Precept 7

October 3, 2013

Summary:

This paper examines options for fiscal policy frameworks in resource rich developing  countries. In doing so, it reassesses the role of the permanent income hypothesis, especially
in low-income countries seeking to tackle in frastructure and development needs by scaling
up growth-enhancing expenditure.
The paper concludes that the fiscal policy framework:
•should reflect country-specific factors, which may change over time;
•should promote the sustainability of fiscal policy;
•should be sufficiently flexible to enable scaling up growth-enhancing expenditure,
especially in low-income countries;
•should consider absorption capacity constraints and the quality of public financial
management systems;
•should provide adequate precautionary buffers in countries that are vulnerable to high
volatility and uncertainty of resource revenue; and
•could be supported by resource funds if they are properly integrated with the budget and
the fiscal policy anchor.

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October 3, 2013

Summary:

This paper provides deeper insights on a few themes with regard to the experience with macroeconomic management in resource-rich developing countries (RRDCs). First, some stylized facts on the performance of these economies relative to their non-resource peers are provided. Second, the experience of Fund engagement in these economies with respect to surveillance, programs, and technical assistance is assessed. Third, the experience of selected countries with good practices in the management of the natural resource wealth is presented. Fourth, the experience of IMF advice in helping RRDCs set up resource funds is discussed. Finally, the main themes and messages from the IMF staff consultation with external stakeholders (CSOs, policy makers, academics) are presented.

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October 3, 2013

Summary:

This paper aims to widen the prism through which Fund policy analysis is conducted for resource-rich developing countries (RRDCs). While all resource-rich economies face resource revenue exhaustibility and volatility, RRDCs face additional challenges, including lack of access to international capital markets and domestic capital scarcity. Resource exhaustibility gives rise to inter-temporal decisions of how much of the resource wealth to consume and how much to save, and revenue volatility calls for appropriate fiscal rules and precautionary savings. Under certain conditions, it would be optimal for a significant share of a RRDC’s savings to be in domestic real assets (e.g., investment in domestic infrastructure), though absorptive capacity constraints need to be tackled to promote efficient spending and short-run policies are needed to preserve macroeconomic stability. The objective of this paper is to develop new macro-fiscal frameworks and policy analysis tools for RRDCs that could enhance Fund policy advice.

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October 3, 2013

Abstract:Are natural resources a "curse" or a "blessing"? The empirical evidence suggests that either outcome is possible. This paper surveys a variety of hypotheses and supporting evidence for why some countries benefit and others lose from the presence of natural resources. These include that a resource bonanza induces appreciation of the real exchange rate, deindustrialization, and bad growth prospects, and that these adverse effects are more severe in volatile countries with bad institutions and lack of rule of law, corruption, presidential democracies, and underdeveloped financial systems. Another hypothesis is that a resource boom reinforces rent grabbing and civil conflict especially if institutions are bad, induces corruption especially in nondemocratic countries, and keeps in place bad policies. Finally, resource rich developing economies seem unable to successfully convert their depleting exhaustible resources into other productive assets. The survey also offers some welfare-based fiscal rules for harnessing resource windfalls in developed and developing economies.Access the article here

October 3, 2013

Abstract:

 A windfall of natural resources (or aid) faces government with choices of how to manage public debt, investment and the distribution of funds for consumption. The permanent income hypothesis suggests a sustained increase in consumption supported, once resources are depleted, by interest on accumulated foreign assets. However, this strategy is not optimal for capital-scarce developing economies. Incremental consumption should be skewed towards present generations. Savings should be directed to accumulation of domestic private and public capital rather than foreign assets. Optimal policy depends on the impact of distortionary taxation and ability of consumers to borrow against future revenues.

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October 3, 2013

Abstract:

This paper addresses the efficient management of natural resource revenues in capital-scarce developing economies. It departs from usual prescriptions based on the permanent income hypothesis and argues that capital-scarce countries should prioritize domestic investment. Because revenue streams are highly volatile, governments should protect consumption from shocks by increasing it only cautiously. Volatility in domestic investment can be moderated by a buffer of international liquidity, but it is also important to structure investment processes to be able to cope efficiently with substantial fluctuations. To date, most of the resource-rich countries of Africa have not had investment rates commensurate with their rate of resource extraction.

Access the article here. An earlier version of the article can be found here.

April 2, 2013

Precept 10 states that resource revenues can be used by governments to facilitate private investment for diversification as well as exploiting opportunities for increased domestic value added. The report supports the underlying statement of Precept 10, that increasing growth of the domestic economy requires a significant increase of private sector investment. In addition the report provides a number of general points specifically for resource rich countries.

Precept 9 recommends that government use resource wealth for increasing efficiency and equity in public spending. In doing so the government is required to raise the capacity for spending. As resource rich countries have a large concentration of revenues accumulating to government, the government must be able to spend that money effectively. The report provides a number of guideline recommendations on public spending.

Precept 7 states that resource revenues must foster continued high levels of domestic investment if those revenues are to promote sustainable and inclusive economic growth. A general principle of the Precept is that once it has been decided to invest, investment in public capital is particularly beneficial. The report supports this principle and places emphasis upon infrastructure investment.

The Growth Commission report analyses 13 economies which experienced sustained high growth rates for 25 years or longer. In doing so it identifies some of the characteristics of high growth economies and considers how these can be replicated. The underlying statement of the report is that growth is a necessary, albeit insufficient, condition for broader development. It is found that no country achieved sustained growth without also maintaining high rates of public investment. Such investment furthermore crowds in private investment and allows new industries to emerge. Public investment is however affected by the availability of savings, the report finding that high income economies often have a saving rate of between 20-25%. One sector which has been neglected and which the report highly recommends for public investment to reach is infrastructure.

The report also directly addresses growth in resource rich countries. The Dutch disease and fluctuating commodity prices, whilst presenting a challenge, are not insurmountable. They have not been handled well by many governments however. Extraction rights are sold too cheaply and taxation is too low whilst money accrued is stolen or wasted. As a response to these challenges the report suggests government begin by deciding how to allocate exploration and development rights and an accompanying tax regime. Once revenue is collected, government should aim to invest between 5-7% of GDP in the domestic economy. Remaining revenue ought to be invested in a politically insulated savings fund.

Access the report here.

April 2, 2013

 

At a fundamental level Precept 7 deals with the trade off between using revenues to benefit the present generation or accumulate assets to yield returns for the future generation. Once this has been decided the question arises as to how those investments are to be made. The Precept recommends for limited immediate consumption but for a substantial portion of revenues to be invested in domestic assets. Investment in foreign assets such as Sovereign Wealth Funds (SWF) is discouraged for developing countries.

Whilst most of the paper is oriented towards oil funds, the paper provides general insights on structuring laws to build revenue management institutions.

 

Precept 8 states that revenue volatility ought to be addressed through gradually and smoothly building up domestic expenditure and investment from resource revenues. Due to resource volatility spending and revenue generation ought to be decoupled through establishing a ‘Sovereign Stabilization Fund’ – similar to a SWF but with the purpose of covering short run volatility. As such the paper provides useful guidelines on the legal and institutional instruments which can support in the management of resource wealth.

 

The chapter by Bell and Faria addresses the institutional and legal issues in the management of resource wealth. The authors consider legal aspects such as integrating an oil revenue management system with international obligations as well as more political concerns such as transparency and oversight and control mechanisms. Drawing on evidence from Sao Tome and Principe the authors provide a number of recommendations for establishing an oil fund:

     - Large revenue flows ought to be deposited in major international institutions and held in a foreign currency.

     - The fund ought not to be invested in the domestic economy in order to reduce political influence.

     - An investment committee ought to be established and charged with oversight and investment policy of oil fund assets.

     - Portfolio managers ought to be responsible for carrying out the investments.

     - The use of oil resources ought also not to be used as securities for loans, instead lending should be based on credit worthiness.

In establishing a permanent fund inevitable questions arise regarding intergenerational equity, estimates about the size and value of deposits and the efficiency of expenditures. In addressing these issues evidence can be drawn from Timor-Leste, which calculated the ‘maximum sustainable annual expenditures’ by finding the present value of the resource and making available for immediate consumption the expected return on estimated value in addition to the return on the balance in the account.

Access this chapter here.

April 2, 2013

In Precept 7 a major trade-off that arises when government seeks to foster domestic investment is whether to use revenues for current expenditure or invest them in the future. As a general principle, the Precept recommends for low income countries to invest a substantial portion of revenues in the domestic economy rather than in Sovereign Wealth Funds as these are more beneficial for high income countries. The paper provides insights on some of the trade-offs which have to be made in setting up a SWF.

 

Precept 8 states that revenue volatility ought to be addressed through gradually and smoothly building up domestic expenditure and investment from resource revenues. Due to resource volatility, spending and revenue generation ought to be decoupled through establishing a ‘Sovereign Stabilization Fund’ – similar to a SWF but with the purpose of covering short run volatility. As such the paper provides useful guidelines on setting up and maintaining such a fund.

 

The paper by Bacon and Tordo provides policy makers with a reference document to be used when establishing and operating oil funds. Evidence is drawn from twelve oil funds and three mineral resource funds, taking into considering the major practical issues which arise in doing so:

     - Formalizing the objectives of the fund and placing these within the context of overall fiscal policy (whether revenue is used for current consumption, invested in non-financial assets or for purchase of financial assets).

     - Legal foundation of the fund (whether the fund is ‘virtual’, i.e commingled with other government resources, or ‘real’, i.e held separate from other government assets).

     - Rules governing the payments into and out of the fund (either savings funds and permanent income or stabilization funds and revenue volatility).

     - Arrangements for financial management of the fund (making decisions on asset class, asset managers and oversight of fund performance).

     - Nature of fund oversight (provisions for oversight at different levels).

 

The paper concludes by comparing the individual funds and creating a set of 20 good practice indicators for the design and operation of an oil fund. The indicators include:

     - Setting formal and clear rules on payments into and out of the fund.

     - Effective management of funds in order to maximize long-term returns, subject to an acceptable level of risk.

     - Establishing funds with flexible governing rules and good public support in order to adapt to changing circumstances.

     - Entrenching rules of transparency and accountability within overall management.

Access the report here.

April 2, 2013

Precept 7 states that resource revenues must foster continued high levels of domestic investment if those revenues are to promote sustainable and inclusive economic growth. This introduces the question of how those resource revenues ought to be used and consequently also of which generation has a right to those revenues. The paper considers ownership of resources and the distribution of resource revenues through dividends.

 

Wenar makes the case that the resource curse is fundamentally a result of a lack of property rights enforcement. Thus, slow growth, civil conflict and authoritarianism plague these countries. Wenar begins with the premise that each country’s people are the rightful owners of the country’s natural resources. This is often laid out in national constitutions and in international human rights treaties, yet it is often violated by authoritarian regimes or civil warriors. In considering how the benefits can be accrued by the rightful owners resource dividends are rejected as unfeasible due to a lack of incentives for doing so. Instead, existing treaties and accompanying institutions need to be employed to “bring all resource sales into the system of enforced market rules” (p. 3). This is achieved through applying two mechanisms. Firstly, litigation in the courts of the country from which the extraction companies originate. Secondly, by establishing an ‘anti-theft’ system operated by developed countries governments to punish countries which buy resources from a disqualified regime. 

Access the report here.

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