An Elementary Model to Assess the Impact of Different Levels of Oil Prices on the Mauritian Economy


Karim Jaufeerally, November 2005

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Abstract

An elementary model is proposed to assess the impact on the Mauritian economy of different levels of oil prices. It uses data readily available from the National Accounts published by the Central Statistics Office, from the Bank of Mauritius’ annual reports and from BP’s annual energy statistical review. The data used is Imports of Mineral Fuels and Lubricants (IMFL), Export of Goods and Services (EGS), Gross Domestic Product (GDP) at factor costs and at market prices (GDPmp), Gross National Savings (GNS), Gross Domestic Fixed Capital Formation (GDFCF), Final Consumption Expenditure (FCE), Gross National Disposable Income (GNDI). Various ratios are computed from 1976 to 2004 and displayed graphically. It is found that these ratios exhibit interesting trends over the years. They are also correlated with each other to a high degree. Using those ratios, it is possible to map out the impact of oil prices on savings and consumption in Mauritius. Hence, one can infer what levels oil prices will begin to have deleterious effects on the Mauritian Economy. It is very important to understand that we do not attempt to predict the evolution of oil prices at all, whether on the short, medium or long term. We only attempt to assess the impacts of different levels of oil prices on the Mauritian economy. It is found that as oil prices increase a larger proportion of our export revenue goes into paying for mineral fuels, whilst savings expressed as a percentage of GNS over GDP(mp) drops and FCE takes a larger share of GNDI and investment expressed as GDFCF over GDP drops with a two year delay.

Thus according to the model, once 30% or more of EGS goes into paying for IMFL, GNS and GDFCF drop to very low levels. An economy with very low levels of savings and investment cannot grow for very long and is in severe trouble, economic contraction cannot be far off. Based on a level of EGS of Rs 100 billion (in 2004 EGS was Rs 95 billion) at an average price over a year of US$ 60 per barrel, 15.7% of EGS goes into paying for IMFL and savings falls to 16% and investment falls to 23.5%. At US$ 80, IMFL takes 21% of EGS and GNS drops further still to 9% of GDP(mp) whilst investment slides to 19.65%. At US$ 110 per barrel 29% of EGS goes into paying for IMFL and GNS falls to zero with investment to a low 13.8%. Hence, it can be said that sustained high prices (above US$ 110 per barrel) could lead to the economic collapse of Mauritius.

 

Introduction

The Mauritian economy is very much export orientated due to the fact that there are few natural resources and the internal market is small (estimated population: 1,200,000, CSO 2004). The main exports are sugar, wearing apparels and clothing to the EU and the US. Tourism is a major provider of foreign exchange with Europe the main provider of tourists. Financial services, with the freeport and offshore sectors, are becoming important foreign exchange providers. It is also hoped that information technology sectors will provide much needed foreign exchange and employment. Like any modern country, Mauritius relies on cheap and abundant oil to make its economy run and above all, grow. The desired economic growth is very much predicated on an increased supply of cheap oil. However, since 2004, oil prices have regularly risen, breaching US $ 40 in May 2004, and in October 2005 oil prices were hovering above the US $ 60 per barrel. Surprisingly this sharp increase in oil prices have had little visible effects on the economy to date and no-one seems to know how high oil prices can climb before impacts are noticeable. This state of affairs is not acceptable given the essential nature of oil and energy in any economy. This paper is a modest attempt to gain a better understanding of the impacts of oil prices on the Mauritian economy.  

 

Methods and Results

The data used for this paper comes from the Central Statistics Office, the Bank of Mauritius and from BP’s Statistical Review of World Energy June 2005. The Central Statistics Office (CSO) is the Governmental organisation responsible for the collection of statistical data on Mauritius. It does an excellent job in compiling and publishing accurate data over relatively long periods of time. For instance, precise econometric data is available for Mauritius from the sixties onwards. The Bank of Mauritius is the Central Bank of the country. It has published financial data in its annual reports on Mauritius from 1966 onwards, the year of its creation. These two organizations are invaluable sources of accurate and up to date information on Mauritius. BP, as a leading global petroleum company, needs no presenting.  

Ratio IMFL/EGS : Imports of Mineral Fuels and Lubricants as a percentage of Exports of Goods and Services  

The first piece of data used is the yearly Importations of Mineral Fuels and Lubricants (IMFL) in Rupees. It is available since 1963 onwards. As the name implies, this figure covers the importation of mineral fuels and lubricants which are virtually all oil based like diesel, gasoline, kerosene, LPG, aviation fuels. The country does not import natural gas (methane), and until very recently did not import any coal. It is important to note that, except for bicycles, all internal and external transportation rely exclusively on oil. With economic and population growth, IMFL has gone from Rs 14.2 million in 1963 to reach Rs 10,020 million in 2004. A thirty fold increase in real terms. The second statistic used is that of Exports of Goods and non-factor Services (EGS) from 1966 till 2004. It includes the value of all goods exports (mainly sugar and textiles) and services like tourism earnings and financial services. In 1966, EGS was Rs 403 million and in 2004 it reached Rs 95,470 million, more than a ten-fold increase in real terms. All of our mineral fuel imports must be paid for in hard-earned US Dollars given that our rather devalued Rupee is not legal tender for oil purchases. It is therefore interesting to see how the ratio of IMFL/EGS varies over the years. This ratio in fact measures the percentage of our foreign earnings that must be devoted to the imports of mineral fuels. Undoubtedly, it is a very important ratio and hence its behaviour over the years is of great interest. Figure 1 shows how this ratio (henceforth called IMFL/EGS) has moved from 1966 to 2004, inclusive of an estimate for 2005. We observe that in 1966 it was a very low 3.82%. It goes up and down a little till 1973. As from 1974, when oil prices reached US$11per barrel, it steadily increases and in 1977, it crosses the 10% mark. By 1979, date of the Iranian Revolution, it crosses the 15% mark. In 1981 it reaches the historic maximum of 19.43%. From 1982 to 1985, the ratio steadily drops but remains above 10% throughout. In that period, oil prices began to drop from US$ 31 to US$ 27 per barrel. The ratio also dropped because EGS increased from Rs 5572 million to Rs 8925 million at the same time. In 1986, oil prices fell precipitously to US$ 14 and for the next 14 years oil prices remained between US$ 14 and 20, except for a transient peak in 1990 due to the First Gulf War. At the same time EGS increased from Rs 11,995 million in 1986 to Rs 69,099 million in 1999. This explains why throughout this period the ratio IMFL/EGS remains well below 8%. In 2000, oil prices spiked resulting in an increase in the IMFL/EGS ratio to 8.73%.

It dropped to about 7% in 2001 and 2002, however as from 2003 it began an upward climb reaching 8% and crossing the 10% mark in 2004, the first time since 1985. In 2005, with oil prices reaching US$ 56 on average, the ratio IMFL/EGS is estimated to reach 15%, a level never seen since 1979.  

The Saving rate from 1976 to 2004 and its correlation with IMFL/EGS

The CSO defines savings rate as the ratio of GNS to GDP at market prices. GNS is calculated by the CSO as the difference between GNDI and FCE. We have used figures from 1976 onwards as just prior to that date, in 1974 and 1975, savings shot up to very high levels due to exceptionally high sugar prices (Sugar is a very important export item for Mauritius), distorting therefore the overall picture. From figure 2, we can see the evolution of savings from 1976 onwards. It stands at 25% in 1976 and very quickly begins a sharp descent to reach the lowest ever of 10% in 1980. It begins to rise as from 1981 and by 1986 it had climbed to above 25% remaining so till 2004 when it falls to 23%. It is immediately clear that it is inversely correlated with IMFL/EGS. The scatter graph of IMFL/EGS against GNP/GDP(mp) clearly shows that in figure 3. There is a very high co-efficient of variation (R^2=0.8454). Such a linear relationship between these two variables was not expected.

FCE as a percentage of GNDI and its correlation with IMFL/EGS

Figure 4 shows the evolution of FCE/GNDI from 1976 to 2004. We note that as from 1977 it increases and breaches the 80% mark. It reaches a maximum of 90% in 1980 and thereafter begins to drop and it reaches 80% once more in 1985. From 1986 to 2004 it remains firmly below 80%. It is obvious that FCE/GNDI is positively correlated with IMFL/EGS. A scatter graph of IMFL/EGS against FCE/GNDI from 1976 to 2004 shows that very clearly (figure 5). The co-efficient of variation is very high (R^2=0.8352).

The investment rate from 1976 to 2004 and its correlation with IMFL/EGS

The investment rate is measured as the ratio of GDFCF to GDP. From figure 6 we see that the investment rate begins a sharp decline from 32% in 1978 to 21% in 1982. As from 1985 it begins a steady climb to reach 34% in 1988. It remains rather high till 1995 when it falls and oscillates around 30%. However by 2004 it had fallen to 25%. Its correlation with IMFL/EGS is much less clear and a scatter graph of IMFL/EGS against GDFCF/GDP reveals a much weaker linkage (figure 7) with a low co-efficient of variation (R^2=0.2474). However, when the GDFCF/GDP time series is shifted back by two years in relation to the IMFL/EGS time series, a much better correlation is obtained, the co-efficient of variation now nearly doubles (R^2=0.4856) as seen in figure 8. It thus appears that there is a two years time delay between high IMFL/EGS and lower investment rates.

IMFL/EGS correlated with GDP/IMFL

A new ratio is introduced which is GDP divided by IMFL. Given that all mechanised transport and 70% of electrical generation in Mauritius require mineral fuels, (oil based products and some coal, whilst the balance is from either hydro power or from burning bagasse, the residue of sugar cane processing) it would appear interesting to calculate how much GDP is generated, directly and indirectly for every Rupee spent on importing mineral fuels. In effect, it measures the multiplying effect on GDP of each Rupee of mineral fuels imported. Figure 9 shows how this ratio has evolved from 1964 to 2004. A link with IMFL/EGS is not immediately apparent. However when IMFL/EGS is plotted against GDP/IMFL as in figure 10, it is very surprising to see the data arranging itself in a declining arc. This implies an inverse relationship between the two variables. Indeed, when IMFL/EGS is low, GDP/IMFL is high. When IMFL/EGS rises GDP/IMFL decreases sharply in a reciprocal manner. The co-efficient of variation (R^2=0.8520) is very high. As can be seen in figure 10, the equation of best fit is an inverse power relationship. Such a relationship between these two variables was not expected.

Discussion

We have seen that the IMFL/EGS ratio has varied widely since 1966, climbing to very high levels from 1979 to 1984 which corresponds to the second oil shock. This period corresponds exactly to a period of low or non existent economic growth as can be seen in figure 11. As from 1985, oil prices begin to drop significantly, the ratio IMFL/EGS also drops significantly and from there on Mauritius embarks on a twenty year period of continuous economic growth. We are not claiming direct causality, but common sense dictates that low oil prices had a positive role to play at this point. Most probably it was a necessary condition for economic growth but of course not sufficient on its own.

We have seen that as IMFL/EGS increased, the savings rate decreased simultaneously and proportionately. Very high co-efficients of variation are not proof of causality, but they do indicate that strong causal links exist between the variables under consideration. It can be postulated that as oil prices increase and the IMFL/EGS ratio increases, more funds are devoted to paying for oil products, and so more funds leave the country, there is less money around to save, hence the savings rate drops.

We have also seen that as IMFL/EGS increases, FCE/GNDI increases in step and linearly. This is to be expected given the drop in savings noted earlier because what is not saved is consumed and what is saved is not consumed. It shows the overall consistency of the data we have analysed and of our approach. The investment rate also drops but with a two year delay and at a lesser pace than savings. The same mechanisms are at work here, less savings means less capital available for investments.

The inverse relationship between IMFL/EGS and GDP/IMFL is the most baffling, yet the same mechanisms are most probably at work. Less money around due to high oil prices means less economic activity, hence less GDP generated and so the multiplying effect of fuel imports drops.

We are now in a position to describe the impacts of high oil prices on the Mauritian economy. As oil prices increase, the cost of importing mineral fuels and lubricants increases, if the export of goods and services does not increase rapidly enough, the IMFL/EGS ratio increases. It represents an increased outflow of money for the same level of economic activity. Savings drop as a greater proportion of the national income is devoted to consumption.

This drop in savings means that after a delay of two years (approximately) investments (GDFCF) also begin to drop, albeit at a slower rate. As more money leaves the country to pay for higher oil costs, there is less money around to generate economic activity, hence for each Rupee of oil imports, less GDP is created. The GDP/IMFL ratio drops.

Using the different equations we have devised, the impacts of different levels of oil prices on savings, investments and consumption in Mauritius is shown in the table below. The CSO estimates that for 2005 EGS will be Rs 105,000 Million. The IMFL/EGS ratio is computed by keeping this value for EGS as constant and varying the value of IMFL in line with increases or decreases in oil prices. Given the average price of a barrel of oil for 2004, it is a simple matter to compute the projected IMFL for each given price of a barrel of oil.

 

 

Average Oil Prices over a year (US$ per Barrel)

IMFL

Rs Million

EGS

Rs Million

IMFL/

EGS

 GNS/GDP(mp)

Savings Rates

GDFCF/GDP

Investment rates

FCE/

GNDI

GDP/

IMFL

40

11,020

105,000

10.5%

22%

27%

78%

9

60

16,530

105,000

15.7%

16%

23%

84%

7

80

22,040

105,000

21.0%

9%

20%

90%

6

100

27,550

105,000

26.2%

3%

16%

95%

5.4

110

30,305

105,000

28.8%

0%

14%

98%

5

120

33,060

105,000

31.5%

-3%

12%

101%

4.9

 

From the above table it is seen that with oil prices below US$ 40, IMFL/EGS will be below 10.5%. Savings rate will be a healthy 22%, investment 27%, FCE only 78% of GNDI and the multiplying effect of fuel imports a healthy factor 9. It is the business as usual scenario. At a price of US$ 60 on average over a given year, Mauritius will be entering a period similar to the late seventies. It is possible that such a level, if extended over one or two years, might trigger a recession in Mauritius. Prices above US$ 80 will usher in a new era given that Mauritius has never been in a situation when 20% or more of its EGS goes into paying for IMFL. From the model, it is clear that savings will be very low, investment will fall and FCE will rise to 90% of GNDI. Mauritius will be in Terra Incognita.

As from US$ 110, savings drop to zero, investment is now very low and nearly all of our GNDI goes into FCE. Above this price level, the Mauritian people will have to eat into their accumulated savings just to satisfy the same level of consumption. For how long can such a situation last before very severe repercussions begin to unfold? How tenable can such a situation be?

It is fair to assume that a country cannot be expected to grow economically when it if forced to consume all of its income to maintain its accustomed level of consumption. It is fair to assume that the people of such a country will have to cut down their consumption in order to avoid spending past accumulated savings. Now if consumption falls to avoid depleting accumulated savings, then economic activity will fall, a contraction of economic activity will unfold.

Conclusion

A simple, yet coherent model has been proposed to model the impacts of different levels of oil prices on the Mauritian economy. As at October 2005, the average price of oil hovered close to US$ 57. It is very close to that level which can begin to have significant impacts on the local economy. How high or how low oil prices can move up to or down to is basically an unanswerable question. However, should world oil demand closely match world oil supply as appears to be the case, continued high prices or even significantly higher prices cannot be ruled out. The model shows how close we are to an oil price level where savings fall and where most of our national income goes into consumption. Any substantially higher oil prices will depress savings to very low levels. For an EGS of Rs 100 billion, oil prices higher than US$ 110 will make savings plunge to zero. All of our GNDI will go into consumption. It will be an intolerable situation for the country. Consumption will be curtailed and may even spiral downwards sharply. This will equate in a severe economic contraction. There is the distinct possibility that the economy collapses altogether. It is time for the people of Mauritius to consider what ought to be done if high prices persist on the medium term or even long term. It is not a vain pursuit. It may turn out to be one of the most vital issues the people of Mauritius have to face.

 

References:

  1. National Accounts of Mauritius, various issues from 1966 to 2004
  2. BP Annual Energy Statistical Review of 2005
  3. Bank of Mauritius Annual Reports, various issues from 1966 to 2004
  4. Table of Data used
  5. Computed Ratios

 

Glossary of Terms Used

EGS: Export of Goods and non-factor services

Exports and imports of goods are compiled according to the General Trade System, using the national boundary as the statistical frontier. All goods entering the country are recorded in imports and goods leaving the country, in exports.

FCE: Final Consumption Expenditure

Consumption expenditure is made up of final consumption expenditure of households and Government.

GDP: Gross Domestic Product

The sum of value added of all domestic producers gives the GDP

GDFCF: Gross Domestic Fixed Capital Formation

GDFCF consists of the net additions to the assets of producers of tangible reproducible goods which have an expected lifetime of use of more than one year

GNS: Gross National Savings

Gross National Disposable Income (GNDI) less total final consumption expenditure gives GNS

GNDI: Gross National Disposable Income

The sum of Gross National Income (GNI) and net transfers from the rest of the world gives GNDI

GNI: Gross National Income

GDP plus net primary income from abroad gives GNI

IMFL: Imports of Mineral Fuels and Lubricants

The Rupee value of all imports of petroleum products and lubricants and coal