by Franklin Bendu
Sierra Leone is an interesting case in mineral sector development in a post-conflict country where it is trying to attract investment whilst as the same time facing the challenge of ensuring it gets a fair share of the resource rent generated. The end of the civil conflict in 2002 coincided with the start of high prices of minerals which lasted from 2003 to 2010. Though mineral exports accounted for over 75 percent of merchandise exports, mineral revenue has contributed on average 4.6 of domestic revenue between 2003 and 2014. According to the
United Nations Conference on Trade and Development (UNCTAD), “the potentially most important direct contribution from mineral extraction is the rise in host-country income, much of which takes the form of government revenue” (UNCTAD, 2007). However, developments in the mineral sector over the past year has meant the contribution of the mineral sector has fallen dramatically in 2015. The two iron ore mines are now under new ownership and unlikely to produce in 2015, and the only large scale diamond company has stopped operation because of shortage of working capital.
The change from 2013 to present could not have been more different. Gross Domestic Product (GDP) grew by 21.3 percent in 2013 and is forecast to fall to 6.6 percent in 2015, mainly as a result of developments in the mineral sector. Mining contribution to GDP was 18 percent in 2013 and is forecast to drop to 3.6 percent in 2015. In 2013, mineral export was US$1.4 billion (91 percent of merchandise exports), but this is forecasted to fall to US$247.9 million in 2015. Mineral revenue as a proportion of domestic revenue was almost 10 percent in 2013 and is forecast to fall to less than 5 percent in 2015. Why has it come to this? The blame cannot be solely placed on the government. First the outbreak of the EVD in 2014 have had an adverse impact on economic activities including the mining sector. However, the main underlying factors are the fall in price of iron ore which has affected the cash flow of the two iron ore companies and the inability to attract capital for further expansion.
One of the main benefits from mineral endowment is the wealth that can be created through taxation. The issue of low tax revenue from the mineral sector is not peculiar to Sierra Leone as many mineral rich countries have been unable to translate mineral wealth to mineral revenue through taxation. To ensure that government as the owner of mineral resources is able to generate a fair share of the resource rent from the extraction of its mineral wealth, three key issues are important: First, the design of effective mineral taxation policies and ensuring its proper implementation. Second, it is important that government get the right type of investors into the mineral sector. Third, there has to be the political will and institutional capacity to monitor the operations of the mineral sector.
There are currently five large scale mining companies in Sierra Leone and each has a mining agreement with government. These different agreements have various fiscal provisions which for all intent and purpose has led to government not getting a fair share of the resource rent generated. A case in point is the Sierra Rutile Agreement which was signed in 2002 but re-negotiated twice in two years. By 2004, the royalty rate had been reduced from 3.5 percent to 0.5 percent. To translate this into revenue, between 2006 and 2014, total rutile exports amounted to US$620 million. Royalty payments from the company has amounted to just over US$3 million. If the royalty rate of 3.5 percent was applied, royalty rate would have been over US$ 22 million.
Mineral extraction is capital intensive and as such it is very important that the right type of investors operate in the sector. However, making sure that this happens depend on the decision relating to the award of production licenses and the due diligence checks undertaken by government on prospective investors. Frequently, government officials make the argument that after the civil conflict, it was difficult to get investors into the mineral sector and as such those that took the risk to invest have to be rewarded through investment incentives and fiscal concessions. The capacity of the mining companies is very important, especially when the price of minerals are falling as they are at the moment. What has happened in Sierra Leone over the years is that the country has been unable to attract established mining companies into the mineral sector. In Guinea, there is Vale mining iron ore, whilst in Liberia three is BHP Billiton and ArcelorMittal in their iron ore sector. These companies because of their size are much more able to cope with falling prices. In Sierra Leone, the two main iron ore mining companies are under new owners as both went into administration in 2014 and 2015. At the moment, production of iron ore is at a standstill the current iron ore price level is not enough to cover their operational cost. No production also means no royalty payment for government. The diamond mining company is also facing severely challenges in attracting capital for its underground kimberlite operations as it had exhausted the open pit reserves. Again no production of diamonds means no revenue for government.
Another key issue is the lack of technical capacity in government institutions responsible for overseeing the operations of the mining companies. The National Revenue Authority has an Extractive Industry Unit but is grossly understaff to undertaken any meaningful forensic audit on the financial statements of mining companies. In all of this, it is imperative that there is the political will to ensure the enabling environment that will not only attract investment into the sector but also ensure the existing legislations are implemented.
Impact on the economy
The challenges facing the iron ore and diamond sub-sectors have already impacted on government, employees and local businesses in the country. Due to their inactivity, royalty payments from the mineral sector will reduce substantially in 2015. Local employees have been made redundant with its attendant consequences on their families. Local businesses are also owed tens of millions of dollars in outstanding obligation from these companies. In Sierra Leone, local businesses access loans from commercial banks at very high interest rates. As such, failure by these mining companies to make timely payments to these businesses imposes additional repayment cost to the banks and affects their credit history.
The way forward
Some issues worth considering going forward include: First, government should recognise that mineral endowment is finite and hence the need to establish the enabling environment to attract the right type of investors; second, taxation instruments are the main vehicle for generating revenue for government and as such it is important for the provisions in the mineral agreements to be in line with existing legislations governing the sector; third, the political will to ensure laws are implemented; and fourth, the need to invest in institutional capacity.
Franklin Bendu is a PhD researcher at IDS working on governance and taxation in Sierra Leone.