Bacon, R., and Tordo, S., (2006) ‘Experiences with Oil Funds: Institutional and Financial Aspects’

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.

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