Public investment effectiveness i s another important dimension to act on. Beyond will, converting o i l revenue into public investments requires a number o f supportive elements. The first one is budget revenue predictability, as in i t s absence public spending typically shifts from investment to consumption activities (Celasun and Walker, 2008). A s o i l revenue starts to -6- flow, budget predictability would be strengthened by (i) development o f tools to manage o i l the price volatility and uncertainties related to extraction (reserves, costs), and (ii) reduced upward expenditures deviations (which need financing). The second one is an effective MTEF, which makes investment decisions consistent (and thus more realistic) with those related to other spending ~ategories,'~ personal emoluments in particular. The complementarity between capital and current expenditures i s also central to effective service delivery. Finally, investment effectiveness would be strengthened through greater screening capacities, requiring that investment project selection be guided by clearly defined priorities, competitive bidding when required," and the preparation o f pre-feasibility studies (including the calculation o f net present social value using either cost-benefit or minimal-cost analysis). Should private participation be sought, frameworks for soliciting, selecting and managing private investment in sectors o f interest (energy and telecommunications notably) should be developed. CHALLENGES C. MACRO-ECONOMIC 1.19 With oil forthcoming, Ghana i s confronted with two major macro-economic challenges. The first one, specifically related to oil, i s the management o f o i l price and output volatility and the unpredictability associated with it. The second one i s the nature and recent evolution o f the recurrent fiscal balance, which, if l e f t unaddressed, will elevate pressure to use o i l revenue to cover public consumption expenditures rather than t o finance needed investments. 1.20 Budget stabilization requirements prevent the direct transmission o f oil revenue to the budget. Ample variations in international o i l prices (and hence o i l revenue) are incompatible with sound budget execution, and in turn negative for investment planning and the development o f medium-term frameworks. In practice, addressing volatile issues boils down to fixing the share o f o i l revenue to be transferred to the budget,16 and investing the remainder abroad (given the need to decouple these investments from Ghana's economic cycles). A first stabilization mechanism consists o f setting up a reference price (typically equal to the long- term price forecast), and transferring only the revenue from o i l production evaluated at that reference price to the budget, and saving the remainder in a Stabilization Fund (SF) if the actual price i s higher, or tapping such a fund if the actual price i s lower. A second mechanism consists o f building a Permanent Income Fund (PIF) - or "heritage" fund, where only the interest rate revenue from the accumulated assets i s channeled to the budget. l7 World price and real interest rates assumptions would determine the income which can be spent every year, even after o i l reserves have been l4In this endeavor, an effective MTEF would benefit from the re-classification o f current vs. capital expenditures. For instance, the development funds (the District Common Assembly Fund (DACF), the Road Fund, and the Ghana Education Trust Fund (GET) - which represented 3.2 percent o f GDP in 2008), which are classified as capital expenditures, actually finance the National Youth Employment Program (NYEP) which employs above 100,000 people. l5 Since 2005, the Public Procurement Board (PPB) focuses on enforcing the use o f open competition (national and international competitive tender) above the minimum threshold, and on reviewing / authorizing requests from MDAs that wish to use less competitive procurement methods. Nevertheless, the degree o f adherence and compliance with public procurement rules remains uncertain in the absence o f a monitoring system o f procurement by value. 16 For the sake o f budget transparency though, all oil revenue would be accounted for in the budget, with some portion being saved in oil fund(s) and the remainder treatedjust as the same as any other government income. l7 contrast, the proposal tabled for discussion by MoFEP's fiscal regime technical team under Ghana's previous In administration to channel two-thirds o f oil revenue to the budget would have failed to insulate the budget from volatility in crude oil prices. The proposal was envisaging using the remainder to set up the Petroleum Regulatory Authority and the National Oil Company (NOC) in a f i r s t phase (the f i r s t 3 years o f extraction). In a second phase, the remainder would have been used to set up a heritage fund (40 percent) and a stabilization fund (60 percent). -7- exhausted. Ongoing discussion related to the preparation o f an o i l revenue management bill provides the opportunity to address these concerns in a transparent manner. 1.21 Stabilization and Permanent Income funds differ on several grounds. Beyond sharing similar stabilization objectives, both finds also require solid institutional frameworks to be effective, regarding in particular investment strategies. And none o f these funds i s effective t o protect fiscal sustainability in the absence o f control mechanisms on the general budget." But these funds also differ o n two important grounds. The first one regards amounts to be channeled to the budget and their exhaustive nature. With a SF, all o i l revenue will have been spent at the end o f the extraction period, assuming that the reference price i s correctly set (i.e. that forecasts are fulfilled). In contrast, with a PIF, only a share o f o i l revenue will have (by definition, as "permanent") been spent by the end o f the extraction period. In the example set below, amounts spent under a PIF over the extraction period would only represent 45 percent o f Ghana's total o i l revenue over the same period. The second one regards the sensitivity o f the spending rules attached to the two funds with respect to a sudden change in world prices or new discovery. 1.22 Under conservative assumptions, a Permanent Income Fund in Ghana could generate US$458 million per year, given the stream o f expected o i l revenue discussed above at US$75 per barrel and a real interest rate at 3 percent.lg This amount (expressed in real terms using 2008 prices) i s broadly equivalent to the amount o f official transfers (Official Development Assistance, ODA) received annually in the last 5 years (2004-8), and represents 45 percent o f the US$1,021 million expected annually from o i l revenue (and to be spent with a SF under perfect price forecasting). The table below gives a sense o f the sensitivity o f the permanent income to various assumptions regarding o i l prices and real interest rates.20 All amounts are expressed in real terms (US$2008). Table 1.1: Real Annual Permanent Income, Various Assumptions (US$ millions) Real Interest rate 1Yo 3% 5Yo Oil Price (US$ per barrel) 50 79 203 293 75 179 458 660 100 270 697 1,010 Source: World Bank staff calculations. 1.23 I t i s worth emphasizing that a Permanent Income Fund would need to be invested abroad. Beyond the need to decouple PIF investments from Ghana's cycles to manage volatility, the permanency o f incomes can only be insured if financial returns on the PIF are guaranteed. For that reason, it is not advisable t o invest in projects which can be justified for their high social returns (and would thus be in almost all cases domestic), but with l o w commercial returns (van Wijnbergen, 2008). This i s the case o f a number o f public investment '* The fiscal responsibility law currently in preparation with IMF technical assistance could help enforcing a hard budget constraint along with P F M reforms addressing the issues discussed in the paper, and an effective MTEF (see World Bank, 2009c, for greater discussion o f these issues). 19 See van Winjbergen (2008) for a detailed discussion o n permanent income funds. 20 An alternative way is t o compute the permanent income in per capita terms, which i s obtained by subtracting f i o m the real interest rate the population growth rate. With a 1.6 percent annual population growth rate projected for the period 2010-2030 (Source: World Development Indicators), the real permanent income would be US$2 14 m i l l i o n for a real interest rate o f 3 percent and a barrel price at US$75. -8- projects, which are public t o begin with because their l o w commercial returns make their implementation uninteresting t o the private sector. PIF should thus be constituted o f commercial investments abroad (e.g. stock markets and sovereign bonds o f non-oil high income countries). However, the permanent income (the annual interest income generated by the PIF) channeled to the budget could certainly be used to finance domestic investment projects with high social returns. 1.24 A Stabilization Fund would b e more sensitive to changing price and oil reserve assumptions, particularly during the peak period o f extraction. Revisions in world o i l price assumptions (or similarly, o i l price forecast errors) would affect similarly (in relative terms) the amounts channeled to the budget from a Stabilization Fund or a Permanent Income Fund.2' Nonetheless, changes in amounts channeled to the budget in absolute terms following a revision in world price assumptions or reserves could differ much more widely. For instance, with a Stabilization Fund a revision upwards o f long-term world o i l prices to US$lOO per barrel in 2015 would channel an additional U S $ l .1 billion to the Ghanaian economy, whereas with a Permanent Income Fund, it would channel US$240 million. In turn, political pressures to frequently revise world price assumptions might be more pronounced with a Stabilization Fund, as immediate stakes are higher. Similarly, a sudden change in reserves assumptions would affect amounts channeled to the budget much more immediately under a SF than under a PIF. 1.25 W h i l e a PIF can b e considered as a n extreme solution, there i s probably s t i l l a need to decouple transfers to the budget f r o m the extraction profile. By equating transfers over an infinite number o f years, a PIF might be considered extremist as placing stabilization needs before development needs, even if at the same time preserving inter-generational equity. But aiming at neutralizing price volatility only would induce great budget volatility in the next decade given the known extraction profile as o f today (see Figure 1.1). In turn, the revenue management framework could also consider including a mechanism to decouple transfers from the yearly extraction profile. 1.26 Budget stabilization requirements also call for better management o f energy-related subsidies. Even more pressing in terms o f budget execution is the management o f subsidies to energy related state-owned enterprises. Although benefiting from a favorable electricity generation mix (hydro vs. thermal), public transfers to the energy sector s t i l l absorbed 1.2 percent o f GDP in 2008. Transfers paid mostly for below-cost recovery tariffs and are therefore largely absorbing o i l prices fluctuations, transmitting them directly to the expenditure side o f the budget. In the face o f it, the authorities could consider raising the pass through o f world prices to domestic consumer prices (Le. aligning tariffs t o production costs). This could be done while protecting the most vulnerable consumers through a progressive tariff structure and/or targeted transfers. The use o f domestic gas in the near future could also be an element o f greater predictability in electricity costs. 1.27 M o r e generally, the recent drop in the Ghana's fiscal recurrent balance undermines i t s ability to use oil revenue for financing investment. In the last four years, Ghana's recurrent 21 Typically, the legal framework establishing such funds grants the Government with the possibility to amend amounts transferred to the budget's consolidated fund based on the annual estimate of the permanent income (certified by independent auditors), or o f the revenue benchmark in case o f a stabilization hnd. In case where the Government wants to exceed the legal appropriation, detailed explanation i s generally to be provided to the Parliament, such as in Timor-Leste's Petroleum Fund. -9- balance declined by more than 6 percentage points o f GDP (from 8.3 to 2.1 percent o f GDP), mostly as a consequence o f increased public sector wages and energy subsidies.= The promised "single spine" payroll reform, pending issues related to payroll management, and the absence o f cost-recovery mechanism in the energy sector are all threatening to bring this balance further down. With a recurrent balance at 2 percent and concessional borrowing historically at 5 percent o f GDP, Ghana with Development Partners can now finance 7 percent worth o f investment expenditure, far below the 10-11 percent needed t o rapidly close i t s infrastructure gap.23 Table 1.2: Widening Recurrent Deficits Contributed to a Deteriorated Fiscal Balance Ghana recurrent and overall fiscal balance, 2005-8 (as a percentage o f GDP) 2005 2006 2007 2008 Total revenue 27.1 27.3 28.8 27.5 Recurrent expenditure 18.8 22.0 22.9 25.4 Wages 8.5 9.7 10.1 11.3 Good and services 3.2 3.7 4.0 3.7 Social transfers 2.7 2.9 4.3 3.8 Energy subsidies 0.7 1.5 0.0 1.2 Contingency fimd 0.0 0.8 1.4 1.6 Domestic debt interest costs 2.8 2.6 2.3 2.7 External debt interest costs 0.9 0.8 0.8 1.1 Recurrent balance 8.3 5.3 5.9 2.1 Domestic-financedcapital expenditures 5.9 7.9 9.2 10.5 ODA-financed capital expenditures 6.1 4.5 5.2 5.2 Arrears repayments 1.3 0.5 0.7 1.o Overall fiscal balance -4.9 -7.5 -9.2 -14.5 Source: IMF. 1.28 Oil revenue will not suffice to restore fiscal sustainability. Although tempting in the face o f current imbalances and smoothing needs to avoid disrupting or delaying public programs, borrowing on non concessional terms against future o i l revenue (that is, forward selling oil) to postpone fiscal consolidation would elevate risks o f debt distress. Indeed, as pointed by the recent joint Debt Sustainability Analysis (IMF and World Bank, 2009), even with o i l production, failure to reduce the large primary deficit and sustain this consolidation over the coming years would result in a much less favorable debt sustainability outlook.24 22 These figures do not include arrears and contingent liabilities accumulated throughout 2008 and disclosed in August 2009 at the mid-year budget review. The consideration o f these arrears and contingent liabilities further reinforces the trend o f widening recurrent deficits observed since 2005. 23 Meeting Ghana's infiastructure needs could cost US$1.6 billion per year for the next decade, out o f which US$0.6 billion for maintenance and U S $ l .O billion in the form o f capital expenditure, see Chapter 5 . 24 With fiscal consolidation and oil, public debt to GDP, projected to reach 63 percent o f GDP in 2009, could f a l l t o less than 40 percent by 2029. Under this baseline, Ghana is classified among countries at moderate risk o f debt distress. - 10- D. PRODUCTIVITY, COMPETITIVENESS, AND SOCIAL CHALLENGES 1.29 Channeling windfall oil revenue into the economy poses a number o f additional challenges. The first one i s the likely appreciation o f the Real Exchange Rate (RER) - the increase in the price o f non-tradable goods and services, as demand for them increases with windfall revenue in the face o f a limited supply response, and its corollary in terms o f lost export competitiveness. The second one i s the likely drop in productivity, as more factors get concentrated in non-tradable sectors where potential productivity gains are much scarcer.*' The third one i s the existence o f re-allocation (investments, migrations) and transition costs (lost markets and know-how), which can make temporary specialization very costly overall if the society has to return to i t s previous specialization patterns. This risk exists with oil, given its exhaustible nature and the possibility that it conducts to an untenable pattern o f specialization. These challenges are often known as "Dutch disease" in reference to the impact o f gas discovery in 1959 in the Netherlands which led to deep de-industrialization and economic stagnation when gas was exhausted. 1.30 .Ghana has already many o f the symptoms o f the Dutch disease. Ghana has a large and growing non tradable (non-agricultural)26 sector, comprising many parts o f the public sector and a wide range o f private activities (construction, finance, trade) servicing large resource-based extractive industries (gold), and remittances and ODA.27 Structural transformation has been slow in the face o f l o w productivity levels, the latter also affecting export competitiveness as factor prices (land, labor) remain high in comparison to their marginal productivity. In the last two decades, "non-traditional exports" have only grown modestly and not enough to shake the position o f traditional exports, gold, cocoa and timber, whose respective positions have only varied in time with international prices. In 2007-9, the spending o f Eurobonds proceeds (US$750 million, or 5 percent o f GDP), even if entirely used for investment projects (mostly t o expand electricity generation capacity) coincided with an acceleration o f domestic price inflation. Although impossible to establish a strict causal relationship between the two events, this nevertheless suggests a risk o f real exchange rate appreciation with o i l revenue (directly as demand pressures rise, or indirectly through anticipations and related speculative bubbles). And time series analyses o f the impact o f additional capital inflows2* on relative prices point t o the same conclusion. 1.31 Several structural factors may be at the origin o f these symptoms. A l o w supply response to increased demand in the non-tradable sector is theoretically at the origin o f RER appreciations. In Ghana, several factors could suggest that the potential supply response in non- 25 Larger potential productivity gains in tradable sectors are theoretically justified by the possibility to exploit greater gains o f specialization and larger economies o f scale, greater access to knowledge and know-how and higher competitive pressures. There i s consistent empirical evidence to suggest that productivity gains are higher in tradable sectors than in non-tradable sectors (It0 et al., 1997, De Gregorio et al., 1994, Baldi et al., 2004, Egert et al., 2003). The distinction between tradable and non-tradable sectors i s nevertheless tenuous, and evolving over `time. One way to think about it i s to look at the cost required to transport some products and services fiom one economy to another. 26 Ghana also has a subsistence agriculture sector which i s mostly non-tradable, although for reasons o f a very different nature. 27 The sum o f gold exports, remittances and ODA represented a third o f GDP in 2008. ** Opoku-Afari et al. (2004) suggest that permanent capital inflows have had a strong and significant impact on the real exchange rate. - 11 - tradable non-agricultural) sectors i s indeed low. These include rigid land2' and formal labor markets; a large duality between formal and informal markets:' and a poor infrastructure (energy and water in particular). Besides, the likely existence o f speculative bubbles (for instance in real estate) is not to be ignored, as fuelled with remittances in particular. Figure 1.2: Without Reforms, Oil Could Lower Per Capita Incomes in the Long Run Real per capita disposable income (index 1: 2008) 2.2 2-4 I/ 2.0 - 1.8 - 1.6 - 1.4 - 1.2 - 1.0 - 0 . 8 ! ~ - . #- I . - - - 8 a - ' 1 2008 201 1 2014 2017 2020 2023 2026 2029 ource: World Bank staff calculations. 1.32 Quantitative simulations point to serious risks of Dutch disease and boom and bust cycles. Simulations run over the period 2009-29 with a Computable General Equilibrium (CGE) model specifically designed for this purpose illustrate this point. The model used here i s calibrated on 2008 data, comprises 26 economic sectors (including 6 for agriculture), and depicts a number o f important features o f today's Ghanaian economy: a dual labor market (formal vs. informal), rigid urban and rural land supplies, and fixed electricity tariffs. The model also distinguishes new capital from that already installed - the latter being less mobile than the former - to capture the existence o f reallocation We measure the impact o f o i l revenue on economic activity by comparing a baseline scenario (without oil) with a first alternative scenario where three-fourths o f the entirety o f o i l revenue (i.e., no savings o f o i l revenue, as with a 29 Notwithstanding the reforms now under way with regards to land tenure, access to land continues to be an important consideration for enterprises, particularly in the metropolitan areas. Delays in land registration and titling n create bottlenecks in access to land and i site development. 30 Ghana ranks particularly poorly in terms of Labor Market flexibility, ranking 145thin Doing Business. H a l f formal sector employees are in the public sector where wage setting i s grossly de-linked from performance. 31 The high prevalence o f informality in Ghana remains an important obstacle to improvements in productivity. Some 87 percent o f the Ghanaian workforce i s employed informally as farmers (52 percent) or in self employment (35 percent). The informal sector i s less able to invest in business, gain access to credit, establish standards or participate in industry bodies. Ghana ranks 137* in the Doing Business survey for ease of starting a business. 32 See Annex 1 for a more detailed presentation o f the model. - 12- stabilization fund) would go to finance additional public consumption, the remainder financing investments (public and private, through the equalization o f marginal returns); a second scenario where one-half o f total o i l revenue would go to finance additional public consumption, the remainder financing investments. Comparing the baseline scenario (where real disposable per capita incomes would grow by 3.4 percent per year) with the first alternative scenario suggests that, after the initial demand boom (which would peak in 2015 and get exhausted by 2020), Ghana's long-term growth trajectory would actually shift down in comparison to a non-oil scenario. The long term per capita income growth rate would decelerate to 2.4 percent and, by 2029 real per capita incomes would be 14 percent lower.33 Investing a greater share (half) o f the o i l revenue could narrow this gap - as real exchange rate appreciation would be partially offset by greater productivity gains - but not close it. Indeed, irreversible private investment decisions (and related specialization choices) made in the. earlier years o f extraction could prove to be sub- optimal when the o i l gets exhausted a few years after. By that time, lost external markets would become extremely difficult to regain. Furthermore, Ghana's ability to effectively invest most o f i t s o i l revenue - in the first years o f extraction in particular given the amounts expected - i s also questionable in the face o f the institutional and public financial management challenges evoked above. 1.33 Agriculture could be particularly exposed to Dutch disease consequences during the boom period. As one o f the major tradable sector, Ghanaian agriculture would be particularly exposed to the risk o f losing external competitiveness through real exchange rate appreciation. Given the large mobility o f the labor force (between agricultural and informal labor markets), a greater demand for labor in cities could exert upward pressure on agricultural wages and reduce external competitiveness o f both import competing and export oriented agricultural sectors. Non- tradable agricultural goods could also suffer, if close substitutes to tradable goods. One reason often advanced to explain the limited impact o f recent food price spikes o n food consumption was the ability o f Ghanaian households to replace imported food with domestic staples (e.g. rice with cassava) in their consumption baskets. The symmetric effect could thus also happen, if the price o f imported food was to decline with respect to that o f domestically produced food. O n the other hand, a RER appreciation could make imported inputs less costly, and o i l revenue could be invested in agriculture to raise i t s productivity. The Nigerian precedent (but also that o f Ecuador, Mexico, Algeria, Iran), where the o i l boom o f the 1970s severely affected agriculture, i s a case in point.34 And experience suggests that once market share i s lost it can be extremely hard to regain due to the loss o f commodity-specific capital-both physical (e.g., processing plants) and human (scientific knowledge and technical skills). This i s particularly the case in export markets, when supply chains are often complex and difficult to establish. Ghana is s t i l l trying to recover market share in the European pineapple market having lost ground with the slow conversion to new varieties demanded by European supermarkets. 1.34 An oil boom could exacerbate rural-urban spatial disparities. We use the same simulations to illustrate this point, comparing a non-oil scenario to two alternative scenarios, 33 In net present value terms, given the initial boom, the difference would nonetheless become marginal. Using a social discount rate o f 7.5 percent would basically equate the discounted incomes in the two scenarios. 34 Nigeria experienced an o i l boom in the 1970s that severely affected its agriculture. The real value o f the Naira more than doubled during the decade, leading to a sharp decline in the price o f tradable agricultural commodities. Per capita agricultural production fell by 40 percent f i o m 1970 t o 1982 and Nigeria rapidly became a large food importer. Public investments financed by o i l revenues and intended t o boost productivity were largely wasted in expensive and ultimately unproductive schemes, such as large scale irrigation. - 13 - where o i l revenue is more or less consumed by the Government. The comparison is here made for the year 2015, at the peak o f extraction. Results indicate first that the real exchange rate would significantly appreciate (by 11 to 12 percent), whatever the use o f o i l revenue (consumption or investment), suggesting similar tradablehon tradable contents o f public consumption and investment expenditures patterns. But investment matters otherwise, as it would increase productivity overall, and thus contain export losses at the economy-wide level. Nonetheless, agriculture would not necessarily benefit from increased investment, as the latter would rather go to other sectors - such as non-tradable sectors, and mining, if attracted by high private rates o f return. In the event, agricultural exports would decline by 5-6 percent (mostly cocoa), while agricultural output would decline by 1 percent with respect t o a baseline non-oil scenario. These figures sharply contrast with the overall positive effect o f o i l revenue on per capita incomes in the short run, and emphasize the risk o f a widening urban-rural divide during the boom period. Table 1.3: Spending Oil Revenue Would Hurt Agricultural Output and Exports Deviations with Respect t o a Non-oil Baseline Scenario in 2015 Alternative 1: oil revenue Alternative 2: oil revenue mostly consumed half invested Real exchange rate 13.0% 11.5% . Real disposable per capita income 12.5% 10.1% Exports volumes -19.1% -14.0% Agricultural exports volumes -6.5% -5.5% Agricultural output volumes -1.0% -1.2% Source: World Bank staff calculations. Table 1.4: An Oil Boom Could Induce Significant Redistribution Effects Initial 10% RER . . 25% RER aooremtion Poverty Headcount National 28.6% 28.7% 28.8% Urban 10.7% 10.7% 10.7% Rural 39.3% 39.7% 39.8% Western 18.6% 19.3% 21.0% Central 19.9% 20.1% 18.4% Greater Accra 1 1.8% 11.8% 12.3% Volta 31.7% 32.5% 3 1.3% Eastern 14.7% 14.8% 15.4% Ashanti 20.5% 21.0% 20.7% Brona Ahafo 29.7% 29.3% 29.4% Northern 52.2% 52.3% 52.5% Upper East 70.5% 70.3% 70.3% Upper West 87.9% 87.8% 88.0% Income change Public sector employees 0.6% 1.6% Private formal employees -0.1% -0.2% Private informal employees 0.4% 1.1% Export Farmers -3.0% -7.4% Food Crop Farmers 0.3% 0.7% Non-Farm Self-Employed 0.1% 0.3% Non-working 0.5% 1.2% Source: World Bank staff calculations. 1.35 M i c r o analysis confirms that export farmers would be the main direct losers from a real exchange rate appreciation. A micro-accounting analysis o f the most recent household survey (GLSSS, for the years 2005/6) allows assessing the extent to which Ghanaian households' welfare would be impacted by a change in the price o f tradable over non-tradable goods, on both - 14- their revenue and consumption sides.35 Given households' initial position vis-a-vis the national poverty line (broadly at $PPPl.25 a day), the same analysis also allows t o measure the impact o f a FER appreciation o n poverty. The analysis, however, ignores the primary incomehpending effect from o i l revenue that is the cause o f FER appreciation, and which could compensate groups for lost welfare if redistributed. Results suggest small aggregate changes (in national welfare or poverty), but a fair amount o f distributional change for an assumed RER appreciation o f 10 percent (and more with 25 percent). The poorest segments and regions o f the Ghanaian society-food crop farmers in the Northern, Upper East, and Upper West regions-are likely to benefit from an increase in the relative price o f non-tradable goods, although often times not enough to raise their incomes above the poverty line. O n the other hand, export farmers (from the Western region in particular) are likely to experience substantial welfare losses, with a number o f these households slipping below the poverty threshold. 1.36 Threats o f Dutch disease contrast with agriculture's large potential for growth and poverty reduction. Macro and micro analyses discussed in the preceding paragraphs suggest that markets immediate reaction to the injection o f o i l revenue in Ghana's economy would tend to affect negatively commercial agriculture, in spite o f great agro-ecological p o t e n t i a ~ . ~ ~ Subsistence farming would not be affected, as isolated from markets, but the deterioration o f commercial agriculture would weaken rural households' ability to grow out o f poverty. In 2005/6, more than 85 percent o f Ghana's poor were living in rural areas, and even if an o i l boom could induce accelerated rural-urban migration (as well as the development o f off-farm activities), agricultural development will continue to remain central to the growth and poverty reduction agenda (World Bank, 2008) in Ghana for many years. There are indeed many reasons to believe that agricultural productivity growth could be a key engine o f industrialization and economic take o f f in Ghana. First because agricultural goods are important inputs for the industry, directly for some sectors (e.g., food processing, textile), and indirectly through their impact on real wages (as households' consumption basket is skewed towards food and textile items). Second because agricultural productivity growth creates surpluses, breaking the vicious circle o f subsistence farming, where nearly everything produced i s consumed within the same harvest cycle. In effect, enhanced productivity releases workers or time for other activities, increases savings and investments, reduces farmers' vulnerability, and thus raises their ability to take productive risks. I t also creates demand for industrial products, which i s crucial in the presence o f fixed costs in industry. And third because even when potential productivity growth i s weak, public support to agricultural development might s t i l l be considered as an efficient transfer mechanism to target the poor (Bourguignon, 2006). These elements could justify greater public 35 The analysis considers households' individual patterns o f consumption and sources o f income, attaching t o each o f them a degree o f tradability. A net consumer (respectively producer) o f tradable goods will record welfare gains (resp. losses). See Medvedev (2009) for detailed discussion. 36 Northern Ghana, where most o f the rural poor reside, i s vastly unexploited for a number o f reasons-diseases, poor soils, climatic risk, and very l o w population and road density. However, the potential o f this region is huge, as demonstrated by the experience o f the `Cerrado' in N o r t h Brazil and Northeast Thailand, which share similar ecologies. Both regions were turned into highly competitive poles o f commercial agriculture for cassava, soybeans, sugar, rice, maize, cotton and beef. Factors that contributed to this success included: (i) improved agricultural technology, both varieties and soil management; (ii) publicly financed infrastructure, rural credit, and business ii a development services; ( i ) dynamic private sector and a conducive investment climate; and (iv) a policy environment that sets prices in line with world prices. -15- intervention in agriculture (in the North in p a r t i c ~ l a r to mobilize this potential and reduce the )~~ transitional costs which would result from an oil-driven boom and bust cycle. Such an intervention could in part be financed with o i l revenue, and take various forms, from the provision o f agricultural public goods (research, extension, infrastructure, investment climate) to targeted interventions to raise people's economic m~bility.~' E. TRADE-OFFS A WAY FORWARD AND 1.37 With oil .revenue flowing, Ghana will be confronted with a number o f choices. Ghana needs first to decide what part o f o i l revenue it wants to spend now, versus later. This inter- temporal choice should be dictated by absorptive capacities considerations (the social return o f o i l revenue spending). Inter-generational considerations, however, could also be considered, as choices made today (based on a given discount rate, or degree o f preference for the present), would have irreversible consequences on future generations (the first o f which being the fact that next generations will not be able themselves to choose h o w to use oil, as reserves would have been depleted). The second choice relates to i t s distribution. Some groups might be more affected than others at the margin by the direct impact o f o i l extraction (e.g. o n the environment) and spending (Dutch disease). But other groups might deserve greater support given their disfavored initial situation. For instance, if households from the Western region are likely t o lose more from an untargeted spending o f o i l revenue, they would s t i l l remain far less poor than those from the Northern regions (see Table 1.4). 1.38 Nonetheless, whatever choices made, a number o f actions should be rapidly undertaken to raise the potential developmental impact o f oil. In turn, raising the social rate o f return o f o i l revenue spending will attenuate some o f the trade-offs discussed above. Ghana would strongly benefit from elevating its institutional and macroeconomic absorptive capacities before channeling o i l revenue into the economy. Raising such capacity will take time, while o i l revenue will grow extremely rapidly in the first years o f extraction. The risk o f misuse is thus particularly high in these years. In the face o f it, Ghana could consider the following actions, most o f which would be justified even in the absence o f oil: Increase transparency on oil revenue. Minimizing risks o f political capture call for greater social accountability, which cannot expand without economic transparency. The latter could be improved as Ghana adopts and implements a Freedom o f Information Act; and stipulates/enforces accountability mechanisms regarding: (i) publication o f reports on the revenue and their use, and (ii) disclosure o f bidders' identity and bidding documents. The the EITI process could be used in this regard. In turn, increased transparency should open the door to design a home-grown institutional response to the risk o f political capture. Various experiences from the rest o f the World can inspire Ghana, but none o f them will become effective if not fully and broadly owned locally. Restore fiscal sustainability. H i g h fiscal deficits threaten macro-economic stability, and using o i l revenue to finance them would only postpone the adjustment while missing an important development opportunity. The needed adjustment will call in particular for a 37 The Government o f Ghana i s envisaging in this regard to harness resources of the Savannah areas with value- n added processing, improved technology coupled with strategic investments i people and service (Government o f Ghana, 2009). 38 n The relative merits o f these approaches will be discussed i details in a forthcoming World Bank report on poverty and spatial inequalities. - 16- related service delivery and review o f the public payroll and energy subsidies in light o f (i) poverty alleviation and (ii) fiscal affordability. Public financial management reforms discussed above would consolidate the fiscal adjustment effort. Remove bottlenecks in non-tradable sectors. Dutch disease effects would be mitigated by removing constraint to competition and domestic supply response in non-tradable sectors, including: high barriers to entry into formal sectors (starting a business, labor regulation and minimum wages, access to finance, urban land tenure), and poor infrastructure (water, electricity) for urban SMEs. The latter would benefit from higher consideration to PPP options, leaving greater financial capacity for the Government to finance projects with high social returns. Introduce stabilization mechanisms for managing oil price volatility. The first mechanism would consist in restoring the pass through o f international prices into gasoline and utilities tariff, along with establishing targeted mechanisms to protect the poor. A second mechanism to shield the budget from o i l price volatility would consist in establishing a fund (between a stabilization fund and a permanent income fund, see above), from which predictable transfers would be made t o the budget. Increase the provision o f agricultural public goods. The reform would consist in raising agricultural spending up to 10 percent o f government budget (from 6-8 percent currently) to support the provision o f various public goods, including feeder roads, research, extension services, water and power supplies, storage capacities, irrigation for smallholders, and safety standards. 1.39 These policy actions would significantly magnify the potential developmental impact o f oil. Quantitative simulations suggest that the early implementation o f the reforms in energy, civil service, land regulation, PFM reform and agriculture3' evoked above could significantly improve the developmental impact o f o i l revenue. The average real per capita disposable income over the period 2010-29 could be 9-13 percent higher with these reforms than without, that is, higher than in the non-oil scenario discussed before (see Figure 1.2). Simulations also suggest that the effect o f these reforms, which aim at raisin public investment effectiveness, would take 4$ time to materialize. Indeed, the discounted income (which gives preference to the first years o f the period) would be less enhanced than the undiscounted one. In particular, c i v i l service, PFM and private sector reforms would take time to generate important gains. By the same token, delayed implementation o f these reforms would entail high opportunity costs as a large share o f , o i l revenue would have been sub-optimally spent. 1.40 Although key to raise the quality o f oil revenue spending, the reforms above would not address all issues. The first one is the intergenerational equity issue, as next generations would be deprived o f the opportunity to decide h o w to manage o i l if its revenue is fully spent during the extraction period. The second one i s the distribution issue, as these reforms would only marginally contain a widening ruralhrban gap in the boom period. The third one relates to downside risks associated to these reforms: implementation delays, political feasibility, a large exposure to changing price and reserve assumptions during the first years o f extraction could all 39 We simulate the following reforms: energy reform: electricity tariffs match production costs; civil service reform: formal sector wages are determined by their marginal productivity; private sector reform: the urban land supply i s made more responsive to its remuneration; and PFM reform: a larger share o f oil revenue spent i s allocated to investment (75 against 50 percent); agricultural reform: improved rural land productivity. 40 A 7.5 percent social discount rate i s used in the computations. - 17- .3 : rea E1i eve Revenue Change in Real Per Capita ~ j 5 p o s a ~ ~ e During 201 1-29, with Respect to a Non-Reform Scenario Income DEnergy sector reform aCivit service refom CJ Private sector reform PFM reform Agriculture reform 0% T* ~ n d i ~ o ~income t e d Discounted Income Sorrice bVorld Bank s a f f caiculations - 18- 2. REVENUE PROJECTIONS A. INTRODUCTION 2.1 The exploitation o f Ghana's newfound petroleum resources will undoubtedly have an important impact on the economy of Ghana. This chapter assesses the likely scale, nature and timing o f that impact based on parameters known to the World Bank at the time o f writing and assumptions made about key economic factors such as the o i l price, production costs and product markets. 2.2 The chapter provides projections of: (i)the value o f production and (ii) direct government revenues.41 Broader economy impacts, such as j o b creation, imports, import substitution, economic linkages to suppliers and the downstream processing o f gas are not measured but discussed qualitatively. 2.3 The ultimate scale o f Ghana's petroleum resources i s not known but more information i s becoming available as exploration progresses. In order o f certainty, most to least certain, the current knowledge o f Ghana's petroleum resources can be summarized thus: . The Jubilee o i l field has proven recoverable o i l reserves o f 490 million barrels (mmbbl), which i s already o f sufficient size and quality to justify commercial e ~ p l o i t a t i o n . ~ ~ However, additional drilling and tests are being conducted to prove a higher reserve base estimated t o be at least 1,200 mmbbl and possibly as much as 1,800 mmbbl. The o i l consortium43 i s therefore proceeding with development o f the Jubilee field in phases, with Phase Ibased on the "core" area o f the field where reserves have already been proven.44 Phase Iwill produce 120,000 barrels o f o i l per day (bpd) at peak with field l i f e o f the order o f 15 to 20 ears. Gas would be produced in association with o i l at a rate o f Y 120 million standard ft per day (mmscfd) but would initially be re-injected pending . availability o f a gas pipeline and market.45 A further one or more phases o f the Jubilee field development are under consideration, dependent o n the level o f additional reserves proven up during a campaign o f drilling in 2009. To date Phase I1 has been described as possibly expanding production to 250,000 bpd o f o i l at peak with a field life o f the order o f 25 to 30 years, commencing some t w o to three years after completion o f Phase I. Gas output would reach 250 mmscfd and by . then a gas pipeline and market i s more likely to be available. Less certain i s the possibility that additional o i l fields will be discovered by the same consortium, some o f which may be sufficiently close to Jubilee to allow the sharing o f 41 Major levies on petroleum operations based on negotiated petroleum contracts (see Box 2). This does not include dividend withholding, taxes on inputs, employee taxes and a variety o f minor taxes. 42 Tullow Oil plc Trading Statement, January 2 1,2009. 43 The oil consortium comprises Tullow Oil plc, Kosmos Energy, Anadarko Petroleum, Sabre Oil and Gas and the EO Group. 44 The "core" area of the field holds only a portion o f the proven reserves, which according to data from GNPC i s 269 mmbbl and this -serves as the basis on which project design and commercial assessment has proceeded, even though the field i s considerably bigger than this. The IFC has itself, in relation to agreeing i t s loans to Kosmos and Tullow, relied upon an independently certified reserves assessment of just 22 1 mmbbl in the "core" area. 4s A small amount of gas will be used to generate power used by the oilfield facilities. The consortium plans to commence commercial negotiations for the supply of gas and access to pipeline capacity during 2009. - 19- facilities.46 Exploration drilling in 2009-201 0 will test potential additional resources ~~ based on prospects, some o f which may contain up to 500 m r n b b ~Other companies hold exploration rights over adjacent areas displaying the same or similar geology. Over the next few years several wells will be drilled to test whether similar sized resources extend out to these areas. The first such well was completed by Amerada Hess in . December 2008 south o f Jubilee but did not discover oil. Finally, the development o f a gas pipeline and markets based o n Jubilee would increase the likelihood o f the existing Tan0 gas fields, which are located in shallow water nearer the coast, being feasible to exploit using shared i n f r a s t r ~ c t u r e . ~ ~ 2.4 T h e level and quality o f data available to the W o r l d Bank on Phase I are judged as sufficient to allow a Base Case projection to b e made together with sensitivities to higher and lower o i l price outlooks, a higher capital cost and shorter duration o f peak production. The projections are based on the January 2009 World Bank long-term o i l price forecast o f $75 per barrel. Sensitivity has been tested at $30, $50 and at $100 per barrel. 2.5 A qualitative but not quantitative assessment o f the impact o f Phase I1 and other larger but less certain petroleum resource scenarios i s also made. B. JUBILEE I PHASE BASE CASE 2.6 For purposes o f this analysis the base case i s defined as a single offshore field with 500 million bbl o f recoverable o i l reserves; output capacity o f 120,000 bpd o f o i l and 120 mmscfd o f gas; output at peak capacity for 5 years followed by 14 years o f declining output; first production in 201 1; re-injection o f all gas; capital cost o f $4 billion (including purchase o f FPS0).49 K e y Results (in real U S dollars5') are: . Total field life value o f petroleum o f $37.5 billion, averaging $2 billion annually and peaking at $3.3 billion from 2012 to 2015. . Total field l i f e government revenues o f $19.4 billion, averaging just over $1 billion annually and peaking at $1.8 billion in 20 16; . Government share o f total value over field life o f 52 percent; government share o f net cash flow o f 69 percent (undiscounted) over field life;51 46 In January 2009 the Mahogany-3 well discovered a discrete deeper reservoir o f oil underneath the known Jubilee field. Additionally, a relatively small discovery called Odum was made in February 2008, which could possibly use the same production facilities as Jubilee. 47 A prospect i s a geological feature detected by seismic and other surveying methods thought likely to contain petroleum but which has s t i l l to be tested by drilling. As such, present estimates o f petroleum resources are highly n speculative. Several prospects have been identified and will be drilled i the coming year, beginning in late January 2009 with the Tweneboa prospect. 48 Until now, the viability o f exploiting the Tan0 gas fields had been affected by their modest size and limited market opportunity. 49 A Floating Production Storage and Offloading vessel (FPSO) will serve as the central surface facility receiving o i l from sub-surface wells and processing it for storage and offloading onto oil tankers and any pipeline connection. An FPSO may be purchased or leased. The oil consortium plans to lease the FPSO but can exercise an option to purchase it after two years, an option that i s assumed will be taken at a cost o f some $725 million. 50 January 2009 prices. - 20 - . An o i l price o f $50 results in total government revenues o f $8.6 billion (-56 percent) and government share o f net cash flow o f 55 percent; a price o f $100 results in total government revenues o f $29.3 billion (+51 percent) and government share o f net cash flow o f 72 percent; . At an o i l price o f $30 the project i s marginally economic (16 percent IRR pre-tax) and . generates just $3 billion o f government revenue; A 25 percent capital cost overrun on i t s own reduces total government revenues by 14 percent and, when combined with a $50 o i l price, reduces total government revenues by over 60 percent; . A two-year period o f peak production, as against five years, on its own reduces total government revenues by some 60 percent and, when combined with a $50 o i l price, reduces total government revenues by over 80 percent. Table 2.1: Jubilee Phase IBase Case - $75/bbl Year output Gross Revenue Capital 8~ Government Operating Costs Revenue `000 bpd US$million US$ million US$ million 2008 0 0 397.8 0 2009 0 0 1094.5 0 2010 0 0 1094.5 0 201 1 06.9 2925.0 1108.9 899.7 2012 20.5 3300.0 1268.3 1010.8 2013 20.5 3300.0 350.3 1083.0 2014 20.5 3300.0 350.3 1483.8 2015 20.5 3300.0 350.3 1796.3 2016 101.4 2775.0 327.0 1804.1 2017 89.0 2437.5 3 12.1 1587.4 2018 79.5 2174.9 300.4 1400.4 2019 69.9 1912.4 288.8 1213.3 2020 61.6 1687.4 278.8 1053.0 202 1 56.1 1536.8 272.1 945.7 2022 50.7 1387.6 265.5 839.4 2023 46.6 1275.1 260.5 759.3 2024 43.8 1200.1 257.2 705.8 2025 41.1 1125.1 253.9 652.4 2026 38.4 1050.1 250.6 599.0 2027 35.6 975.1 247.2 545.5 2028 34.3 937.6 245.6 518.8 2029 32.9 900.1 243.9 492.1 TOTAL 37500.0 9818.6 19389.8 Source: World Bank staff calculations. 2.7 Other sensitivities which have not been tested in this analysis would include alternative assumptions regarding the start date o f production, the rate o f output decline from peak levels, operating cost levels, sale o f gas at some stage and types o f financing.52 5 1 The Government share is the sum o f a l l fiscal receipts divided by the cash flow o f the project after meeting all capital and operating costs. 52 The project i s assumed t o be 100 percent equity financed. As a result, the project would not bear the cost o f servicing loans. Debt service costs increase the cost base of a project and reduce government fiscal receipts. -21 - 2.8 Other impacts of Jubilee Phase I on the economy are expected to include the following: Directjob creation: The o i l consortium estimates a total workforce requirement o f a little over 200 during routine operations. The local staffing content would be o f the order o f 40 to 60 per cent in the initial years. During construction higher numbers can be expected, comprising temporary contractors and their construction crews. The sources o f employment would include management and administrative offices in Accra and personnel at supply bases, aviation and port facilities and on rigs, supply vessels and the FPSO. Local goods and services: The local content o f supplies to the oilfield will be l o w in the construction phase in terms o f equipment and services needed for installation because o f the high level o f specialization; in the production phase there i s likely to be improved scope for consumables to be procured locally and Ghana-based enterprises t o supply a range o f non-specialist services. Indirect taxes: Petroleum operations enjoy exemption o f all duties and other charges on imports o f items which are not subject to rules requiring preference to be given t o local sourcing. In practice, this will mean that a very high proportion o f imports during construction and production operations will be brought into Ghana tax-free. Downstream processing: Crude o i l from Jubilee will be o f high quality and readily find buyers in the international o i l market ready to pay international prices; accordingly there i s expected to be no price or marketing advantage to the o i l consortium by selling the crude o i l to a domestic refinery.53 Box 2.1: Some Parameters Affecting Pre-tax Petroleum Economics Recent dramatic oil price movements highlight the difficulty o f reliably forecasting oil prices. However, large and high quality oil deposits like Jubilee have a cost structure that should be able to withstand oil price fluctuations. Moreover, the quality o f Jubilee crude oil (light and sweet) will ensure that it commands a price close to international marker crude oils like Brent. Field production rates display a tendency to reach and then maintain peak output for only a few years before decline sets in. This i s largely a function o f the pressure drive in the oil reservoir. Output can be enhanced through the use o f re-injection wells to artificially sustain pressure drive. In the Jubilee field, gas i s dissolved in oil and i s released at lower pressures once oil i s brought to the surface. The rate o f gas production i s a direct function o f oil production. Gas may be re-injected to enhance oil production rates or for sub-surface storage. Field costs are a h c t i o n o f numerous engineering considerations. Water depths, drilling depths, reservoir size, shape and thickness, pressure drive, quality o f oil-bearing sands, properties o f the oil, to name a few, impact on costs. Fixed costs tend to be high as a proportion o f total costs, so that significant economies o f scale arise. However, some capital items are "lumpy." For example, the sizing o f a Floating Production, Storage and Offloading Vessel (through which all petroleum passes) must be optimized, since this i s the single biggest item to be purchased (or leased). 53The Government may choose to exercise i t s option to take royalty, initial interest and AOE (but not income tax) in crude oil rather than cash. In such case, oil could be supplied to a domestic refinery. However, the value o f so doing would depend, in part, on the compatibility o f Jubilee crude oil and refinery feedstock requirements. - 22 - Box 2.2: The Fiscal Regime for the Jubilee Field The fiscal regime under which the Jubilee field will be operated i s defined by petroleum laws and detailed fiscal terms o f contracts for each o f the two petroleum licenses which Jubilee straddles. In most respects the fiscal terms o f the two contracts are the same and comprise the following elements from which the . Government obtains revenue: . Royalty: 5 percent o f gross oil revenue; 3 percent o f gross gas revenue . Initial Interest: 10 percent o f petroleum revenue net o f royalty and operating expenses Additional Oil Entitlement (AOE): a share o f petroleum revenue net o f royalty and initial interest that i s linked to the project rate o f return (ROR) on a sliding scale; the terms o f each contract are understood to differ so, for this analysis, a four-point sliding scale has been assumed as follows: @ ROR >18% AOE = 10%; @ ROR >23% AOE 15%; @ ROR >28% AOE = 20%; @ ROR >33% AOE . = = 25% (World Bank assumptions) Income Tax: 35 percent o f taxable income after deduction o f expenses and depreciation o f capital expenditures over five years A n additional option exists for the Government to purchase a share o f the Jubilee project on terms specified in the petroleum contract. This option has not been included in the analysis. The new Government has announced that it will exercise this option under which it will acquire a 3.75 percent interest in the Jubilee field, through GNPC, for US$161 million. The fiscal regime yields various revenue streams, some tied to turnover (royalty) and others tied to profitability (initial interest, AOE and income tax). AOE ensures that the tax take rises progressively as a function o f profitability, with minimum Government take (pre-AOE) around 50 percent rising, once all ROR thresholds have been crossed, to over 70 percent. The fiscal regime only applies to upstream oil and gas operations - all revenues and costs up to the point o f disposal (oil tanker or inlet into oil or gas pipelines). There i s scope for specific and different terms to be negotiated for gas. For this analysis, except for the lower gas royalty rate, all other terms are assumed to apply equally to oil and gas. c. IMPACTS OF A LARGER RESOURCE BASE 2.9 Phase I1 of the Jubilee field development would be based on a higher proven reserve base than Phase Iand could be launched some two to three years after completion o f Phase I.The production rate could be double that o f Phase I resulting in a peak level o f gross revenues o f the order o f $7 billion over some five years from as early as 2015. No cost estimates have been provided by the o i l consortium but economies o f scale and sunk appraisal costs would . imply higher pre-tax returns than for Phase I Because o f the progressive structure o f the fiscal regime for any price level, the Government share o f net cash flow would be higher under Phase I1than Phase I . 2.10 By the time o f Phase I1 the sale o f gas (made possible with the likely availability o f a pipeline), rather than its re-injection i s much more likely. Accordingly, a value could be attributed to gas based on sale at the oilfield (into a pipeline under separate ~wnership).~~ The 54 A value o f gas at the wellhead could be derived based on the netback value of gas after considering the cost to transport and process gas downstream o f the Jubilee field, as well as any gas handling facilities needed at the Jubilee field. The netback value o f gas i s highly uncertain and subject to a wide margin o f error. There may also be additional value in the gas at the processing stage, where liquids would be stripped to generate, among other things, Liquid Petroleum Gas (LPG), which can be used as a cooking fuel or motor fuel. - 23 - incremental value o f gas to the Jubilee field is likely to be relatively l o w in gross revenue terms, but it nonetheless can contribute directly to profitability and, hence, to government revenue.55 2.1 1 T h e sale o f gas will have significant economic impact in addition to the incremental contribution to government revenues f r o m the Jubilee field. Without a defined gas development plan only general observations can be made about this impact. However, positive impacts are likely to include: . Investment and jobs associated with the gas chain downstream from the oilfield, including a wet gas pipeline to shore, gas processing and storage facilities, dry gas trunk pipeline(s), gas distribution pipelines and facilities for handling and distribution o f by- products o f gas processing (e.g. LPG, propane, butane);56 . Supply o f gas feedstock for power-generation which would substitute for fuel o i l at existing and planned dual fuel Combined Cycle Generating Turbines, thereby saving . foreign exchange used to import fuel oil; Taxation o f transportation, processing, distribution and sale o f gas. K e y conclusions are the following: . Phase Io f the Jubilee o i l field will proceed, with delay into 201 1 increasingly likely; The economic performance o f Jubilee, and hence Government revenues, i s critically dependent on the o i l price, with a Base Case revenue projection based on the World Bank's current long-term price forecast o f $19 billion ($75 o i l price) and plausible alternative o i l price scenarios yielding Government revenue in a range between $9 billion ($50 o i l price) and $29 billion ($100 o i l price) over field life; 1 A number o f other parameters are subject to uncertainty, in particular, how long peak production o f 120,000 barrels per day can be sustained - if the smaller reserve base that has been used as a basis for evaluating Phase Iby GNPC i s used (implying a shorter period o f peak production and reduced project life), Government revenue would only be $8 billion at $75 o i l price and as little as $3.3 billion at $50 o i l price; . The Government's share o f net profits from Jubilee can be expected to respond strongly to changes in o i l prices, because o f the structure o f the fiscal regime, in a range between approximately 50 percent and 70 percent. A larger scale operation i s increasingly likely to be developed some years after , completion o f Phase I and would yield more than double the expected economic benefits o f Phase I(for any given o i l price), however, it is too early to provide more detailed projections at this stage; 55 n The incremental economics o f gas sales i reality might depend o n tradeoffs between re-injection and gas sale and associated capital and operating expenses. These cannot be assessed on the basis o f the information available. 56 Plans t o establish a gas processing plant with the capacity t o handle 150 mmscfd o f gas were announced by the Government in December 2008 t o be sited o n the coast in Western Province close to the Effasu barge-mounted power generating facilities. The barge presently has 1 2 5 M W generating capacity, equivalent t o 30 mmscfd o f dry gas feed but expansion i s planned. The Aboadze power plant at Takoradi has 5 3 0 M W installed capacity, equivalent t o 130 mmscfd o f dry gas. feed. The Volta River Authority has already contracted t o take 123 mmscfd o f gas supplied through the West Afkican Gas Pipeline t o meet feedstock requirements o f Aboadze. - 24 - 9 Government fiscal revenues are the principal mechanism through which economic benefits will accrue to Ghana since, until the use o f gas becomes viable, the Jubilee operation i s likely to generate limited economic linkages and input substitution opportunities; and 9 The supply o f gas for processing and use downstream in Ghana would provide significantly greater opportunity for economic linkages and input substitution. - 25 - 3. POLITICAL ECONOMY D I M E N S I O N S A. INTRODUCTION 3.1 Africa's development depends, in large part, o n i t s ability to use i t s n a t u r a l resources f o r sustainable and inclusive development. In principle, the fact that Africa i s well endowed with rich natural resources seems like a positive thing since i t should provide the opportunity for countries within the region to meet their considerable development needs. However, in practice, the literature i s full o f examples o f misfortunes with countries rich in such resources performing poorly on the economic, social and political dimensions o f de~elopment.~' 3.2 Since t h e 1990s, there has been a g r o w i n g b o d y o f literature that goes b e y o n d t h e macroeconomic and D u t c h Disease issues t o l o o k a t why some countries with natural resources p e r f o r m well, w h i l e others seem t o miss t h e o p p o r t u n i t y a n d p e r f o r m w o r s e than countries that a r e less well-endowed. This literature looks broadly at the relationship between social and political structures, institutions and policy choices. This chapter provides a brief review o f this growing body o f literature and look at the different attempts t o classify types o f countries and the political and institutional reasons that have led to policy decisions. It then looks at how Ghana ranks in terms o f institutional quality and uses the typologies o f political regime as well as Ghana's performance in the mining sector to ascertain whether there i s cause for concern as to whether Ghana has the right political incentives and sufficiently strong institutions to manage its new o i l rents well. Finally, it looks at how different countries have developed a range o f instruments to strengthen the institutional arrangements for effective management o f o i l and discusses h o w these might be tailored to the Ghanaian context. B. THEROLE POLITICS AND INSTITUTIONS IN DETERMINING OF THE IMPACT OF OIL ON A COUNTRY 3.3 T h e r o o t o f the institutional challenges f o r countries with concentrated natural resources i s a "principal agent problem" (cited in Gelb and Turner, 2007). O i l resources are usually declared as belonging to the whole country but are managed on behalf o f all citizens b y their Government. However, lack o f clarity about what "ownership" really means, along with weak institutions that neither constrain governments nor provide accountability has led to a whole host o f problems. The literature cites collusion with large o i l companies, rent seeking and corruption, increased political patronage, lower entrepreneurship and lower capacity for investment, increased authoritarianism and even civil conflict as common problems that many confront countries that have discovered oil. 3.4 T h e r e have been a n u m b e r o f attempts t o establish t h e causality of the relationship between t h e political and institutional dimensions o n the one hand, and t h e performance o f the c o u n t r y o n the other. While there i s still much discussion on this issue, in general, the literature agrees on two things. First, political and institutional dimensions are the most important determinant o f how a country with o i l performs. As Eifert et al. (2002) note, "the variance o f growth performance among resource rich countries is primarily due to how resource 57 O f 48 countries for which oil comprised more than 30 percent o f total exports between 1965-1995, nearly half scored in the bottom third o f the UN Human Development Index. Closer to home, Nigeria i s cited as an example o f a country that earned US$340 billion but living standards worsened. 26 rents are distributed via the institutional arrangements" (2006).58 Second, countries who do not recognize this importance and who have weak institutional contexts will find weaknesses exacerbated and o i l i s likely to result in a curse rather than a blessing (Eifert et al., 2002). 3.5 T h e r e have been a n u m b e r o f attempts in the literature t o classify the political and institutional reasons for policy failures a n d thus to establish some typologies. Ross (.1999) provides a good summary o f three types o f reasons for policy failure and offers the following typology: (i) cognitive reasons - resource rents are seen to induce a "get rich quickly" mentality, resulting in short-sighted policy decisions and excessive spending; (ii) societal reasons - countries often have existing interest groups with significant political leverage on the state who block growth enhancing policies; and (iii) statist reasons - states are freed from the need to levy domestic taxes and therefore become less accountable to citizens since they no longer need either their votes or their taxes and devote rents to guarding the status quo. Mehlum et al. (2006) take a different approach, focusing on institutional quality and construct an institutional quality index based on data from the political risk services.59 The index runs from 1 to 0 with 1 suggesting that institutions are "producer friendly" and 0 being countries with institutions that are "grabber friendly." The regressions show that, controlling for level o f education and ethnic fractionalization, the resource curse only hits countries with a lower level o f institutional quality. Finally, Eifert et al. (2002) expand o n the societal and statist reasons offered by Ross (1999) above and provide a useful classification o f political features o f five types o f regimes and the coqesponding institutional implications (see Table 3.1). This provides us with the opportunity to confirm whether the concerns raised by Mehlum et al. (2006) work o n institutional quality resonates with what we know about the political features o f Ghana. c. APPLYING THE POLITICAL AND INSTITUTIONAL DETERMINANTS GHANA TO 3.6 G h a n a i s a young democracy with f o u r strengths (World Bank, 2007): there i s no dominant single party in Ghana, parties are quite well institutionalized, and traditional leaders provide some restraint o n the capacity o f the Executive to pursuing their own self-interest and extra-institutional interventions from the military, for example, seem to be rare particularly relative to other neighboring countries. These, and other quantifiable governance indicators, partially explain why Ghana does well on, for example, the Country Performance Indicator Assessment (CPIA). However, as numerous political economists point out, there is a slightly more complex governance picture beneath the surface that suggests that Ghana i s more "grabber friendly" than "producer friendly." World Bank (2007a), Booth et al. (2005), Nugent (1999) and others all show that Ghana does indeed exhibit the political characteristics o f a "factional democracy" (Eifert et al., 2002) and perhaps even has some remnants o f i t s recent past as an autocracy. World Bank (2007a) shows how the political incentives in Ghana produce a high level o f clientelism and patronage politics with government responding to narrow interest groups. Ghana spends far more, on average, on targeted expenditures, such as the c i v i l service wage bill and public investment, but i s average or below average in terms o f spending o n the provision o f public goods, such as the rule o f law, quality o f education or the lengths it goes to push back corruption. Within this context where some interest groups are particularly powerful, big 58This i s based o n a series o f cross country regressions using the data set used by Sachs and Warner o n Dutch Disease and controlling for education and social divisions. " For f'urther discussion o f the index see Knack and Keefer (1995). - 27 - business interests seem to be particularly strong with their influence deriving from personal relationships and the finding o f political campaigns (Booth, 2005). 3.7 Ghana also exhibits large (and increasing) social disparities and social polarization i s an increasing concern. There i s a marked rural-urban divide (Nugent, 1999), regional inequalities are increasing and the role o f ethnic identity seems to be increasing with ethnic grievances rising (Afrobarometer, 2005). While the traditional authorities have, in the past played an important role in arbitrating and building social consensus, the modern state does not appear to have similar mechanisms and, when faced with conflict in Bawku, for example, it turns to the traditional authorities for help. 3.8 One would expect a factional democracy with a recent heritage as an autocracy to also display low levels o f civic counterweight. This i s true in Ghana. A number o f studies show that information i s the most important constraint to more accountability through vertical means, although World Bank (2007a) also suggests that the fact that Ghana has fewer graduates from secondary school also plays a role. A study (World Bank, 2007b) on the enabling environment for social accountability points to five types o f constraints including few political incentives within the Executive t o strengthen accountability mechanisms, centralized and confused intergovernmental arrangements that limit potential entry points, weak enforcement capacity o f the state which leads citizens to put little value in participating since there i s no ultimate recourse, a plethora o f uncoordinated instruments that don't add up to much impact at the national level and, finally, a weak and poorly organized c i v i l society that has little influence on policy debates or their oversight. It i s also worth noting that interest groups representing non-oil sectors such as agriculture in Ghana are particularly weak, particularly when compared to large business interests such as the Chamber o f Commerce. 3.9 Ghana does not yet have a Freedom of Information Act and access to information i s weak. The External Review o f Public Financial Management (World Bank, 2006) notes that budget information i s o f poor quality, information on planned expenditures diverges from actuals and i t s presentation i s not reader friendly to anyone other than budget experts. World Bank (2007a) also notes that, despite media liberalization, media regulation and self censorship remain significant. In addition, relatively few Ghanaians read the newspaper and radio talk shows are the most popular form o f media, suggesting that there i s little flow o f information on policy issues. 3.10 Formal checks and balances exist in Ghana but are generally thought to be quite weak. The 1992 Constitution o f the Republic o f Ghana separates the three arms o f government from each other and Parliament i s expected to provide a check o n the Executive. The Standing Orders o f Parliament provide for the minority party in Parliament to appoint a chair o f the Public Accounts Committee and this has been adhered t o throughout the fourth republic (1993 to date). However, the role o f Parliament as an independent institution to hold the Executive to account i s weakened and contradicted by Article 78( 1) which requires that the President appoint a majority o f cabinet ministers from Parliament, making more than 50 percent o f ministers responsible for implementing policy as well as providing the check and balance o n this implementation. According to the African Peer Review Mechanism (2005), this potentially diminishes the independence o f the legislature and i t s effectiveness in enforcing horizontal accountability. The Office o f the Auditor General also exists in Ghana and prepares annual audit reports which are then presented to Parliament within the constitutional requirements (6 months after the end o f the - 28 - financial year). Challenges however remain with the follow up o f its recommendations on, for example, prosecution for abuse. 3.11 There i s some evidence that some elements o f institutional quality have worsened since 2000, although political incentives and institutional quality, o f course, continue to evolve. Using the International Country Risk Guide, World Bank (2007a) shows that with the advent o f a multi party system in 2000, Ghana moved from being a positive to a negative outlier in the measure o f bureaucratic quality, suggesting that the political incentives changed and there was no longer a need to serve the public interest in the same way. However, the recent elections in Ghana are undoubtedly a sign o f a maturing democracy and may also be a sign that the political incentives in the country are changing. Anecdotal evidence suggests that many people either voted for or accepted a change in part because it i s good to keep political parties "on their toes." The outcome o f the elections also translates into a much more evenly split Parliament, ending the huge majority o f the ruling party and pointing to a potentially more meaningful role for Parliament as a true check and balance. The role o f the new Parliament has, in the first month o f the new Government, also become a subject o f much public debate as many decisions approved by Parliament at over the last year have come under criticism, including the ex gratia package approved for former President Kufuor and the expenses approved for the Ghana at 50 celebrations. Finally, it should also be noted that the Ghanaian institutions that were tested during the election - namely the Electoral Commission, Judiciary Branch and the security agencies- withstood high levels o f tension and came through a very tight and drawn out electoral process unscathed. 3.12 Notwithstanding the evolving institutional and political landscape, the recent political economy literature confirms that Ghana exhibits the traditional political and institutional traits o f a factional democracy a n d that this provides cause for concern on its ability to manage oil reserves effectively. Based o n countries with similar characteristics who have discovered oil, one would expect there to be a strong state role in production, strong interests around how expenditures are used with a preference for responding to big business, short horizons, marked social divisions, little consensus about what and h o w to use o i l rents and l o w levels o f transparency (Eifert et al. 2002). A recent review o f political economy challenges in the mining sector (World Bank, 2009d) confirms that political incentives and institutional quality have indeed proved to be major constraints in better management o f the minerals sector (forthcoming). The report points to an inadequate consensus around a clear legal and institutional framework leading to complex and conflicting legal regimes, poor implementation o f policies and laws, disproportionate influence by big business interests, unclear and non-transparent transfer mechanisms o f royalties, weak mechanisms o f formal checks and balances, a powerful executive style o f politics with the President appointing all the members o f the Minerals Commission and potential conflicts o f interest, with members o f the Committee on Mines in Parliament also being members o f the Boards o f large mining companies, Executive interference in institutional processes o f awarding contracts and cases o f no competition and disclosure in the awarding o f contracts. This has led to high levels o f conflict in mining communities and a perception among many Ghanaians that the country's mineral reserves have not resulted in a "good deal" for the country. Perhaps because o f this, the mining sector has become one in which civil society i s becoming more involved both in the monitoring o f transfers from companies to the Government and how they are used as well as in advocacy around standards and abuses. - 29 - D. INTERNATIONAL EXPERIENCE DESIGNING TAILORING IN INSTRUMENTS FOR GOOD MANAGEMENT RENTSTO GHANA OF OIL 3.13 Given the political incentives and the weak institutional quality discussed above, what are the lessons from other countries as to how this might be addressed? Collier (2006) cautions against a "one size f i t s all" approach and points out developing countries should guard against adopting a Norway model since they are already resource scarce. With this qualifier in mind, however, the literature suggests that Ghana might consider a two-pronged approach, with a number o f immediate, if short-term, measures aimed at minimizing governance risks and improving the level o f consensus, transparency and accountability. However, these measures will ultimately not be sustainable if they are not accompanied by a second set o f measures, starting with a new commitment to an ambitious and comprehensive public sector reform t o deal with the institutional deficit in the medium-term. Without this second set o f measures any attempt to broaden a social contract through consultations or increase the transparency and accountability during the management phase o f revenues will ultimately fail as existing political incentives and broader institutional weaknesses will dominate. With this caveat, we discuss the possible immediate measures first that aim to broaden the consensus or the "social contract" around the use o f a country's resources, as well as increase the transparency and accountability with which the rents are managed. 3.14 I t i s clear that considerable effort should be invested in creating real consensus at the design stage around what the oil rents will be used for and how they will be managed, as well as creating a constituency that has a direct interest in the their good management. This has been done in countries like S2o Tom6 who designed inclusive processes which have created some consensus o n the what and how questions. Since successful models seem to have "influential constituencies with an interest in responsible resource management and the means to hold government accountable" (Moss and Young, 2009), particular interest should be paid, at the outset, to including interest groups from non-oil sectors that are likely to be affected by a negative management o f the resources, as well as those that stand to benefit directly from the new rents. In Indonesia, this required strengthening civil society groups, for example, the voice o f agricultural producers, to express how new revenues will impact their sector vis-a-vis other better connected interest groups, such as those representing big business. Agricultural producers formed part o f a broad coalition that supported the Indonesian regime and there was a broad agreement around equity concerns, particularly the need to stabilize rural economies, and a clear public priority to invest in local, rural communities. A large part o f the funds were, thus, used to finance a community-driven development type operation in rural communities, and agriculture and labor-intensive industry more generally become the agent o f restraint with a direct concern for public spending as well as the need to avoid appreciation o f the real exchange rate. In Norway, policy makers responded to the demands o f a broad-based coalition o f non-oil exporters by implementing policies that focused o n maintaining the competitiveness o f the non-oil sectors during the 1970s and 1980s. In Alaska, such a constituency was artificially created through the Permanent Fund Dividend (Moss and Young, 2009). Nigeria provides an example o f the perils o f not listening to voices from non-oil sectors at the outset and proceeding without a social consensus. And while an inclusive design process will not in i t s e l f change a political culture based on narrow interests, it can help create consensus about what i s to be financed and how. - 30 - 3.15 I n this regard, a commendable first attempt was initiated in 2008 in Ghana to involve shareholders in the design stage through a national dialogue and a series o f regional consultations but more discussion o f the details o f fund management i s needed, particularly with stakeholders who stand to benefit directly f r o m o f the new rents o r b e negatively affected by their mismanagement and could, therefore, become a constituency for good governance o f them. To-date, there has been little space for more in-depth discussions with stakeholders o n the details o f what the rents will be used for and how they will be managed. In this discussion, it might be advisable to ensure that non-oil sector interests, particularly those o f the agricultural sector, are heard and that these are not overshadowed by those o f big o i l companies. Other stakeholders that stand to lose from poor mismanagement o f the resources and who are thus obvious advocates o f a transparent and accountable management o f the rents include private sector actors in non-oil sectors that could lose competitiveness through currency depreciation, as well as local communities who, at present, are faced with the possibility o f increased devolution o f power and resource management to the local level. Until the Government presents i t s revenue management plans it i s not clear whether there are other constituents that stand to benefit from holding Government accountable for using the money for the purposes that it was intended. This i s an important debate and will have to be carefully managed to balance the need for a social consensus with regional and ethnic considerations which are a potentially divisive force (and which have worsened as a results o f o i l revenues in neighboring Nigeria,). There may also be the need to consider compensating (or providing some insurance to) the populations whose livelihoods would be negatively affected by an environmental mishap, such as the fishermen who earn their living from the same water. 3.16 Second, the cases o f Silo Tome and Chad, as well as Ghana's experience in the mining sector, all suggest that it i s equally important to have, as a product o f the design stage, a clear institutional framework. This framework must provide clarity on specifics. Issues such as which government institution(s) will run the concession auctions, h o w will concessionaires be monitored, how will it actually report all the information that it needs for transparency, how will the head(s) o f this institution be appointed, on what basis will they be removed, will there be an independent inspector general to review their work and what reporting arrangements, and to whom, will all require definition. Ongoing discussion related to the preparation o f the Ghana Petroleum Regulatory Authority (GPRA) bill provides the opportunity to do so. 3.17 Third, the literature describes how additional accountability and transparency mechanisms can b e built into institutional frameworks, through oil funds to improve weak institutional contexts. O i l funds have been seen to be an important mechanisms for controlling Dutch Disease and, while they do not provide magic bullet type solutions to weak institutional environments, recent evidence suggests that they can provide an opportunity for better management, if only temporarily. Humphrey's and Sandby (2007) note that for such funds t o be effective three things are necessary: (i) withdrawal decisions should be regulated by clear rules rather than general guidelines; (ii) decisions should be made by broad bodies representing key the interests o f diverse political constituencies; and ( i )i i there should be high levels o f transparency governing their operation. Any earmarking through transfers to o i l funds, o f course, should also be part o f a transparent budget process. SZio Tome, which adopted a revenue law in 2004, provides perhaps the clearest example to-date o f h o w this has been done. -31 - Box 3.1: S5o TomC's Oil Fund The fiamework makes provisions for a number o f additional windows o f opportunity to increase transparency and accountability by placing the responsibility on the company to disclose information in an accessible form to a public information office and, if they fail to do so, they risk losing their contract. It also mandates, and gives wide ranging power to, an inclusive oversight mechanism which includes a broad base o f eleven stakeholders, only one o f which i s appointed by the President (ministers, auditor general, 3 civil society representatives etc). The National Assembly i s also required to hold yearly public hearings on the performance o f the h d . 3.18 Drawing on the experiences from other countries and the experience in the mining sector in Ghana, the new set o f laws currently in Parliament for consideration may, therefore, consider the following: (i) create an independent regulatory body that does not depend o n appointment by the President and o n the Executive for funding; (ii) include a wide range o f stakeholders in oversight mechanisms; ( i ) i i be specific about conflicts o f interest for members o f any mechanism; (iv) have clear disclosure rules, with responsibilities and implementation arrangements defined; and (v) provide sufficient power to the mechanisms to investigate, probe and rule at least until formal judicial institutions are capable o f doing this. 3.19 Fourth, increasing transparency - both through additional mechanisms and beyond - i s perhaps the most powerful set o f actions that a government can take to ensuring good management of oil revenues. Beyond a general commitment to the principle o f transparency, it i s important to ensure that commitments are specific enough to be monitored. Clarifying precisely h o w a specific percentage o f the rents will be used to fund specific actions in specific sectors, with companies and government reporting both royalties received, and when, government revenues broken down by other sources and regularly published, the number and identity o f bidders for concessions disclosed, publication o f bidding documents, and auctions conducted are all lessons from a range o f sites including Texas, Alaska, Peru and Brazil. For future contracts, Ghana may also want to consider international competitive bidding to, as Collier (2006) notes, address the power asymmetry that exists between large o i l companies and developing countries. As Ghana reviews the final draft o f i t s freedom o f information bill which i s presently with Justice Crabbe, these issues will be important to consider and/or incorporate.60 3.20 Fifth, in countries where democratic institutions are maturing and there i s limited experience in civic counterweights as i s the case with Ghana, additional capacity building investments are often needed both for the executive, parliament and civil society. With respect to the executive, the case o f Chile and Indonesia point to the possibility o f empowering a group o f technocrats within the civil service who can work in close coordination with politicians to oversee the management o f the rents and even bolster their credibility. For civil society and the media, it may be possible to use the experiences o f some CSOs that are working around budget literacy, civic education, collective bargaining and accountability in applying compensation standards in the mining sector, for example, to scale up knowledge and ultimately social accountability instruments, particularly outside Accra. However, for c i v i l society stakeholders to do this effectively, Ghana will need to ensure access to information with the passage o f a freedom o f information act which meets international standards.61 Additional 6o Justice Crabbe has been assigned from the Law Reform Commission, in charge o f drafting and reviewing new legislation, to prepare the Freedom o f Information act. 61 A draft act exists which defines what information i s accessible to the public, what information i s exempt and the process by which it can be solicited. I t i s presently being reviewed by Justice Crabbe. A coalition o f CSOs has - 32 - training for parliamentarians in technical issues relating to the petroleum sector, as w e l l as budget literacy, may also be required given the fact that a large percentage o f the new parliamentarians are first time members o f parliament and that that the political incentives suggest that Parliament will become a stronger check and balance, under this Government. 3.21 Sixth and most importantly i s the need to address the political incentives and institutional deficit in the long-term in Ghana. Experience has shown that the institutions o f countries with l o w institutional quality and perverse political incentives are normally hrther weakened and distorted once o i l revenues begin to come o n line and thus, in addition t o the short-term measures described above, the discovery o f o i l in Ghana clearly requires new commitment and support for broader public sector reform. The time might n o w be right to do this for at least four reasons. First, the new Government's manifesto describes its role as one o f an "activist state" and there are indication that a single pay spine for c i v i l servants will be implemented in a phased way focusing o n capacity, skills and greater clarity around roles, responsibilities and institutional processes. Second, the delicate macro situation that the new Government faces demands that inefficiencies, duplications and waste be identified and addressed. The new Government has already held a series o f retreats to attempt to do this within the context o f the budget for the remaining months o f 2009. In addition, the Government, as committed to in i t s manifesto, has made an attempt to consolidate ministries. Third, development partners have been mobilized around the issue o f capacity development since the publication o f the draft Aid Policy Paper in September 2008. The Aid Policy Paper acknowledges that public sector capacity i s l o w and calls for a more comprehensive approach to capacity development. The World Bank and DFID have currently been charged with facilitating thinking o n how development partners might better support the Government in developing i t s public sector capacity and a number o f tools and products are under ' on net payments to government and other public authorities (Revenue Watch). Ghana i s already an EITI country and may want to volunteer to abide by these standards, establish a code o f ethics for the sector, draw o n best practice for corporate and social responsibility programs and start its new phase as an o i l producing country by disclosing the non-commercially sensitive parts o f the increasing number o f contracts with o i l companies. provided extensive comments on this draft and if a large part o f them were to be incorporated k d then passed, Ghana would have a conducive environment for increasing accountability. - 33 - .. 4 8 E E c E e L b I - E M E VI e .- f C C .- c e I d 2 .- F m .- E 0 .- ~n 8 c si? e L. 9.g .- J .. 9 2 b r? 8 x P -0 E .- - L P 2 .- C E J .- c L E U 4. PUBLIC FINANCIAL MANAGEMENT ALREADY A. THEAFUUVAL OIL REVENUE MAGNIFIES OF EXISTINGPUBLIC FINANCIAL MANAGEMENT CHALLENGES 4.1 W i d e n i n g deviations in budget execution a n d g r o w i n g deficit illustrate Ghana's difficulties in enforcing i t s budget law, and highlights i t s p u b l i c financial management challenges. As oil revenue starts to flow into the budget from 2011 onwards, these challenges w i l l be exacerbated and, unless addressed rapidly, the risk o f oil revenue being diverted from its designated use w i l l remain high. T a b l e 4.1: Budget Deviations and Deficits H a v e Been W i d e n i n g Fiscal Deficit (YO GDP) of 2005 2006 2007 2008 Budget 2.6 4.6 3.9 5.7 Actual 3.0 7.5 9.1 14.9 Deviation 0.4 2.9 5.2 9.2 Source: IMF. 4.2 I n t h e face o f it, a n u m b e r o f r e f o r m s c o u l d h e l p reduce fiscal deficits w h i l e making the budget m o r e supportive o f Government's development priorities. It includes: (i) public expenditure planning and budgeting through a more effective MTEF; (ii) developing Ghana's Integrated Financial Management Information System, GIFMIS; (iii) strengthening payroll management and control; and (iv) critically screening capital expenditures. 4.3 In selecting these areas f o r policy r e f o r m it i s i m p o r t a n t t o recognize t h e substantial progress in P u b l i c F i n a n c i a l Management in recent years. G h a n a has made good progress in adding public sector agencies to the computerized personal and human resource management database system (IPPD-2), with 60 percent o f subvented agencies having already been added to IPPD-2. Ghana has also strengthened internal review o f public investments, establishing at the Ministry o f Finance and Economic Planning (MoFEP) a Project Finance Analysis (PFA) Unit with responsibility for analyzing, monitoring and evaluating new investment projects deemed eligible for Government support.62There i s also closer monitoring o f transfers to the energy utilities, with government's cross-debt clearing arrangement between the utility companies settling inter-agency debts at the Ministry o f Finance. And tax administration has improved by further extending the Government's tax collection capacity. B. STRATEGIC THROUGHMORE EFFECTIVE BUDGETING A MTEF 4.4 R e f o r m i n g t h e MTEF w o u l d m a k e t h e budget m o r e strategic. Ghana was one o f the first countries in Sub-Saharan Africa to begin framing annual budgets within a regularly updated Medium Term Expenditure Framework (MTEF). From the middle 1990s, capital and recurrent 62 This unit will also have the responsibility of assisting project sponsors leverage private financing by assisting them in setting up Public-Private Partnership (PPP) Agreements and Private Finance Initiatives (PFIs). To realize the Government's plans, DFID i s providing support in the area o f project evaluation, and the Bank i s providing technical assistance to review and upgrade the current fiamework for investment appraisal and PPPs to ensure that Government resources are deployed in the most optimal manner for achieving the maximum economic benefits. - 35 - budgets were integrated within a unified program-based budget, inclusive o f performance information. But initial enthusiasm was premature. Over a decade after its launch, the MTEF still fails to exert strategic influence o n annual budgeting, which remains incremental, line i t e m based, and adversarial in character. Ministries, Departments and Agencies (MDAs) regularly exceed MoFEP budget guidelines, and pay little attention to the efficiency and effectiveness o f existing resource use. At the same time, an enormous staff effort i s devoted to assembling volumes o f detailed budget information, complete with indicators and objectives, which have n o discernable traction on real budget decisions. 4.5 The budget remains very fragmented, and the annual budget process i s incremental and poor at responding to changing policy priorities in'a fiscally coherent way. As noted in the recent External Review o f Public Financial Management (World Bank, 2009c), the budget process i s very fragmented, with less than 45 percent o f expenditure covered by the MTEF (Items I & I1 are allocated outside the MTEF planning process, as are externally financed investments). Budget ceilings are not credible and are ignored by MDAs. There i s a large variation between initial ceilings and what i s finally negotiated between a line ministry and MoFEP. Cabinet i s not involved in resource allocation trade-offs, in-year releases are unpredictable (even though aggregate revenue projections have been quite accurate) and M D A s act rationally in ignoring MoFEP's MTEF derived budget ceilings. The outer years o f projected program spending are notional, and the performance information contained in the detailed MDA volumes serves little purpose in budget implementation. Prioritization does take place, but by default and not strategically. 4.6 There are many reasons to address these deficiencies and ensure that spending decisions reflect the Government's policy priorities in a manner that i s fiscally sustainable. The first is to make better use o f existing budget resources. Instead o f responding to current policy priorities, the budget funds policies, programs and staffing structures that have accumulated over many years, with some o f questionable relevance. Managers have little incentive to examine critically the existing use o f resources -- financial, physical and human. Their motivation is to defend the status quo lest currently approved resources are lost. Adding o i l revenue to such an inefficient allocation system would mean that they, too, would be inefficiently allocated and used. Current budgeting incentives encourage over-bidding and waste. A well functioning MTEF, introduced early in the preparation process and made the basis o f annual budget ceilings (and cabinet level policy-making through the year) greatly changes these incentives for the better. Additional reasons discussed below include underpinning the goals o f a Fiscal Responsibility Law, and ensuring that arrangements for stabilizing o i l revenue and preventing international price volatility do not undermine domestic budgeting. 4.7 The MTEF needs to be made more comprehensive, and more tightly tied into the annual budget preparation process, and to be the fiscal reference against which future policy decisions with spending implications are assessed. There are three key steps to make Ghana's MTEF more effective as an instrument for strategic budgeting. First, the MTEF should be expanded to cover all categories o f Central Government spending and all sources o f finance at both the aggregate and the MDA level. Second, political commitment to the annual budget process should be strengthened. The Cabinet could play a larger role in approving the sectoral/MDA ceilings proposed by MoFEP o n the basis o f the macro-fiscal situation and the MTEF rolled forward each year. Transparency o f the budget should be increased by MoFEP -36- preparing a Budget Framework Paper (BFP) at the start o f the process. This would set forth the macro-fiscal situation, aggregate available resources, and the proposed sector/MDA allocations consistent with the previous year's MTEF and new policy decisions taken during the year (and anticipated). Third, the MTEF should be the resource availability reference against which all policy decisions with financial implications in current and future years are evaluated. Further, M D A s should be encouraged to prepare sector and sub-sector strategic plans consistent with the overall resource f r a m e ~ o r k . ~ ~ 4.8 The amount transferred from the Oil Fund to the annual budget should be guided by the MTEF and be subject to a fiscal rule. The solution lies in an arrangement which allows the fiscal rule to determine the maximum that can be drawn in any year from the Fund. With a Permanent Income Fund (PIF), the rule would be straightforward, with a same amount channeled every year to the budget. With a Stabilization Fund, the actual amount transferred to the budget should be discretionary within the limit o f the fiscal rule. This would be decided by reference t o a Medium Term Fiscal Framework (MTFF), the macro-fiscal foundation o f a MTEF.64 Furthermore, the implication here i s that, whatever the ultimate use o f O i l Fund revenues, all withdrawals from the Fund pass through the annual budget, so that fragmentation is avoided, and the budget presents a single picture o f government spending. Thus, even if the source o f a project or program's funding might be the CPF, the amount spent would be appropriated through the budget, and thus subject to normal budgetary spending rules, and reported as part o f budget execution. 4.9 The proposal for a Fiscal Responsibility Law (FRL) i s a good one, but the Government should proceed with deliberation, finalizing it only when other components o f the financial management system, such as the reformed MTEF and budget process, and o i l revenue arrangements are in place. Ghana has been considering enacting a Fiscal Responsibility Law. The FRL was announced in the 2008 Budget Speech, and drafting i s underway with assistance from the IMF. It is understood that the FRL will incorporate a fiscal rule based upon a reference level o f public debt (probably 45 percent), above which fiscal adjustment will be triggered, based upon a minimum improvement in the budget primary balance. A Fiscal Council will be established to report compliance and advise the Government. Such a law would be the capstone o f Ghana's public financial management legal framework, which could both enshrine principles o f good PFM, incorporate key processes l i k e the MTEF and the annual budget preparation, and mandate standards o f fiscal transparency, consistent with international good practice. The Government should proceed with developing such a law, but finalize it only when reforms to the MTEF and budget process have been agreed, and how the o i l and gas stabilization fund will operate i s clearer. 63 Some strategic plans are prepared presently, but they are not consistent with available resources, thus do not address intra-sectoral priorities and trade-offs, and serve chiefly as bidding documents to lever additional resources from MoFEP during the budget preparation process. 64 Terminology varies, but a MTEF i s normally seen as comprising two elements: (i) 3 year macro-fiscal plan a embracing aggregate revenues, spending and budget balance, and, (ii) 3 year breakdown of spending by sector a andor main spending ministries. This i s imposed top-down, but as costing improve, increasing the sectorMDA envelopes will reflect the cost of existing policies and programs, leaving "headroom" for new policies. - 37 - 4.10 The Government should ensure full and effective implementation of budget management support systems. Ghana's Budget and Public Expenditure Management System (BPEMS) and i t s Integrated Payroll and Personnel Database (IPPD2) are, respectively, the Government's integrated financial management system and human resources management system. Implementation o f BPEMS started in 1999 with the purchase o f six Oracle Financials modules,65 initially with donor support and since 2005 with the Government's own funding. Both development and roll out have been problematic. Currently, BPEMS operates in 8 pilot ministries, but only a fraction o f transactions are processed through BPEMS, although the system has the capability o f processing all. At the same time, key functions like budget pre aration, releases and production o f public accounts are done by alternative systems. The E Government's intention i s to build on BPEMS to develop the Ghana Integrated Financial Management Information System (GIFMIS), able at fulfilling all these functions, and make it the sole financial management system for all ministries and agencies. Until GIFMIS i s fully operational, Ghana w i l l continue to lack a modern PFM system, capable o f processing multiple transactions rapidly, facilitating control systems, and providing comprehensive and timely reports to management and for external scrutiny. D. MANAGINGPUBLIC SECTOR WAGE BILL THE 4.1 1 There i s an urgent need to contain the growth o f the public sector wage bill through better control of hiring and a more coherent public sector wage policy. The original version o f the Government's payroll management system (currently IPPD2) was launched in 1995 and, after problems emerged a few years ago, replaced with a new version partially implemented in 2007. Although Oracle based, it i s not linked to BPEMS. Connectivity and staff capacity problems have slowed roll out, and many MDAs use their own HR management systems - even though pay scales, excepting for health, are essentially common across government. A major problem i s the absence o f a consolidated establishment list, against which staffing can be controlled. This contributes greatly to the difficulty the Ministry o f Finance has encountered holding the line on staff numbers. In turn, i t contributes to the high and rapidly growing wage bill. The larger point i s that if oil revenue i s not going to result in further uncontrolled staffing expansion, priority must be given to completing the roll out o f IPPD2 and the strengthening o f establishment controls. And if some subvented agencies are allowed to retain their own systems, reporting back to government must be improved, and staffing approval processes and controls established and followed. 4.12 Strengthening public sector payroll bill management and control should result from actions on several fronts: 65 General Ledger (GL), Purchase Order (PO), Accounts Payable (AP), Cash Management (CM), Public Sector Budgeting (PSB), and Accounts Receivable (AR). The system was extensively customized to fit traditional processes rather than modernizing the latter. As a result, it i s costly to maintain, future upgrades are difficult, and ultimately will not be supported by Oracle. A joint donor PFM advisers' review in April 2008 estimated that only 6 percent o f the value o f budget expenditures was being processedthrough BPEMS. 66 ACCPAC i s used by the CAGD for the production o f public accounts, BMS for releases, NETS for Items I11 and IV, and Activate by MoFEP and most MDAs for budget preparation, consistent with GPRS strategic objectives. - 38 - D Strengthening oversight of records regarding enter, exit and transfers of employees in the payroll system, beyond what the legal requirements stipulate. These oversight weaknesses compounds the software problems outlined above, as neither the records o f employees who exit employment are promptly removed from the system, nor are records quickly updated to reflect transfers within the public sector. The responsibility for updating the payroll records i s decentralized t o the respective MDA, so at times it takes several months for records t o be updated. Even though heads o f departments sign the on the number o f employees in their departments on a monthly basis, there is no structure within the MDA or from a central source (e.g. C A G D or OHCS) to routinely check whether staff o n the payroll are indeed at post. Implementing a single payroll spine system that provides comparability across sectors and guides the present system of decentralized wage negotiations. In the absence o f a system that provides comparability across sectors, the present process o f decentralized wage negotiations tends to distort pay reform. There are 9 different service unions that negotiate wage agreements separately for their members with government. In this context, across the board pay increases end up not recognizing distinct categories within these agreements, leaving t o the discretion o f most agencies the decision o f moving staff across grades. The result i s that M D A s tend to abuse the decentralized promotion system. E. PUBLICINVESTMENT 4.13 Given its magnitude in the budget and the emphasis that it has been given as an engine of growth, there i s scope for a more robust approach to the identification, preparation and management of public investments. This would call for the following: Screening public investment proposals, requiring that project selection i s guided by clearly defined priorities, and the preparation o f pre-feasibility studies, including the calculation o f net present social value using either cost-benefits or minimal costs analysis. These steps should allow funds to flow on the margin to projects with the highest rate o f return or the lowest cost o f delivery to beneficiaries; Broadening oversight over the finances of State Owned Enterprises (SOEs) and over external borrowing by having the State Enterprise Commission submit to MoFEP quarterly consolidated reports on the financial position o f SOEs - at present the SEC receives only individual SOE reports, but does not consolidate them. - 39 - 2.0 5 1.5 4 1.0 .. ... 3 0.5 2 0.0 1 -0.5 0 -1 .o -1 -2 Telecoin 0 EIectricrty - . Africa Infrastructuru: Country Diagnostic. ir~w -40- economic and social demands for the next decade. In the case o f Ghana, the package includes the following: P For ICT, completing intra-regional fiber optic l i n k s and providing universal access to a G S M voice signal and a public access broadband internet facility. > For power, 2,000 M W o f new generation capacity,67 and an increase o f electrification up t o 76 percent coverage. > For transport, linking population centers to ports and borders via good quality paved roads, raising rural access to 75 percent and increasing urban paved road density. P For water and sanitation, achieving the Millennium Development Goals. 5.5 Meeting Ghana's infrastructure needs would cost US$1.6 billion per year for the next decade o r around 10 percent o f GDP (Table 5.1). About 60 percent o f this requirement relates to capital expenditure and the remaining 40 percent to operations and maintenance. Almost half o f the total spending requirement is associated with the power sector, with investment needs for that sector alone as high as US$600 m i l l i o n per year. Table 5.1: Indicative Infrastructure Spending Needs in Ghana I I US$ billion per year Capital Operation and Total Sector 1 I expenditure maintenance spending 1 ICT 0.03 0.03 0.07 Power 0.60 I:* ( : : 0.73 Transport 0.27 0.49 wss 0.12 0.20 0.31 I Total 1.02 0.58 1.60 Source: Africa InfrastructureCountry Diagnostic. Note (*) does not include fuel used for electricity generation. Table 5.2: Infrastructure Financing Flows to Ghana (average annual for 2003/06) US$billion per year O&M Capital expenditure Sector Public Sector Public Sector OECD Financiers E& Financiers PPI Total Capex Total ICT 0.18 0.06 0.00 0.03 0.13 0.22 0.39 Power 0.13* 0.06 0.02 0.06 0.01 0.15 0.27 Transport 0.12 0.05 0.12 0.01 0.00 0.17 0.29 wss 0.04 0.02 0.10 0.00 0.00 0.12 0.16 Total 0.47 0.18 0.24 0.10 0.14 0.66 1.13 5.6 During the mid-2000s, Ghana was already spending US$1.1 billion per year (or 10 percent o f GDP) and that total has likely increased (Table 5.2). According to the A I C D review o f infrastructure spending during the mid-2000s, Ghana emerged as a country with a relatively high GDP share dedicated to infrastructure spending. This share has likely increased in 67 The doubling o f existing capacity to 4,000 M W by 2017 would allow satisfying a domestic demand projected to grow by 7 percent annually (including a small and constant proportion for exports to neighboring countries). Additional capacity investment to become a large exporter o f electricity in the region could be envisaged with higher gas reserves than currently assessed, among other industrial choices for gas use. -41 - recent years given that the 2007 Eurobond issue allowed additional infrastructure investments o f US$600 million in 2008 (out o f which US$500 m i l l i o n was used for electricity), more than the entire publicly funded infrastructure investment reported for the earlier period. During the mid- 2000s, public investment was predominantly funded from ODA and domestic public finance, each at around US$0.2 billion per year. Both the private sector and non-OECD financiers also contributed significantly each with around US$O. 1 billion per year. 5.7 During the mid-2000s, Ghana's infrastructure financing gap amounted to US$0.8 billion (or 7 percent of GDP). Just over half o f the financing gap was associated with shortfalls in power sector investment alone. There were also significant shortfalls in transport as well as water and sanitation spending, although these were primarily associated with operations and maintenance. Lack o f adequate maintenance in these sectors explains why some 26 percent o f main roads and 42 percent o f urban water networks are currently in need o f rehabilitation. The rapid expansion o f the feeder roads network, from 11,500 km in 2001 to 42,000 km in 2008, also significantly raised the need for maintenance in the transport sector, given their particular fragility.68 5.8 Ghana's financing gap could be substantially reduced to US0.35 billion per year (or 2 percent of GDP) if all the inefficiencies in existing spending could be addressed. The value o f operating inefficiencies in the utilities sector i s very high, and tackling this problem could save more than US$0.38 billion per year. Improving cost recovery in power and water would save a further US$0.20 billion per year. Overall, these measures would substantially reduce the financing gap, although significant shortfalls o f around US$O. 15 billion per year each would remain for power and transport. Table 5.3: Measures to Address the InfrastructureFinancing Gap (average annual for 2003/06) US$billion ICT Power Transport wss Total Financing gap 0.00 0.46 0.19 0.15 0.80 Reallocate spending 0.03 0.03 Raise capital budget execution 0.01 0.01 Reduce operating inefficiencies 0.10 0.04 0.03 0.04 0.2 1 Improve cost recovery 0.15 0.05 0.20 Remaining gap 0.27 0.15 0.06 0.35 Source: Staff calculations. There are a number o f avenues that can be taken to raise the missing finance: 9 Some contribution could be made through non concessional external borrowing, within the current debt sustainability f r a m e ~ o r k . ~Further public finance on the requisite scale could ' also be forthcoming from fiscal petroleum revenues. It i s estimated that about half of maintenance spending needs in transport are for feeder roads. 69 Under the debt sustainability framework baseline (IMF and World Bank 2009), a maximum o f US$500 million could be borrowed externally per year on a non concessionalbasis without raising the level o f debt distress. - 42 - > There i s also scope to increase private financing flows. These have been relatively l o w t o date, standing at 0.8 percent o f GDP compared to values o f 1-2 percent o f GDP among peers such as Kenya, Nigeria, Senegal and Tanzania. > In the case o f the road sector, there i s a need to increase revenues allocated t o the Road Fund for maintenance purposes, by increasing the allocation o f fuel levy resources from 90 to 100 percent or by increasing fees t o DVLA. B. KEYPOLICYISSUES 5.9 There i s scope to reduce utilities' inefficiencies. The hidden cost o f the inefficiencies can be estimated by comparing revenues captured by Ghana's utilities with those o f a well- performing utility operating under similar circumstances. Taking institutional reform measures t o address these deficiencies needs to be a key priority area. > Ghana's power utility (ECG) loses as much as 0.3 percent o f GDP due to high technical and commercial losses (of about 27 percent, against 15 percent for best performers). > Ghana's water utility (GWCL) loses a further 0.3 percent o f GDP due t o high distribution 10sses'~(estimated around 50 percent, against 20 percent for best performers). > Ghana Telecom has employment levels significantly higher than best practice levels with the associated inefficiencies amounting to 0.1 percent o f GDP. 5.10 Under-pricingi s also a serious issue both in the power and water sectors. > E C G and VRA have historically under-priced power to large industrial customers, resulting in financial losses o f around 1.4 percent o f GDP. Tariff reforms affecting most large industrial customers in late 2007 have improved the situation, but a substantial subsidy o f the order o f US$lOO million (or about 0.6 percent o f GDP) per year remains for the mining industry that pays no more than US$0.06 per kilowatt-hour for power that costs over US$0.13 per kilowatt-hour to produce. Also, commercial and residential tariffs did not keep pace with inflation since the last adjustment in late 2007 and were by end 2009 significantly below operating not mentioning investment costs directly borne by the Budget. > GWCL's tariff structure, including a lifeline o f US$0.45/m3 for the first 20m3, allows full operating cost recovery. However, investment costs are financed through donors funding, and their transmission to end-users would require significant tariff increases. However, given that piped water connections are heavily skewed towards the upper income groups, increased tariffs would allow reducing connection costs and would certainly benefit lower income groups, who currently pay US$5/m3 for water containers. 5.1 1 Strengthening the financial position o f the utilities would put them in a better position to implement much needed investments. 70 Mostly commercial losses due t o illegal connections by private vendors and people in general. In contrast, bills collection rate, at almost 90 percent, is considered high by international standards. 71 The magnitude o f the subsidy varies with the level o f rainfall, which affects hydro-power production capacity and in turn affects the extent t o which costly o i l imports are needed for supplementary power generation. - 43 - Large scale investments in power generation are needed, and are already underway. However, these need to be complemented with significant investments to upgrade the ageing and increasingly unreliable high voltage transmission network. Modernization o f the overloaded distribution network is also needed, though this should be done in conjunction with measures to address problems o f metering, billing, theft, and revenue collection. Access to improved water sources in Ghana is increasing slowly, and access t o piped water has barely moved at all during the last decade. Access t o improved sanitation i s one o f the lowest in the Sub-Saharan region. O n current trends, the country will barely meet the M D G s for access to improved water and will fail t o meet the target for improved sanitation. A concerted effort i s needed to address the "silent crisis" in this sector, which even in Accra has been constraining economic and social activity in the public and private sectors and may pose serious health and environmental consequences. 5.12 Continuing improvements to policy and regulatory frameworks are also needed so ensure that Ghana's infrastructure can make its full potential economic contribution. In power, weak management and regulation remains a key issue. Decision making i s ad hoc and dispersed (PURC, MOFEP, Ministry o f Energy). There i s no clearly defined power sector investment plan based on least-cost principles that could provide the basis for mobilizing both public and private resources in a systematic manner. Yet substantial public funds and bilateral aid go to rural electrification (SHEP) without planning and coordination. In transport, major institutional reforms are underway under the aegis o f the National Transport Policy. As part o f this process, it i s necessary t o complete the establishment o f the new institutional framework with the creation o f the National Roads Authority to act as asset manager for the network and take on the roles o f the Road Funds, as well as the Ghana Rail Development Authority to develop an appropriate regulatory environment for the sector. Supporting legislation in the form o f the draft Road Traffic and Railways Acts also needs to be ratified. In ICT, the recent dissolution o f the N C A Board puts into question the independence o f regulatory oversight for the sector. Key issues where further work is needed include strengthening regulatory capacity for quality o f service regulation, moving towards a more transparent licensing framework for wireless services, developing a transparent strategy for developing national backbone infrastructure with broad-based private sector participation, and continuing to make progress with the liberalization o f access to the SAT I11 submarine cable. In water and sanitation, the National Water Policy was approved in 2007 and the National Sanitation Policy was submitted for approval in 2008. Strategic investment plans have been prepared for both urban and rural water supply but they need to be prioritized and an action plan developed for their implementation. A national action plan for sanitation i s expected during the third quarter o f 2009. While water supply in urban areas is provided by a national water company and in the rural and small towns coordinated by a national agency,72 sanitation i s the responsibility o f local governments who lack the necessary technical and financial capacity. Proper operation and maintenance o f water facilities in rural areas and o f sanitation facilities in general remains a key challenge for the WSS. l2 Community Water and Sanitation Agency (CWSA). - 44 - 9,O 8.0 7-0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 """Y"' 2001 2002 2003 2004 c. LACK COMPETITIVENESSAPPEARS STEM FROM POOR PRODUCTIVITY GHANA'S OF TO 6.3 Despite recent improvements in many sectors, Ghana remains somewhat uncompetitive. In the 2009 WEF Competitiveness Report, Ghana i s shown t o be relatively weak in the related areas o f technology, innovation, education and labor market efficiency suggesting that skills and productivity lie at the hard o f the competitiveness challenge for Ghana. Box 6.1: Global Competitiveness Index GCI a g - gs ..... .... .... ...... ..... I..- . m ....Il.*.IW..l*- ..... nfa --.A.d "..1."...1..1.... I 7- taut af 13fB ............. .................................. *._-* 6 ltotsr of 122)" ........4*.nfEt ...... m i a r b rpbqli N ~,,,,,,,,., s e. , lllllml~---AwF illar: Institutions ......................................................... &3 ..&.a ..... .--...-........ -...... .... - ..... -<. . c stebility. ..-. L-LI.I n **. ***-*.T P 5 .*.,.* 4.0 B R F i c F i e r r q elrh-slsp: w---siE -,,.as ....................... f t F .......3 . P YYY---Y--Iy-y-I I-I------- ....l**I**..*..*. . 3.s *.I,.~"u-*. ".*.** ................................ .*A. .......4.0 n........................ 63433 ,,.,.,4.3 Far: Technological readins55 ......................... uasa..T 16 ....... i Ila r: M a &.st sizs - ._-.-.. .......................... ,.,,= --_... trrw ",."*la3 .... w ..... l l * - l l *1111 I-- n .... .................................. .1.........................~".I * , . I S *.&.*."".".*I 1 14 -.*-.-."Z!*iB iurce: World Economic Forum (2009). 6.4 T h e key issue in determining the competitiveness and prospective path for private sector development will be the ability to increase the productivity o f enterprises. Ghanaian f i r m s are less productive than those o f comparator countries mainly because they are less capital and skill intensive and relatively small in size. Small f i r m s in Ghana are less productive and less capital intensive than small firms even in other l o w income countries in Sub-Saharan Africa, while large f i r m s are relatively productive and relatively capital intensive. Ghanaian f i r m s are primarily oriented toward the domestic market and those f i r m s that do export do not have above average productivity rates. - 46 - Figure 6.2: Labor Productivity i s Particularly Low in Ghana's SMEs Small Large Senegal Senegal Kenya Tanzania Malawi Mauritania Mauritania Kenya Benin Nigeria Nigeria I Ghana Tanzania I Uganda 1 con go,^^ '0 Burundi 1 Rwanda I Benin I Uganda I Malawi I Burundi 7 Congo,DR Madagascar 1 Madagascar I Ghana I Rwanda I Ethiopia D Ethiopia I I 1 Source: World Bank (2009e). 6.5 Firms in Ghana have less machinery and equipment per worker than firms in the comparator countries. The median firm has about US$1,200 o f machinery and equipment per worker.73 While capital intensity i s relatively l o w in Ghana, returns o n capital, are comparatively high. Figure 6.3: Median Capital Intensity i s Lowest for Ghana 1 Source: World Bank (2009e). 73 In comparison, f m s in Nigeria have about US$2,600 o f machinery and equipment per worker. Firms in South Africa have close to US$16,000 per worker, and f m s in Malaysia have approximately US$26,000 per worker. - 47 - D. MARKETS LABOR DO NOT COMPENSATE FOR LOW PRODUCTIVITY 6.6 Firms in Ghana are less likely to export than in any o f the comparator countries. Whereas less than one-quarter o f manufacturing enterprises from Ghana export, more than h a l f export in most comparator countries. Because the international market represents the frontier in efficiency and productivity, Ghana's relatively l o w export participation suggests labor costs are not l o w enough to compensate for l o w productivity. Figure 6.4: In Ghana Relatively Fewer Firms Export Mauritius Thailand Malaysia China South Africa Kenya Swaziland Ghana 0% 20% 40% 60% % o f firms exporting Source: World Bank Enterprise Surveys Note: Comparisons only include manufacturingenterprises. 6.7 Labor productivity i s relatively low in Ghana. The median firm in Ghana produces approximately US$l,000 o f value-added per worker. In comparison, f i r m s in China, Thailand, Kenya, and Swaziland produce between six and seven times as much per worker. Firms in Malaysia produce about fourteen times as much and f i r m s in South Africa over twenty-five times as much. The relatively small size o f manufacturing f i r m s may be a major factor in explaining Ghana's l o w labor productivity. Labor productivity tends to be lower in small firms. The median manufacturing establishment has only about 10 employees in Ghana. By comparison, the median firm in Swaziland had about 60 employees and the median firm in Kenya had about 50 employees (it has been noted there has been a dramatic shift in Ghana over the past decade with small, and potentially informal, f i r m s becoming increasingly important (Teal et al., 2006). -48- Figure 6.5: Median Labor Productivity i s Relatively Low in Ghana Malaysia Mauritius Thailand China Swaziland Kenya Nigeria Ghana $0 $5,000 $10,000 $15,000 Value-added per Worker (2005 US$) I Source: World Bank (2009e). Figure 6.6: Manufacturing Constitutes Only a Small Fraction o f Ghana's GDP 18 16 14 12 10 8 6 4 2 0 Source: World Bank (2009e). 5.8 The ratio o f mandated minimum wage rates to labor productivity (value added per worker) i s also an important determinant o f the demand for labor. The ratio i s 0.56 for Ghana as against 0.4 in Cambodia and 0.43 in China. Labor market policies such as minimum wages, statutory redundancy pay, etc, have an obvious bearing on the labor market, setting the rules o f the game. The fact that hiring workers formally results in a very high cost makes many Ghanaian employers continue to hire workers casually. Many o f the recent gains in total factor productivity have come from agriculture with little progress made by industry. In consequence, - 49 - Ghana has not had the competitiveness to attract internationally mobile labor-intensive industries such as garments, footwear or electronic assembly. E. OPERATIONSARE NOT CONSIDERED BINDING REGULATIONS ON ONGOING BUSINESS 6.9 While Ghana has made significant strides in terms o f removing the barriers to private sector activity in Ghana, ranking in the top 10 reformers o f 2006 and 2007 and now ranking in the top half o f countries assessed in the W o r l d Bank "Doing Business" survey, it i s sometimes commented that Ghana has i t s worst rankings in the sectors which are most important for a low-income country (those related to starting a business, labor regulation and gaining access to finance). Equally, however, Ghana has by far the most attractive business environment o f any o f the countries in West Africa. Table 6.1: Doing Business Indicators I Ease of Doing Business Starting a Business II 2007 137 I I 2008 143 II I Dealing with Licenses I 142 I 139 I Employing Workers 145 144 Registering Property 31 27 Getting Credit 109 102 I Protecting Investors I 38 I 33 I Paying Taxes 65 83 Trading Across Borders 76 63 Enforcing Contracts 50 50 I Closing a Business I 104 I 99 I I Overall Ranking 87 82 F. FOREIGN INVESTMENT HAS FAVORED COMMODITIES AND SERVICES 6.10 I n part due to the favorable market for commodities in recent years, but also due to the relative attractiveness o f Ghana as the "Gateway to West Africa," the value o f FDI and the country's share o f regional FDI flows have both increased. Unrest in several o f Ghana's neighboring countries has served to enhance Ghana's attractiveness as a regional location for processing crops such as cocoa, as well as serving the regional markets. In addition, Ghana has benefited from investment in logistics as it has reestablished i t s historic position as a trade route to the landlocked countries o f the Sahel due to continued uncertainty in CBte d'Ivoire. 6.1 1 Extractive industries typically bring with them an international standard o f business services (accounting, finance, etc.). International mineral resource conglomerates are essentially a conduit for mobilizing capital for emerging market investment. Internationally capital markets are receptive to emerging market offerings for extractive industries (Ashanti Gold was historically the only Ghanaian company with an international listing). It i s possible that the increased presence o f "international standard" companies in the o i l sector will serve as a catalyst for the provision o f business services in Ghana, for which there is already a nascent regional service cluster. There i s strong anecdotal evidence to suggest that internationally - 50 - mobile companies are choosing to locate their regional headquarters in Ghana over other West African countries. Table 6.2: Inward FDI Stock as a Percentage o f GDP (2000- 2007) Source: UNCTAD, 2008. G. ACCESS FINANCE COMPETITIVE TO IS 6.12 The pattern o f access to finance in Ghana i s nuanced. Larger firms have markedly better access to capital than smaller ones. There i s some evidence that limited access to finance i s a function o f perceived risks in certain sectors, notably manufacturing and agriculture, while the relative success o f the service sector in Ghana has provided an attractive market for bank lending to salaried workers who were previously ignored by a finance sector directed to support priority economic sectors. 6.13 The Doing Business indicators for Ghana which are relevant to access credit are more favorable than those for other countries which rank higher than Ghana overall. This would suggest that it i s not the financial sector environment which i s constraining enterprise access to finance. In the WEF Global Competitiveness Report Ghana ranks 102 out o f 134 overall but 69th for financial sector sophistication (this sector has the highest score o f any sector with 4.3). 6.14 Since 2003 Ghana has undergone a far-reaching reform o f the financial sector which has led to significant sector growth. Competition in the banking sector i s showing encouraging signs with the entry o f new banks, primarily from abroad, especially from Nigeria. Possibly as a result o f new competition, credit to the private sector has increased significantly from 13.1 percent o f GDP in 2004 to 24 percent in 2007. Capital markets have also shown significant growth in recent years, the Ghana Stock Exchange index rose 32 percent to record highs in 2007, trading volume rose 193 percent and market capitalization increased to $13.5bn, more important, new listings raised over $130m o f capital for Ghanaian companies. The maturity o f the Government bond market has been extended to 5 years largely due to the opening o f the term fixed income markets to foreign investment, which dominate the longer end o f the market. Despite improvements, stock exchange and bond markets remain amongst the world's least liquid, and the number o f listings (34) remains below a critical mass for a vibrant, sustainable market. 6.15 Long term finance institutions remain modest despite recent growth; the insurance sector i s US$400m, a 60 percent increase since 2005 but s t i l l only 2.5 percent o f GDP. The state pension fund, SSNIT, dominates capital markets and continues to be by far the largest financial institution in Ghana with assets equal to around 10 percent o f GDP (although the recent rapid -51 - growth o f bank assets i s bringing some banks closer to this position). N e w legislation will reduce the role o f SSNIT and t h i s facilitation o f private schemes will be vital to building the domestic capital market. At present, state influence in the financial sector remains through significant direct and indirect ownership stakes in several institutions and serves t o direct capital to microfinance and venture capital. 6.16 The changes and improvements in the financial sector have produced dramatic results in a relatively short period o f time. Institutions have been reformed to better establish the value o f credit and allow for allocation on the basis o f comparative benefit. The greater flexibility allowed to financial institutions in the allocation o f credit has not only been as a result o f regulatory and policy reform, it has also been a function o f technological innovation, which has lowered individual transaction costs and facilitated down-scaling o f banking operations. Perhaps reflecting the wider options open to banks, Enterprise Survey data suggests the manufacturing sector has yet to benefit fully from the substantial reforms to the financial markets. The limited use o f credit and l o w levels o f investment by manufacturing f i r m s shows that use o f financial instruments i s not as far along in Ghana as in several o f i t s cohort. 6.17 Interest rates remain high, most likely explained by the challenges in shaking off a record o f double digit inflation and high government borrowing as well as a history of a high proportion of non-performing loans. Non-performing loans, having fallen from 23 percent in 2002 to 6.1 percent in September 2007, grew to 8.8 percent in M a y 2008; however, the NPLs come from the traditional borrowers. Moreover, non-performing loan rates are markedly higher than average at financial institutions with a history o f state influence and which have tended to support identified sectors o f economic priority (Agricultural Development Bank, National Investment Bank and Merchant Bank all have N P L rates higher than their peers). 6.18 Not surprisingly, the sectors with poor loan performance face high interest rates and limited supply of credit. In the year to M a y 2008, these trends were even more marked, with services receiving over 42 percent o f all new credit while manufacturing received only 8.5 percent. More remarkably, the share o f households in new credit rose to 33.4 percent, up from 19.2 percent for the same period in 2007, while enterprises shared 66 percent (down from 77.7 percent in 2007). On year to year basis, credit to households increased by 89 percent to GH6856.3 million, compared with 49 percent increase for the same period in 2007. Within lending to the enterprise sector, there i s a significant concentration in the Commerce and Finance and the Services sectors, together representing more than half o f all enterprise lending. The interest rates payable by blue chip companies (such as large international conglomerates) is broadly comparable to treasury bill rates, while the rates paid by SMEs i s about the same as that paid by individual borrowers, and notably lower than that paid by enterprises in the agricultural sector. Details o f a recent credit conditions survey contained in the July 2008 Financial Stability Assessment published by the Bank o f Ghana indicated that Small and Medium-sized Enterprises continue to benefit from increased access to credit, despite an overall net tightening o f credit stance to enterprises. The report identified increased competition in the banking sector as the main contributing factor to the net easing o f credit to SMEs. 6.19 The finding that manufacturing companies have difficulty accessing credit could possibly reflect the fact that manufacturers face challenges in competition, leading t o high default rates, while the banking sector i s relatively efficient and competitive, directing the bulk - 52 - o f new loans to consumer finance, addressing the needs o f the burgeoning salaried workforce o f the service sector where risks are low. Table 6.3: Analysis o f Commercial Bank Lending to Enterprises (August 2008) Source: Bank of Ghana. H. SUPPLY RESPONSE IN NON-TRADABLE INCREASING THE DOMESTIC SECTORS 6.20 T h e challenge for Ghana w i l l be how to migrate f r o m a position o f low productivity, basic technology and limited innovation in an environment in which a strong natural resources sector and accompanying services establish a relative high real exchange rate and an effective floor on wages. A s l o w costs will not allow Ghana to compensate for l o w productivity, an accommodating business regulatory environment and a free market in factors (land, labor etc.) will not be sufficient to l i f t Ghana to the higher productivity platform necessary to be competitive as a resource rich economy. Moreover, the wage floor established by the service sector will continue to be centred on the urban areas, especially Accra, encouraging migration. Ultimately, Ghana must migrate to a position o f higher value added production (and service delivery) through investment in education and technology. There is limited scope for gradualism and support for agriculture and rural enterprises will be important to sustain employment. I. OVERCOMING THE INFRASTRUCTURE CONSTRAINT 6.21 Ghana's poor infrastructure emerged as by f a r the dominant perceived barrier to development in the most recent Enterprise Survey with some 49 percent o f companies highlighting unreliable electricity supply as the biggest obstacle to growth. Access to water i s also frequently cited by companies as an important constraint. Investment in increased power generation and distribution capacity as well as water availability have already been acknowledged as a priority and this should be accompanied by a tariff and regulatory reform which ensures availability o f power and water on a sustainable basis, as discussed in Chapter 5. J. FACTOR IMPROVINGMARKETS L a n d Tenure 6.22 Notwithstanding the reforms now under way with regards to land tenure, access to land continues to b e an important consideration for enterprises, particularly in the metropolitan areas. Delays in land registration and titling create bottlenecks in access to land and - 53 - in site development. Although issues with land tenure are typically perceived t o be greatest in the rural areas and where traditional authorities have greater say, the recent Enterprise Survey showed that for the manufacturing companies, Accra and Kumasi have the highest proportions o f f i r m s indicating that access to land i s a serious obstacle. Reforms to address this constraint could include systematic land titling and customary boundary demarcation through implementation o f the Land A c t and Land Use Planning Act. Implementation could be facilitated through the development o f one-stop-shop for land administration. Figure 6.7: Access to Land i s Difficult in Urban Areas I 32.0% c w 2 30% s 2 25% .- 0 3 20% M .- c .w 15% m u 10% 5 c ;. 5% c W 2 0% W n Accra-Tema 1 Kumasi I Tamale 1 Takoradi Source: World Bank (2009e). Access t o land I Informality and Employment 6.23 The high prevalence o f informality in Ghana remains an important obstacle to improvements in productivity. Some 88 percent o f the Ghanaian workforce i s employed informally as farmers or in self employment. The informal sector is less able to invest in business, gain access to credit, establish standards or participate in industry bodies. This challenge is particularly important outside o f the metropolitan zones. In the Upper East region there are at present only three privately-owned enterprises with more than 20 employees. Increased access to credit i s likely to be one o f the major catalysts for enterprise formalization. This process can also be encouraged through improvements in taxation, licensing and land titling. Ghana still ranks 137* in the Doing Business survey for ease o f starting a business. Ghana ranks particularly poorly in terms o f labor market flexibility, ranking 145th in Doing Business. Rigidities in the labor market lead to a lack o f training and this feeds into the weak productivity, particularly for the informal sector which is reflected in relatively l o w private sector wages, particularly for the informal sector. 6.24 I n addition to the need for investment in education and skills development, the labor markets can be supported through the implementation o f a new Labor Act, amending and consolidating existing legislation and establishing a National Labor Commission with a mandate to address issues related to tripartite dialogue. - 54 - Table 6.4: Public Sector Wage Premiums Are High and Growing 1991192 1998199 2005106 K. Wage Public sector 1.15 1.12 1.47 Wage Private sector Formal 1.oo 1.oo 1.oo Wage Private sector Informal 0.65 0.49 0.63 All 0.22 0.16 0.27 Source: GLSS, various issues. -55- 7. AGRICULTURAL C O M P E T I T I V E N E S S A. INTRODUCTION 7.1 Ghana i s poised to enter a new period o f macroeconomic management and growth, driven by oil revenues that will begin to come on stream in 2011. Ghana's agricultural sector - and the 70 percent o f Ghana's poor who live in rural areas and whose livelihoods depend o n farming - stands to benefit from the surge in demand for agricultural commodities as well as the increased public revenues available for agriculture-related investments. At the same time, international experience shows that the competitiveness o f the agricultural sector is often hurt from a natural resource discovery. 7.2 There are three reasons why agriculture's performance will largely determine the national benefit from the emerging oil sector. First, agriculture i s often a relatively tradable sector and therefore more at risk from `Dutch Disease,' resulting from the impacts o f resource booms on the exchange rate. Given that agriculture provides over one-third o f GDP, agriculture's performance remains critical to overall growth performance. Second, an estimated two-thirds o f Ghanaian manufacturing depends on agricultural inputs, so an uncompetitive and stagnating agricultural sector would also undermine the competitiveness o f m a n ~ f a c t u r i n g .Third, as the ~~ recent World Development Report 2008 Agriculture for Development has emphasized, inclusive agricultural growth is particularly effective in reducing poverty, especially when large numbers o f the poor depend on farming. Even with more rapid rural-urban migration, the majority o f the poor in Ghana will continue to be rural for decades to come. 7.3 This chapter outlines the risks o f the rising oil economy to the agricultural sector, and provides policy options for transforming oil resources into a positive opportunity to spur pro-poor agricultural growth and Competitiveness. It first outlines the pathways by which o i l revenues could impact the agricultural sector. Second, i t reviews the current strengths and weaknesses in Ghana's agricultural competitiveness. Finally, i t suggests policies and priority expenditures in the sector to maintain and improve competitiveness as well as instruments to enhance the efficiency and effectiveness o f increased public expenditures in the sector. B. ENVIRONMENT AGRICULTURE OIL AND A CHANGING MACRO-ECONOMIC FOR 7.4 As discussed in the Overview, exploitation o f newly-discovered natural resources can provide substantial resources to Governments and to factors o f production employed in the `booming' sectors. However, how these `resource booms' are spent can create substantial macroeconomic upheavals, including the so-called `Dutch Disease' whereby existing successful sectors are harmed because o f a loss o f international competitiveness. These effects include induced changes in the exchange rate, both the real exchange rate (the relative prices o f non- tradable and tradable goods) and the nominal exchange rate. 7.5 It is useful to distinguish three possible effects o f an export-led natural resource boom: 74 Breisinger, 2008; Fiess and Vemer, 2003. - 56 - An increase in the price o f non-tradable goods and services due to a rapid expansion o f demand financed by o i l revenues. This `spending effect' can be induced from demand originating in the public or the private sectors; Upward pressure on costs in both tradable and non-tradable sectors as production factors such as labor are attracted into the booming sector in response to higher returns. This i s the `resource movement' effect; An appreciation o f the nominal exchange rate because o f increased o i l revenues leading to a decline in the price that domestic producers o f tradable products receive (as well as reduced prices o f their tradable inputs). 7.6 T h e `Dutch disease' would occur if any o f these effects leads to a loss o f competitiveness among domestic producers. For instance, competing imports might become cheaper, resulting in a loss o f domestic market share. In the case o f exports, a loss o f competitiveness vis-&vis other exporters would see a decline in Ghana's exports. 7.7 A fourth consequence o f the oil economy i s also possible: the likelihood that urban more politically powerful constituencies are better able to capture rents generated by oil revenues leading to growing rural-urban and regional inequality. 7.8 Despite these potential risks, Ghana's oil economy presents an unparalleled opportunity for the agricultural sector and for poverty reduction in particular. Demand for food, especially higher valued products, such as horticulture and livestock products, will increase as incomes rise. This i s likely to be somewhat muted in the short term, however, since the immediate employment potential in the o i l sector will be low; Urbanization and urban consumer preferences will lead to increasing demand for processed and foods with greater domestic value-added. Provided Ghana's tradable sectors can remain competitive, this provides an opportunity for both farming and the food processing manufacturing sector; Government revenues for public investment in agricultural sector will increase and help alleviate chronic under-investment in public goods that has constrained agricultural growth. 7.9 Yet, historical experience suggests that countries experiencing oil booms have often ignored agriculture leading to decimation o f vibrant agricultural export sectors, escalating food imports, and growing i n e q ~ a l i t y Examples o f the negative fallout to agriculture from .~~ the o i l booms o f the 1970s and 1980s include Nigeria, Ecuador, Mexico, Algeria, Iran and Iraq.76 Even countries such as Chile, that have imposed safeguards to manage natural resource windfalls, have experienced threats to their agricultural competitiveness (see B o x 7.1). These experiences underline the special challenge confronting Ghana in managing the emerging o i l economy. 75 It i s also worth noting that in some instances, such as the commodity price spike in 2 0 0 7 - 0 8 , the agricultural sector can actually be the cause o f the boom and exchange rate appreciation. 76 On Ecuador, see Fiess and Verner (2003) and Byerlee (1989). On Mexico see Scherr (1985). See Pinto (1987) and Watts (1987) for evidence on Nigeria. - 57 - Box 7.1: Nigeria and Chile in a Resource Boom Nigeria experienced an o i l boom in the 1970s that severely affected i t s agriculture. The real value o f the Naira more than doubled during the decade, leading t o a sharp decline in the price o f tradable agricultural commodities. Per capita agricultural production f e l l by 40 percent from 1970 t o 1982 and Nigeria rapidly became a large food importer. Public investments fmanced by o i l revenues and intended t o boost productivity were largely wasted in expensive and ultimately unproductive schemes, such as large scale irrigation. M o r e recently, Chile implemented a strong rule-based system t o manage revenues from copper and other minerals based o n the `well-regarded Norway model' o f maintaining revenues overseas during periods o f high prices. Nonetheless, during the last minerals' boom, the Chilean peso appreciated by about 50 percent relative t o the dollar over 2002-2008. This severely squeezed profits in a very dynamic agricultural export sector, based o n horticulture. ;ource: Pinto, 1987; Valdes, pers. comm. 7.10 Finally, Ghana's oil bonanza may well be temporary due to either limited oil supplies or the volatility of oil prices, and future economic growth will again be dependent o n agriculture. Yet experience shows that once market share i s lost it can be extremely hard to regain due to the loss o f commodity-specific capital-both physical (e.g., processing plants) and human (scientific knowledge and technical skills). This is particularly the case in export markets, when supply chains are often complex and difficult t o establish. As an example, Ghana i s s t i l l trying to recover market share in the European pineapple market having lost ground with the slow conversion to new varieties demanded by European supermarkets. c. IMPACTS OF EXCHANGE RATE MOVEMENTS AND THE EXTENT THE OF TRADABLE SECTOR Differential impacts within agriculture 7.11 Exchange rate appreciation will have differential impacts across the agricultural sector, depending on the extent o f tradability. Knowing which agricultural commodities are tradable and which are non-tradable i s crucial for the appropriate policy response. Export commodities such as cocoa and pineapples are unambiguously tradable and are adversely affected in direct proportion to the exchange rate appreciation and the increase in the price o f production factors, land and labor. Staff analysis suggests that agricultural exports volumes could be significantly affected by an o i l boom-led real exchange rate appreciation. In 2015, agricultural export volumes (mostly cocoa) could be 5-6 percent lower with o i l than without oil. Import- competin commodities such as rice, vegetable oils, sugar and poultry will experience similar impa~ts.~'Some commodities appear to be non-tradable in that they are not physically traded (e.g. cassava, yams, plantains, and millet). However, an exchange rate appreciation may have a negative impact on the prices o f non-tradables where there are tradables that are close substitutes (e.g., rice for cassava). The available evidence from Ghana suggests that prices o f imported rice ' do pass through to prices o f domestic staples, although the effect i s not large, even for domestically produced rice (see B o x 7.2). Seemingly exchange rate appreciation would have only modest impacts on the incomes o f food crop farmers. 77 Ghana's imports as a share o f total agricultural imports in 2003-05 were cereals (30 percent), sugar (13 percent), diary and h i t s and vegetables (9 percent each), and vegetable oils (8 percent). Wheat is a major cereal import but Ghana does not produce wheat. - 58 - Box 7.2: Price Transmission and the Extent o f Tradability Examining the correlation between prices o f imported and domestically produced commodities at different locations can indicate the extent o f tradability (see Table below) reports correlation coefficients between prices o f a sample o f domestic food staples and the import price o f rice - Ghana's main food import-for the period 2000-08. A high correlation indicates tradability and/or strong substitution effects (Cudjoe et al., 2008). This reveals: (i) prices o f domestically produced r ice are only modestly related to the import price; (ii) price transmission between imported rice and local maize, cassava and yam even though the last three are not traded by Ghana in significant quantities (the bulk o f imported maize i s for the poultry industry); and (iii) price that transmission varies b y location, with prices in more remote locations being more affected by import prices, counter to what would be predicted. Correlatio local foods Source: Cudjoe et al. (2008); Italics denote statistical significance at the 5 percent level. Exchange rate appreciation and the impact on intermediate inputs 7.12 The impact o f exchange rate appreciation on competitiveness depends on the effects on production costs as well. To the extent that inputs used in agriculture are tradable, production costs will fall with exchange rate appreciation. In general, few inputs are applied in agricultural production with fertilizer use particularly l o w compared to other countries in the region. However, data for 2006 and 2007 indicates total fertilizer imports o f 190,000mt - equivalent to 26kgha. Other agro-chemical imports have also increased substantially to around 20,000mt from around one-tenth this amount in 2000.78 7.13 Although prices o f fertilizer and the like comprise the bulk o f purchased inputs and may be reduced with an exchange rate appreciation, the low share in the aggregate cost structure means that the impact on overall costs will be limited. Exceptions are rice and maize where detailed farm budgets across a range o f farms types and locations indicates that tradable inputs account for between 22 - 46 percent o f total costs for maize and 30 - 41 percent for rice.79 This indicates that negative impacts o f exchange rates for rice and maize would be partly offset by lower input prices. Will increasing world prices offset the `Dutch disease'? 7.14 I t might be tempting to believe that in the aftermath o f the world food crisis, higher prices for agricultural commodities in world markets will offset the negative effects o f the Dutch disease on agricultural competitiveness. However, agricultural commodity prices had already sharply declined by the end o f 2008. Available projections from the World Bank and ''MoFA (2008). 79 Winters-Nelson and Aggrey-Fynn (2008). - 59 - FA0 suggest that real prices o f agricultural commodities over the next decade will be at comparable levels to 2005, although somewhat higher than the period 1996 - 2000.80 Although commodity prices may be more volatile, they are not likely to be the salvation for Ghana's agriculture in an emerging o i l economy. D. MAINTAININGCOMPETITIVENESS OF AGFUCULTURAL THE VALUE CHAINS 7.15 The extent to which oil will be inimical to agricultural growth will depend o n the scope to improve competitiveness o f agricultural value chains. Some interventions such as in rural infrastructure are likely to be critical to competitiveness o f most value chains. Other priority interventions will be conditional o n factors specific to each cost structure - many will be firm-specific - but available qualitative and quantitative assessments o f agricultural value chains suggests a number o f sources o f inefficiencies that warrant urgent attention. Threats to cocoa exports 7.16 Cocoa i s clearly a special case in which Ghana i s globally competitive - indeed, cocoa beans command a quality premium against international competitors. But it i s also worth remembering that Nigeria's once vibrant cocoa sector never recovered from the effects o f the o i l booms o f the 1970s and 1980s. Nonetheless, recent achievements in Ghana are impressive - an increase in production from 400,OOOmt annually in the late 1990s to over 650,000mt in recent years - despite the negative nominal rate o f assistance afforded the sector and a modest appreciation o f the exchange rate:81 Recent reforms by COCOBOD and CMCS2have increased the share o f the producer price to 70 percent o f the net F O B price83(from around 40 percent at the start o f the decade) which, combined with recent high cocoa prices, has been a boon to producers. The 30 percent margin between export and farm prices is comprised o f two elements: (i) costs associated with the operations o f COCOBOD and CMC; and (ii) official export the an tax which i s revised annually.84 For the 2007/08 crop year the official export tax was 11.1 percent.85 7.17 The exchange rate appreciation will reduce the Cedi price o f cocoa (and poses a threat to the finance operations - see B o x 7.3). T o sustain producer prices in absolute terms producers' share o f F O B prices needs to increase. This could be achieved by reducing the formal export tax rate and/or by further increasing the efficiency o f COCOBOD and CMC. A s illustrated in Figure 7.1, the composition o f these costs has changed markedly in recent years, with freight and administration costs having increased substantially both in absolute and World Bank, 2008c; FAO/OECD, 2008. Brooks et al. (2007) report nominal rates of assistance for the cocoa sector o f -2 1.7 percent for the period 2000 - 2004; this i s markedly lower than previous levels o f 30.9 percent for the preceding five years and -36.2 percent for 1990 - 1994. 82 These are the Cocoa Board (COCOBOD) which i s responsible for supporting cocoa production through targeted programs and for domestic delivery o f cocoa beans to the export warehouses. The Cocoa Marketing Company (CMC) i s the monopoly body responsible for selling Ghana's beans on the world market. 83 The use o f fob as the benchmark price allows for certain expenditures to be deducted from the fob price while maintaining the 70 percent commitment. These include costs o f activities such as mass spraying that purportedly directly benefit farmers. In aggregate, payments to farmers account for about 60 - 65 percent o f revenues from exports and domestic sales. 84 I M F (2008). 85 WTO (2008). - 60 - proportionate terms. A closer scrutiny o f these expenditures may identify efficiencies that can be achieved without undermining the important role that COCOBOD plays in the marketing system. Another option would be to increase value adding in line with Government's strategy, but this may be even more challenging. Box 7.3: Exchange R a t e Appreciation and F o r w a r d Cocoa Sales Under existing arrangements in the cocoa market, the CMC has access to Ghana's cocoa exports at a predetermined price (denominated in Cedis). Forward sales typically occur 6 - 8 months prior to the start o f the main crop season, and are typically denominated in sterling. As well as allowing Bank o f Ghana to anticipate balance o f payments developments, revenues from forward sale provide working capital for payments to cocoa farmers at time o f delivery. Since producer prices are fixed, CMC avoids facing a price risk. It does, however, face a currency risk and could n lose substantially if the Cedi appreciates against the currency i which the forward sale i s denominated. ource: LMC (1996). Box 7.4: Can Ghana Increase Value Addition I n Cocoa? Increasing value addition in the cocoa sector i s an important policy objective o f Government. Recent investment in new facilities means Ghana has the potential to process a substantial share o f its production.86 Realizing t h i s potential faces a number o f obstacles. First, beans are only a small fraction o f input Second, given the high costs o f shipping other ingredients combined with the high costs of shipping processed cocoa compared to beans, efficient production typically requires processing in close proximity to (European) final consumers. Third, tariff escalation in importing countries compounds this disadvantage. Fourth, efficient production requires regular and predictable access to local supplies which i s not the case in Ghana. Figure 7.1: The Composition o f Cocoa Marketing Costs in 1995-98 and 2006-08 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% - 1995/96 1997198 - 2005106 2007108 1995/96 - 1997/98 - 2005106 2007108 Source: COCOBOD. Competiveness o f other value chains-room for improvement 7.18 Many value chains appear to have considerable `competitive space' and could weather a modest exchange rate appreciation o r increase in factor costs. Estimated rates o f return for plantation crops (oil palm and rubber), fruits (mangos, pineapples and citrus), soybean, 86 The manifesto o f the new administration sets a target o f 60 percent. *' the average chocolate bar, producer proceeds account for about 4 percent. For -61 - chilies, tomatoes, and guinea fowl are high in all cases, although the complexity o f organizing individual chains varies widely among them.** Yet, even in these cases, the analysis has identified considerable scope for improving efficiency, such as through reducing high post- harvest losses for citrus and other horticulture crops where timely evacuation and marketing i s essential. 7.19 I n other cases, efficiency improvements are critical for competitiveness; these improvements should be achievable. For example, rice consistently shows high losses in processing. The milling ratio for rice in major rice producing countries averages around 0.65kg o f milled rice per l k g o f paddy but this ratio i s only 0.50 to 0.55 in Ghana. The combined effect o f raising the conversion rate to 0.65 and increasing yields to 3.2 tons per hectare by applying a modest dose o f nitrogen fertilizer would make all rice production systems privately profitable even if world prices return to their l o w levels observed in 2002.89 Other countries in West Africa, . such as Sierra Leone, have achieved international levels for milling ratios, and there i s no reason why better coordination along the rice value chain and targeted technical assistance in processing and milling could not succeed. 7.20 Finally, some value chains such as poultry and vegetable oils are especially vulnerable since they appear to be barely competitive under a range o f scenarios. There are undoubtedly opportunities to increase the efficiency o f such chains, but Ghana should also be prepared to accept declining competitiveness and rising imports for some commodities where it has little comparative advantage. E. POLICY OPTIONS FOR IMPROVING COMPETITIVENESS 7.21 Robust agricultural growth i s a precondition for achieving middle income status by 2015 - a stated policy objective." Investing in agriculture i s an existing development objective which demands renewed vigor (and resources) in light o f o i l revenues. Well-coordinated interventions will be needed to maintain competitiveness and achieve rapid and sustainable growth in agriculture. T o a large extent, these recommendations reiterate existing approaches espoused in the proposed national long-term development plan and the existing sector strategy (FASDEP 11). The threat and opportunity posed by the o i l economy adds greater urgency to these ongoing efforts. 7.22 Previous analysis has highlighted the growth impacts o f applying existing technolo better - an additional two percentage points to agricultural GDP by some J 5l estimates. In that sense, the policy response i s one o f intensification and scaling up o f numerous, relatively small-scale efforts in the sector that show initial success. 7.23 Interventions can be broadly grouped into the following: P revising trade and tax policies to reduce the impact o f Dutch disease effects; 88 Owusuansah and Amoaku (2008). 89 Winters-Nelson and Aggrey-Fynn (2008). Breisinger et al. (2007); Breisinger et al. (2008). 91 See Jackson and Acharya (2007). - 62 - 9 public investments in core public goods, such as infrastructure, irrigation, and research; and 9 providing matching grants t o productivity-enhancing investments by private farmers and agibusinesses. Trade and tax policies 7.24 One option would be to implement a compensating tariff `surcharge' on import substitutes tied to exchange rate movements. There are at least three reasons why this might not be a good strategy for Ghana. First, cereal imports are already protected by a tariff o f 20percent and any higher tariff would impose tradeoffs o f efficiency and further erosion o f economy-wide competitiveness through higher food prices. Second, oor consumers spend a relatively higher share o f their budgets o n food so a tariff i s anti-poor?' Finally, it i s difficult in practice to establish rule-based tariff compensation, so that this approach runs a real risk o f political capture o f tariff decisions that would impose even higher costs in terms o f efficiency and equity. 7.25 On the export side there i s clearly the potential to reduce o r remove export taxes to compensate for any loss o f competitiveness within the domestic cost structure - this should be a priority consideration for the cocoa sector. Similarly, continued liberalization in key export markets - especially to reduce tariff escalation on processed products - will improve Ghana's competitive position although if pursued through multilateral approaches this poses a simultaneous risk o f preference erosion. Investments in core public goods 7.26 Current spending on agriculture i s below the 10 percent target committed to under NEPAD. Total spending by M o F A amounts to about 1.8 percent o f the budget, with additional spending in the sector by other ministries raising the total to 6-8 percent.93 Carefully designed public investment programs have considerable potential to use o i l revenues to enhance competitiveness and reduce poverty. Based on extensive research, the highest payoffs are likely to be for investments in core public goods, especially agricultural R&D, infrastructure (rural roads) and education and skills (see Table 7.1: ) all o f which can improve productivity and competitiveness. Recent evidence also points to good returns from investing in irrigation in Sub- Saharan Africa.94 Indonesia during the 1970s, successfully transformed rural areas by tapping o i l revenues for these types o f investments and increased i t s competiveness as measured by its share o f global agricultural markets. Some investments, especially rural infrastructure and education, also helped develop the rural nonfarm sectors. 7.27 Evidence from Ghana i s consistent with these findings: a 1 percent increase in agricultural spending i s estimated to increase per capita agricultural value added o f 0.15 percent;this impact i s higher than that observed from other sectors. 92The proportion o f expenditure spent on food i s 65 percent for the poorest decile o f rural households but only 36 ercent for the richest decile o f urban households (Cudjoe et al., 2008). ' Ghana Strategy Support Program, 2008. 94 World Bank (2008a). - 63 - 7.28 More specifically, the key investments for competitiveness o f Ghanaian agriculture are: Agricultural technology, including improved varieties, land and water management, and post harvest issues, for both traditional commodities and emerging higher value commodities. This i s not business as usual: investments must be driven more by market forces, be accountable to users, and involve partnership with the private sector, including farmer organizations; Roads, especially rural roads, and communications more generally. A s in most Sub- Saharan Africa, the high cost o f transportation revealed in value chain analysis indicates the high returns from improving market access. These returns are likely highest in the North where infrastructure i s especially poor; Regular water and power supplies given the hygiene requirements o f food processing, especially refrigeration and the vulnerability o f food stuffs to spoilage;'' Irrigation, but small scale rather than large scale (see below); and Clear and credible quality and safety standards with efficient testing and enforcement, including certification, to ensure access to sophisticated markets, especially overseas. Table 7.1: Returns to Public Investment in Agriculture and Impacts on Poverty Reduction Rankings, fiom 1-best to 7-worst I China(2000) I India (1993) I Thailand (1999) I Uganda (1999) 1 Expenditure Program return poverty return poverty return poverty return poverty Agricultural R&D 2 2 1 2 1 2 1 1 Irrigation 5 6 4 7 5 5 Education 2 1 3 3 3 4 3 3 Roads 3 3 2 1 4 3 2 2 Telecommunication 4 5 Electricity 6 4 8 8 2 1 Health 7 6 4 I Soil and water conservation I I 1 6 1 5 I I I 1 4 1 I Anti-poverty programs I I 7 1 5 1 4 I I I I I Source: Fan and Rao (2008). Making better investments 7.29 Effective utilization o f the greater fiscal space created by oil revenues assumes domestic absorptive capacity to manage larger public expenditures - in this case both investments and the provision o f services such as extension advice. Notwithstanding a number o f systemic problems with public financial management exist (World Bank, 2009c) and institutional constraints within M o F A (IFPRI, 2009) the fact that current spending i s so l o w suggests absorptive capacity does indeed exist. Overall procurement systems are judged to be sound (Public Procurement Board, 2007,) and measures being adopted to streamline expenditure management systems. These measures, combined with the fact that current expenditures so low, provides prima facie evidence that bottlenecks are unlikely to be encountered should agriculture- 95 Loch and Boakye (2006). - 64 - related investments be increased significantly. I t i s less obvious that the current agricultural extension system could rapidly scale-up additional funding. On the one hand, diagnostic assessments report the absence o f operational funds mean extension staff i s often under- employed, suggesting that the impact o f existing staff could be enhanced relatively easily. On the other hand, current activities focus on technology adoption and other farming practices with little extension in broader competitiveness or value chain skills. To be sure, improved technology adoption will certainly raise yields but a more substantive effort t o improve competitiveness will require greater access by farmers to a broader range o f knowledge which current public system i s ill-suited to provide (IFPRI, 2009). Private provision - even with public funding o f such - services i s one option, although the market for privately provided extension services remains under-developed (on both the demand and supply side). It may be tempting t o use the increased flexibility in oil-financed public expenditures to 7.30 provide transfers and subsidies to reduce production costs. These may be justified in very select cases, but in general competitiveness i s best served by investments that spur long-run productivity growth. Box 7.5: Subsidies versus Investments Given greater budget flexibility, there will be increased political pressure for subsidies and other transfers to reduce production costs. Some subsidies may be seen as an investment-for example, carefilly targeted fertilizer subsidies to help develop a dynamic private fertilizer market and grants to help farmers buy small irrigation pumps. Over time, these subsidies can be phased out, as the market develops. Other subsidies such as tractor subsidies are much more difficult to justify since the private sector can usually develop tractor markets when it i s profitable to do so, and these subsidies are not sustainable in the long term. Some other transfers may also be a good use of oil revenues to reduce rural poverty and inequality, especially safety nets and employment schemes for those l e f t behind due to lack o f skills or old age. Matching grants to farmers and the private sector 7.3 1 Additional public investments need to be complemented by innovative approaches to ensure that increased spending i s efficiently utilized and reaches its targets. These . approaches generally require working directly with the private sector and communities. Community driven development grants focused on income generation. Matching grants can be provided directly to community-based or farmer-based organizations for small scale irrigation, market infrastructure, processing equipment, and capacity building. The Fadama program in Nigeria now has more than a decade o f experience in channeling these grants to rural communities. The most recent evaluation estimates that 2.3 million people have benefited, with an average income gain o f 60percent in the second phase o f the program in 12 states.96There is also experience in Ghana with these . approaches that could be scaled up using farmer-based organizations. Innovation and technical assistance grants. These grants typically provide funds o n a matching basis to private industry and strong farmer organizations to test innovative approaches, invest in collective goods such as cold chains, provide business services and market analysis, and contract technical assistance to help coordinate and improve ~~ 96 Nkonya et al. (2008). - 65 - efficiency along the value chain. The Grains Development Partnership in Ghana i s using this approach. Other countries are using autonomous public-private agencies to manage such services and grants, especially for horticulture value chains. F. IMPROVING THE INVESTMENT CLIMATE FOR COMMERCIAL AGRICULTURE 7.32 Both the community driven funds and innovation funds require strong private sector participation,which in turn requires a n improved investment climate. This could provide high payoffs t o agriculture. According to a survey o f 54 large companies in Ghana, agriculture and the food and beverage sector is the most attractive industrial sector t o invest in; from 1994 - 2002 over $204 m o f FDI (1 1.5 percent o f total FDI) was invested in agriculture and a large share o f the further $346 m invested in manufacturing occurred in food-related business.97 7.3 3 A supportive business climate i s critical for improved competitiveness. Two issues are o f particular interest t o agriculture: Land availability, especially for commercial farming which requires substantial contiguous plots for efficient production. The challenge is to reduce the currently high transactions costs and time to assess land and provide tenure security for medium term investments, while protecting the rights o f current users; Access to rural finance. While the rural finance network has expanded substantially in recent years resulting in increased rural deposit mobilization, little is being recycled into agricultural credit, especially for small-holders. Commercial bank lending to agriculture remains extremely l o w at 4.1 percent." Making investmentspro-poor 7.34 Careful targeting o f expenditures by region and type o f farmer will be needed t o ensure that investments are pro-poor and reduce the risk o f rising inequality. Box 7.6: Exploitingthe Agricultural Potential o f Northern Ghana Northern Ghana, including much o f Brong-Ahafo Region, i s part o f a broad agro-ecological zone, k n o w n as the Guinea Savannah that occupies an estimated 7 m i l l i o n square km in sub-Saharan A f i c a . The agriculture o f this region i s vastly unexploited for a number o f reasons-historical (animal and human diseases), poor soils, climatic risk, and very l o w population and road density. However, the potential o f this region is huge, as demonstrated by the experience o f the Cerrado in Brazil and Northeast Thailand. In both cases, regions with very similar ecologies and problems t o the Guinea Savannah have been turned into major poles o f commercial agriculture that are highly competitive in global markets in commodities such as cassava, soybeans, sugar, rice, maize, cotton and beef. Factors that contributed t o this success included: (i) improved agricultural technology, both varieties and soil management; (ii) publicly financed inkastructure, rural credit, and business development services; (iii) dynamic a private sector and a conducive investment climate; and (iv) a policy environment that set prices in line with w o r l d prices. Overall, however, Thailand which favored a smallholder led model has been more successful in combining growth with poverty reduction. Source: World Bank (2009g). 97 Aryeetey et al. (2008). 98 Data for the share o f lending as at June 2008, while that for non-performing loans i s at August 2008. - 66 - 7.35 Regional priorities. The major potential area for expansion o f competitive small and medium-scale farming is in the guinea savannah zone where most commodities with strong demand are produced - rice, maize, cassava, soya and beef (especially Brong Ahafo and Northern Regions). These together with the Upper (East and West) Regions are also areas o f high poverty rates which merit special attention in any investment program. Given evidence f r o m other countries, investment in these less developed regions may be win-win - they would provide higher payoffs since they are starting from a very l o w level, and they would directly address the poor (see Box 7.6).99 7.36 Small versus large-scale farming. Larger-scale commercial farming has a role in improving agricultural growth and competitiveness, but to be inclusive and achieve poverty reduction targets, small and medium farmers must be at the core o f a strategy to use o i l revenues to revamp the agricultural sector. Especially in the North o f Ghana, there is considerable land and water that could be brought into production through investment in large-scale commercial farming. But even in this case, poverty reduction impacts can be enhanced through involvement o f smallholder farmers through contract and out-grower schemes which usually require some donor or public sector support (see B o x 7.7). Box 7.7: Extending the Benefits o f Private Investmentsthrough Outgrower Schemes The Integrated Tamale Fruit Company (IFTC) involves 2,000 small-holder farmers each responsible for one acre o f organic mangos, alongside their own plantation o f around 300 ha. Participants negotiate their own land arrangements with customary authorities. ITFC provides an interest fkee loan for start-up inputs (quality planting material, extension advice, etc.) equivalent to $2,400. Initiated only in 2000, some outgrowers are now harvesting h i t for export. Most rubber and oil palm plantations in Ghana include out-grower schemes o f some form. UNILEVER i s supporting two oil palm plantations to strengthen out-grower arrangements. TOPP was established in 1983 and now covers 255 farmers on 1,018 ha. The second, BOPP, began in 1995 on 1,650 ha involving 438 farmers. Small-holder yields within the program are reportedly two-thirds above those outside the scheme. Contrary to the mango example, both schemes acquired land from the Government and attracted beneficiaries into the area. Note that, in all these cases, concessional finance from donors has been essential to fund the start-up costs and provide working capital even though the operations are ostensibly private sector driven. Public budgets augmented by oil revenues could be similarly utilized. G. CONCLUSION 7.37 The lessons from many countries experiencinga sharp inflow o f oil o r other mineral revenues suggest that Ghana's policy makers will have to pay particular attention to the agricultural sector to ensure that its competitiveness i s not undermined nor inequality increased. However, the potential for increased public expenditure from o i l revenues i s also a unique opportunity to enhance competitiveness, foster agricultural growth, and reduce poverty. Doing this will require a carefully designed program o f public expenditures focusing o n core public goods as well as community development funds and well targeted interventions in value chains. Increased capacity at all levels o f government will be needed to ensure better use o f public funds, complemented by autonomous public-private agencies. Increasing the voice o f 99 Fan and Rao (2008). - 67 - famers and other agricultural interests will also be important in ensuring a just allocation o f public expenditures to the sector. - 68 - Annex 1: The Computable General Equilibrium (CGE) Model 1. The CGE model developed for this study i s a typical neoclassical model with endogenous prices, market clearing, and imperfect substitution between domestic and foreign goods, allowing for endogenous factor accumulation (capital, land) and labor force participation. As in any CGE prices are endogenous on each market (goods and factors) and equalize supplies (imports; Ghanaian production for the domestic market; factors supply) and demands (final demand from households, the Government, investors and the rest o f the world; intermediate demand from producers; factors demand), so as to obtain the equilibrium. The equilibrium i s general in the sense that i t concerns all the markets simultaneously. This type o f modeling allows combining detailed databases with a sound micro-based theoretical framework capturing the interdependence and inter-linkages o f markets. With such characteristics, C G E models are useful tools to assess the long t e r m impact o f shocks and structural reforms. The underlying assumption o f market clearance and monetary neutrality renders, o n the contrary, CGE models improper t o address short-term impacts o f macroeconomic policies. 2. The model i s calibrated for the year 2008, updating with national accounts Ghana's Social Accounting Matrix (SAM) for the year 2004 (Ghana Statistical Services, 2006). The SAM and the model comprise 26 sectors o f activity, one representative Ghanaian household and one trading partner, the World. Production factors comprise two labor types, formal and informal, physical capital, two land types, urban and rural, and one specific factor t o generate electricity (hydro-electric capacities). 3. Supply i s modeled using nested constant elasticity of substitution (CES) functions, which describe the substitution and complement relations among the various inputs. Producers are cost-minimizers and constant returns to scale are assumed. Output results from t w o composite goods: intermediate consumption and value added, combined in fixed proportions. The intermediate aggregate is obtained by combining all products in fixed proportions (Leontieff structure). The value-added i s then decomposed in two substitutable parts: labor and a capital- natural resource bundle. In formal sectors (administration, financial services), nominal wages are indexed to urban land prices (with an elasticity o f %). As such, the formal labor market clears through reversing excess supply to the informal labor market where wages equalize supply and demand. Capital, land (urban and rural), and hydro-electric capacities are fully employed and imperfectly substitutable. Demand for capital makes a distinction between "old capital" and "new" capital. The model thus integrates the notion o f vintage capital, to distinguish the process of allocating capital already installed, from that resulting from contemporary investment (puttyhemi-putty production function). "New" capital can be allocated more flexibly than "old" capital. It substitutes for other types o f capital more easily (land, hydro-electric capacities). Accelerating investment therefore strengthens the capacity for adjustment o f the productive sector to changes in relative prices. 4. Income from labor and capital accrue to the representative household. This income i s allocated t o consumption and savings using the Extended Linear Expenditure System (ELES) specification. Household demand i s derived from maximizing the utility function, subject t o the constraints o f available income and consumer price vector. Household utility i s a positive function o f consumption o f the various products and savings. Income elasticities are - 69 - differentiated by product. The calibration o f the model determines a per capita subsistence minimum for each product, which will be consumed whatever the price and the income o f the households, while the remaining demand i s derived through an optimization process. The subsistence share in the consumption o f basic goods is higher than in the consumption o f luxury goods. With lower disposable income, the households' savings rate declines t o protect subsistence consumption. Government and investment demands are disaggregated in sectoral demands once their total value i s determined according to fixed coefficient functions. 5. The model assumes imperfect substitution among goods originating from different geographical areas. Import demand results from a CES aggregation function o f domestic and imported goods. Export supply is symmetrically modeled as a constant elasticity o f transformation (CET) function. Producers decide to allocate their output to domestic or foreign markets responding to relative prices. 6. Several macro-economic constraints are introduced in this model. First, the small country assumption holds, the Ghanaian economy being unable to change world prices; thus, i t s imports and exports prices on world markets are exogenous. Capital transfers are exogenous as well, and therefore the trade balance is fixed, so as to achieve the balance o f payments equilibrium. Second, the model imposes fixed real public expenditures, t o reflect the Government's choice o f delivering a given amount and quality o f public services and ability to borrow. Tariff rates for electricity are exogenously set, and thus consumer subsidies endogenously cover the difference between prices and costs. Tax rates and O D A are exogenously determined and thus government savings are residually determined. Third, investment i s set by the availability o f savings, the latter originating from households, Government and abroad. 7. The dynamic path o f the model strongly results from this savings-investment rule: a change in investment influences physical capital accumulation in the following period. Land and informal labor supplies also respond favorably (but moderately, with elasticity o f 0.1 and 0.2 respectively) to their remunerations. Total factor productivity responds positively (with an elasticity o f 0.1) to the ratio o f exports over GDP. Population and total labor force growth are set exogenously, as well as hydro-electric capacities. - 70 - References African Peer Review Mechanism (2005), Country Review Report and Programme o f Action o f the Republic o f Ghana, A P R M Secretariat, Midrand, South Africa. Afrobarometer (2005) "Sustained Support for Democracy in Ghana" Afrobarometer Briefing Paper No. 18. 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