Sierra Leone, one of the world’s poorest countries, is at a fascinating historical juncture whereby the decisions made by the re-elected government will determine the opportunities available to its next generation. Having experienced stable but unspectacular growth in the decade since the civil war, the nation is on the cusp of a natural resources boom. This could be the catalyst for Sierra Leone’s rapid development but sadly, as is the case in many other African states, it could also be the main restraint to that development.

This CAI paper explores the challenges Sierra Leone faces in ensuring that a historical opportunity is utilised, and the many downsides of natural resource booms are avoided. Although this paper is specific to Sierra Leone, similar observations are applicable to many other resource-rich developing countries, including many of Sierra Leone’s regional neighbours.

History of Sierra Leone’s mineral sector

Sierra Leone’s history aptly illustrates the term ‘resource curse’, which development experts use to describe how citizens of countries well endowed with natural resources often suffer lower living standards than those without such resources. From the discovery of diamonds in 1930, exploitative practices have dominated the governance of such resources in Sierra Leone.

Under British colonial administration, a monopoly over mineral rights in Sierra Leone was granted to the Sierra Leone Selection Trust (SLST), a wholly owned subsidiary of the Consolidated African Selection Trust, for 99 years from 1935.⁽²⁾ The terms of the agreement required a rental fee of just £7,500 (US$ 11,000 today) per annum to be paid to the colonial administration and a corporate profits tax of 27.5%.⁽³⁾

Unfortunately, the granting of independence in 1961 did not lead to Sierra Leone’s mineral wealth trickling down to its people. In fact, there was a distinct decline in living standards relative to other states over time, primarily caused by deeply inappropriate governance under the long dictatorship of Siaka Stevens. Corrupt deals allowed cronies and business associates of Stevens privileged access to mineral resources, following the nationalisation in 1971 of SLST.⁽⁴⁾ Whilst Stevens retired in 1985 as a billionaire, his people were among the poorest in the world.

The civil war and after

The civil war in Sierra Leone lasted from 1991 to 2002, against a background of a general economic collapse which had swept the country by the early 1990s. The Revolutionary United Front (RUF) exploited diamonds and gold in the south and east of the country to finance a militia comprised of previously unemployed youths left idle from the collapse of the state education system in the 1980s.

In the decade since the civil war ended, Sierra Leone has experienced stable but unspectacular growth, leaving it near the bottom of the United Nation’s Human Development Index.⁽⁵⁾ However, the country’s mineral and petroleum reserves offer an opportunity to create a peaceful and prosperous future, especially due to the generally high commodity prices of the last decade.

Sierra Leone’s natural resources sector

The diamonds for which Sierra Leone is famous are still an important contributor to exports, employment and government revenues. However, iron ore now holds the most promise for the country, with the recent development of two large iron ore mines, Tonkolili and Marampa, having the potential to transform the economic structure of the country. Production from these two mines has been primarily responsible for gross domestic product (GDP) growth of 15% in 2012 and a predicted 13% in 2013, according to the International Monetary Fund (IMF).⁽⁶⁾

Although these growth rates are forecast to moderate, there is the potential for other large mines to develop as there is still significant exploration and prospecting taking place in the country. Alongside diamonds and iron ore, Sierra Leone has respectable deposits of rutile, bauxite and gold, all of which it is currently exporting.

Another significant area of promise stems from the potential for offshore petroleum deposits, and Sierra Leone could join its fellow West African states, Ghana and Nigeria, in developing an oil industry. Exploration in recent years has revealed that some fields may be commercially viable and companies including African Petroleum, Anardarko, Chevron and Tullow Oil are now actively involved in this sector.

The upcoming challenges

These developments pose huge challenges to Sierra Leone’s government due to the developmental challenges intrinsic to large natural resources sectors. Challenges range from the increased opportunities for corruption to the need for a high number of technically qualified staff able to manage different aspects of the natural resources sector.

A major challenge facing Sierra Leone is the existence of generous agreements for the biggest mining companies in the country, all of which contradict the 2009 Mines and Minerals Act.⁽⁷⁾ This includes incentives such as corporate tax holidays, relief from import duties, and relatively generous royalties. Despite such incentives, the country has so far been unsuccessful in attracting any major international mining company to invest in the country.

In recent years, there have been attempts on behalf of Ernest Bai Koroma’s government to renegotiate mineral resources agreements, some of which have been successfully renegotiated in favour of the government. However, these agreements are far from ideal. With support from the fiscal affairs department of the IMF, the Ministry of Finance and Economic Development (MoFED) has been drafting an Extractive Industries Revenue Act to establish fiscal terms for both mining and petroleum.

Even if the government gets such a crucial reform through parliament, there are serious concerns about its ability to collect revenues. International mining companies are notorious for using sophisticated accounting practices to minimise their taxable income. This includes, but is not restricted to, transfer mispricing, the extensive use of tax havens and false invoicing. Perhaps the most worrying of these issues is the extent of tax havens used by the major mining companies operating in Sierra Leone.⁽⁸⁾ Tax havens include Bermuda, British Virgin Islands, Guernsey and Jersey.⁽⁹⁾ There are also very serious suspicions over the low prices being reported by mining companies and on which Sierra Leone’s royalty revenue depends.

To mitigate this, Sierra Leone needs aggressive and capable authorities overseeing the sector. Despite substantial British Government assistance, Sierra Leone’s tax authority lacks capacity and is yet to establish a unit focussing on mining companies. This is symptomatic of MoFED’s lack of senior-level focus on mining revenue issues in recent years.

The newly established National Minerals Agency (NMA) is responsible for administering mineral licences and generally overseeing non-fiscal aspects of minerals governance.⁽¹⁰⁾ Although it contains a cadre of committed and professional staff, there are serious organisational and financial issues which may constrain its effectiveness. The Ministry of Mines and Mineral Resources, which is charged with overseeing the NMA and conducting mining policy more generally, is short of expertise.

A symptom of the Sierra Leonean Government’s dysfunction is the country’s recent suspension from the Extractive Industries Transparency Initiative (EITI), a global civil society initiative which aims to reconcile payments reported by companies with revenues recorded by governments.⁽¹¹⁾ Sierra Leone’s temporary suspension occurred after it failed to become EITI compliant by a December 2012 target.⁽¹²⁾

A longer-term challenge to efficient government is the threat of ‘state capture’ by powerful interests. This is a particular threat due to the enormous importance to the country of just one or two companies, which may feel they hold the balance of power in negotiations, especially if they have extensive financial interests in other countries. This concern is magnified by the reputation and history of the country’s key investor, Frank Timis, a controversial Romanian-Australian businessman who chairs African Petroleum and Sierra Leone’s largest iron ore miner, African Minerals.

Managing the revenue

Even if we make the optimistic assumption that Sierra Leone is able to effectively collect revenues, there is still the problem of the fiscal management of the upcoming surge in revenues. Although revenues from the mining sector can provide the funds for essential investments in infrastructure, education and healthcare, there are several interrelated macroeconomic and fiscal dangers inherent in growing mineral revenues.

One concern is that the dramatic increase in government revenues will lead to spending beyond the economy’s absorptive capacity, referring to the government’s ability to spend on productive projects. This can lead to white elephant projects such as national stadiums or spending sprees on items such as presidential jets. Even in apparently productive sectors such as education or healthcare, there could be unproductive spending, such as the purchase of luxurious ministerial vehicles.

A related concern focuses on the volatility of mineral revenues, stemming from variations in both the production and prices of Sierra Leone’s minerals. Production can vary due to financing and infrastructure problems, whilst minerals prices are subject to global economic forces. This can lead to either expenditure varying dramatically on a year-on-year basis, or public debt rising dramatically.

There are also non-fiscal macroeconomic concerns which can threaten economic progress. One well-known phenomenon is the unemployment which results in other export sectors of the economy due to exchange rate effects from the mining boom. Currency appreciation caused by demand for domestic currency makes other export sectors uncompetitive, thus causing unemployment in those industries. As these other sectors may be more labour intensive than mining, these job losses won’t be mitigated by new opportunities emerging in the mining sector.

As these are well recognised challenges faced by resource-rich economies, significant consideration has gone into devising fiscal structures which can effectively convert revenues from the mining sector to productive expenditure. Domestically, there has been some consensus that natural resource revenues should be diverted towards identified national priorities such as infrastructure, healthcare and education. However, this does not by itself protect against the dangers discussed above.

Therefore, with IMF assistance, there have been discussions over what fiscal rules to put in place with the intention of ‘smoothing’ expenditure so that spending increases at a predictable and sustainable pace. This will involve the creation of a fund that receives mineral revenues, at least during periods when mineral revenues are high, and thus protects the budget.

Many other African states have set up similar funds for a variety of purposes. Angola, Ghana and Nigeria have all recently launched sovereign wealth funds (SWFs).⁽¹³⁾ A key motivation is revenue/price stabilisation, with funds flowing from the SWFs into the fiscal purse in periods of revenue/price shortfalls. However, another motivation stems from the recognition that the mineral and petroleum revenues financing the SWFs are finite, and that part of the revenues should be saved for future generations. This is a controversial idea for some when current poverty levels are considered.

There are serious concerns that whatever solutions are devised will be in vain, as politicians and civil servants seek to divert expenditure to their own ends. In a country with limited checks and balances, and with a weak history of democratic participation and parliamentary oversight, opportunities for corruption will proliferate. There are other, more subtle ways to ensure that Sierra Leone benefits from the foreign-owned mining sector within its borders. One of these involves identifying sections of the minerals value chain and capturing some of that within the country. More specifically, this means identifying opportunities for Sierra Leonean workers and firms in processing and refining ore, and providing energy, water, logistics and information technology services, amongst others. This could lead to substantial mining-related profits and employment.

However, it is also necessary to diversify the economy so that it is not excessively dependent on mining and petroleum. Sierra Leone has great potential for tourism due to its green landscape and beautiful beaches, forestry and agriculture. The finite nature of its minerals and petroleum reserves makes planning for their depletion a shrewd move.

Conclusion

Many of the dangers caused by policy mistakes and mismanagement are outlined above. However, they co-exist with Sierra Leone’s youthful and growing population, with 45% of Sierra Leoneans under the age of 15.⁽¹⁴⁾ This youth bulge could be the basis for economic growth if youth are properly utilised in paying jobs. However, if youth unemployment is allowed to fester at a time when sections of the country are getting rich, social tensions could increase dramatically, with disgruntled young men being used as agents of conflict, as has occurred in the past.

The coincidental timing of Sierra Leone’s minerals boom with a young population entering the workforce makes the next few years particularly critical in ensuring the country’s future. If it can manage the next few years wisely, Sierra Leone will make rapid strides towards middle income status. If not, an equally rapid decline is far from inconceivable, as Sierra Leone’s own history perfectly demonstrates.

Written by Steve Macey ⁽¹⁾

NOTES:

(1) Contact Steve Macey through Consultancy Africa Intelligence's Finance & Economy Unit (finance.economy@consultancyafrica.com). This CAI discussion paper was developed with the assistance of Ingi Salgado,and was edited by Nicky Berg.
(2) Kargbo, J., 2013. “The Mining sector and growth in Sierra Leone: Lessons for the future”, in Johnson, O.E.G. (ed.). Economic challenges and policy issues in early 21st century Sierra Leone. International Growth Centre and Bank of Sierra Leone.
(3) Ibid.
(4) Ibid.
(5) United Nations Development Programme (UNDP) website, http://hdr.undp.org.
(6) International Monetary Fund (IMF) website, http://www.imf.org.
(7) Sierra Leone Ministry of Mines and Mineral Resources website, www.slminerals.org.
(8) Dieckmann, S., ‘Not sharing the loot: An investigation of tax structures and corporate structures in the mining industry of Sierra Leone’, DanWatch, 3 October 2011, http://www.nmjd.org.
(9) Ibid.
(10) Sierra Leone Ministry of Mines and Mineral Resources website, www.slminerals.org.
(11) Extractive Industries Transparency Initiative (EITI) website, http://eiti.org.
(12) Ibid.
(13) ‘The boom in African sovereign wealth funds’, African Development Bank, 2013, http://www.afdb.org.
(14) ‘World Population Prospects, the 2010 revision’, United Nations, 2010, http://esa.un.org.