Angola should adopt an 'Export-Price-Norm' to escape the 'China shock'
It might be a surprise to most people but one of the fastest growing economies in the world over the last 10-15 years has been Angola. A combination of structural reforms and a commodity boom have boosted growth in the oil-rich African country. However, Angola is, however, at a crossroad and the future of the boom might very well now be questioned. It is monetary tightening in China, which is now threatening the boom. The reason for this is that Angola has received significant direct investments from China over the past decade and the rising oil prices have fueled oil exports. However, as the People's Bank of China continues to tighten monetary conditions in China it will likely have two effects. First, it is likely to reduce Chinese investments - also into Angola. Second, the slowdown in the Chinese economy undoubtedly is a key reason for the decline in oil prices. Both things are obviously having a direct negative impact on the Angolan economy. Angola's monetary policy is likely to exacerbate the 'China shock' This is how the IMF describes Angola's monetary regime:
Angola’s de facto exchange arrangement has been classified as “other managed” since October 2009. The Banco Nacional de Angola (BNA) intervenes actively in the foreign exchange market in order to sterilize foreign currency inflows in the form of taxes paid by oil companies. Auctions were temporarily suspended from April 20 to October 1, 2009 leading to the establishment of a formal peg. Since the resumption of auctions, the kwanza has depreciated. However, the authorities maintain strong control over the exchange rate, which is the main anchor for the monetary policy. The BNA publishes a daily reference rate, which is computed as the transactionweighted average of the previous day’s rates negotiated with commercial banks. Banks and exchange bureaus may deal among themselves and with their customers at rates that can be freely negotiated provided they do not exceed the reference rate by more than 4 percent.Hence Angola de facto operates a pegged exchange rate regime and it is pretty clear in my view that this regime is likely to exacerbate the negative impact from the 'China shock'. The China shock is likely to lead to depreciation pressures on the Angolan kwanza in two ways. First the drop in global oil prices is likely to push down Angolan export prices - more or less by a one-to-one ratio. Second, the expected drop in Chinese investment activity is likely to also reduce Chinese direct investments into Angola. The depreciation pressures could potentially become very significant. However, if the Angolan central bank tries to maintain a quasi-pegged exchange rate then these depreciation pressures will automatically translate into a significant monetary tightening. The right thing to do is therefore obvious to allow (if needed) the kwanza to depreciate to adjust to the shock. There are two ways of ensuring such depreciation. The first one is to simply to allow the kwanza to float freely. That however, would necessitate serious reforms to deepen the Angolan capital markets and the introduction of an nominal target - such as either an inflation target or an NGDP target. Even though financial markets reforms undoubtedly are warranted I have a hard time seeing that happening fast. Therefore, an alternative option - the introduction of a Export Price Norm (EPN) is - is clearly something the Angolan authorities should consider. What I call EPN Jeff Frankel originally termed Peg-the-Export-Price (PEP). I have long been a proponent of the Export Price Norm for commodity exporting economies such as Russia, Australia or Angola (or Malaysia for that matter). The idea with EPN is that the commodity exporting economy pegs the currency to the price of the commodity it exports such as oil in the case of Angola. Alternatively the currency should be pegged to a basket of a foreign currency (for example the dollar) and the oil price. The advantage of EPN is that it will combine the advantages of both a floating exchange (an "automatic" adjustment to external shocks) and of a pegged exchange rate (a rule based monetary policy). Furthermore, for a country like Angola where nearly everything that is being produced in the country is exported the EPN will effectively be an quasi-NGDP target as export growth and aggregate demand growth (NGDP growth) will be extremely highly correlated. So by stabilizing the export price in local currency the central bank will effectively be stabilizing aggregate demand and NGDP. Operationally it would be extremely simple for the Angolan central bank to implement an EPN regime as al it would take would be to target a basket of for example oil and US dollars, which would not be very different operationally than what it is already doing. Without having done the 'math' I would imagine that a 20% oil and 80% US dollar basket would be fitting. That would provide a lot of projection against the China shock. And if it turns out that China is not slowing and oil prices again will rise an EPN will just lead to an 'automatic' appreciation of the kwanza and monetary tightening of Angolan monetary conditions and in that way be a very useful tool in avoiding that skyrocketing oil prices and booming inward investments do not lead to the formation of for example property bubbles (many would argue that there already is a huge property bubble in the Angola economy - take a look here).