New OxCARRE working papers on resource funds, deforestation, and infrastructure

New OxCARRE research available at the website [oxcarre.ox.ac.uk]:

Anthony J. Venables ([sites.google.com] OxCARRE) and Samuel E. Wills ([samuelwills.wordpress.com] OxCARRE) write on

Resource Funds: stabilizing, parking, and inter-generational transfer

The paper explores strategies for managing revenue from natural resources, focusing on the balance between domestic and foreign asset accumulation. It suggests that domestic asset accumulation is the priority in developing countries, while there are three motives for accumulating foreign assets; inter-generational transfer, temporary ‘parking’ of funds, and stabilisation. The paper argues that the first of these is inappropriate for low income countries. The second is required if it is difficult to absorb extra spending in the domestic economy and takes time to build up domestic investment. The third is important, and depends on the extent to which the economy has other ways of adjusting to shocks.

Available here [oxcarre.ox.ac.uk, pdf].


Liana O. Anderson ([liana-anderson.org] CEMADEN), Samantha De Martino (University of Sussex), Torfinn Harding ([sites.google.com, NHH Bergen), Karlygash Kuralbayeva ([lse.ac.uk], LSE) and Andre Lima (University of Maryland)

The Effects of Land Use Regulation on Deforestation: Evidence from the Brazilian Amazon

To reduce deforestation rates in the Amazon, Brazil established in the period 2004-2010 conservation zones covering an area 1.5 times the size of Germany. In the same period, Brazil experienced a large reduction in deforestation rates. By combining satellite data on deforestation with data on the location and timing of the conservation zones, we provide spatial regression discontinuity estimates and difference-in-difference estimates indicating that the policy cannot explain the large reduction in deforestation rates. The reason is that the zones are located in areas where agricultural production is likely to be unprofitable. We also provide evidence that zones reduce deforestation if the incentives for municipalities to reduce deforestation are high. We rationalize these finding with a spatial economics model of land use, with endogenous location of conservation zones and imperfect enforcement. Our findings point to the need for other explanations than the conservation zones to explain the sharp decline in deforestation rates in the Brazilian Amazon since 2004.

Available here [oxcarre.ox.ac.uk].


Rabah Arezki ([rabaharezki.com], IMF) and Amadou Sy ([brookings.edu] Brookings Institution)
Financing Africa’s Infrastructure Deficit: From Development Banking to Long-Term Investing

This paper studies the appropriate financing structure of infrastructure investment in Africa. It starts with a description of recent initiatives to scale up infrastructure investment in Africa. The paper then uses insights from the literature on informed vs. arm’s length debt to discuss the structure of infrastructure financing. Considering the differences in investors’ preferences that Africa faces, the paper argues that continent’s success to fill its greenfield and hence risky infrastructure gap hinges upon a delicate balancing act between development banking and institutional long-term investment. In a first phase, development banks which have both the flexibility and expertise should help finance the riskier phases of large greenfield infrastructure projects. In a second phase, development banks should disengage and offload their mature brownfield projects to pave the way for a viable engagement of long term institutional investors such as sovereign wealth funds. In order to promote an Africa wide infrastructure bond markets where the latter could play a critical role, the enhancement of Africa’s legal and regulatory framework should however start now. 

read on here [oxcarre.ox.ac.uk].

FT: Oil: From boom to bailout

The FT published an in-depth article about how some countries are coping, and addressing, the recent fall of commodity prices, in particular fossil fuels.

Cheaper crude means many developing countries will take longer to catch up with advanced economies

The problem, says Mr Basu [World Bank chief economist], is that too many producing countries are in denial about the shift or the potential remedies — and are afraid of the political consequences. “It will be very difficult. There’s no getting away from it,” he says.

Yahoo/Bloomberg: Norway to World: We're Sitting Out the Big Wealth Fund Selloff

Yahoo/Bloomberg have a piece in which Egil Matsen (new deputy central bank governor in charge of oversight of the investor and head of the department of economics at NTNU) discusses the strategy of Norway's Sovereign Wealth Fund in the current downturn of oil and equity markets. The strategy? Keep calm and carry on as if nothing is happening.

Read on here [yahoo.com].

Sovereign Wealth Funds in the New Era of Oil

OxCARRE associate Rabah Arezki and colleagues Adnan Mazarei, and Ananthakrishnan Prasad from the IMF, and also available on the IMFDirect blog here, write on

Sovereign Wealth Funds in the New Era of Oil

By Rabah Arezki, Adnan Mazarei, and Ananthakrishnan Prasad 

As a result of the oil price plunge, the major oil-exporting countries are facing budget deficits for the first time in years. The growth in the assets of their sovereign wealth funds, which were rising at a rapid rate until recently, is now slowing; some have started drawing on their buffers.

In the short run, this phenomenon is not cause for alarm. Most oil exporters have enough buffers to withstand a temporary drop in oil prices. But what will happen if low oil prices persist, and how will policymakers react?

We explore here the fallout from low oil prices on sovereign wealth funds in oil-exporting countries and find that that they have important domestic implications. The impact on global asset prices will depend on the extent to which the unwinding of oil exporters’ sovereign wealth funds is not compensated by portfolio adjustment in other parts of the world.

The rise of sovereign wealth funds

In the early 2000s, high oil prices brought about a massive redistribution of income to oil exporters, resulting in current account surpluses and a rapid buildup of foreign assets. Governments established new sovereign wealth funds or increased the size of existing ones to help manage the larger pool of financial assets.

The total assets of sovereign wealth funds are concentrated in a few countries. As of March 2015, it is estimated at $7.3 trillion, of which $4.2 trillion are oil and gas related. While there are large differences across sovereign wealth funds, available information on their asset allocation points to a significant share in equities and bonds. 

Oil prices and the redistribution of global income

With high oil prices throughout the 2000s, the aggregate current account balance of exporters reached about $630 billion in 2011, exceeding that of emerging Asia combined. The current account surpluses of oil exporters are vanishing in 2015, however, and it is unlikely that this decline will reverse soon. On current projections, their combined current account balances could recover to about $200 billion in 2020.

In contrast to the 2000s, the recent oil price drop has been driven mainly by supply factors  that may lead to a decoupling of the paths of asset accumulation between these two groups of sovereign wealth funds. The rate of asset accumulation by sovereign wealth funds in emerging Asia—mostly oil importers—is likely to rise but it will likely decline for the funds in oil-exporting countries. Of course, much will depend upon the strategic asset allocation choices made by the largest sovereign wealth funds in the low oil price environment.

Impact on global asset markets

The overall impact of the fall in oil prices on asset prices will depend on whether oil importers have a lower marginal propensity to save than oil exporters. The fall in oil prices tends to transfer wealth from oil exporters to high-saving emerging Asian countries—but also to many other countries, including large advanced economies, some of which have a low propensity to save. From a global perspective, this implies lower global saving and higher interest rates. 

Precisely how much the savings of the sovereign funds of oil producers decline depends, of course, on changes in their fiscal and external current account balances. Sovereign wealth funds’ market operations will also depend on how much their governments opt to borrow or draw on their fiscal buffers, including those kept with sovereign wealth funds. Saudi Arabia issued its first sovereign bonds since 2007 to local banks to finance its fiscal deficit.

In addition, oil-exporters’ sovereign wealth funds are significant holders of U.S. treasury debt and private equity. Our back-of-the-envelope calculations show that, prior to the oil price decline, countries of the Gulf Cooperation Council (GCC) alone were projected to have a combined fiscal surplus of about $100 billion in 2015 and of about $200 billion between 2015 and 2020, but are now likely to reach a combined deficit of $145 billion in 2015 and over $750 billion in 2015-20. This implies change in net assets available to sovereign wealth funds in the GCC alone of $250 billion in 2015 and $950 billion in 2015-20.

Considering the expected tightening in U.S. monetary policy—especially against the background of concerns about market liquidity, increasing risk aversion, and falling reserve holdings by some emerging markets—a substantial change in the path of asset accumulation by sovereign wealth funds will likely have a direct effect on financial markets.

A study by economists at the Federal Reserve has shown that if foreign official inflows into U.S. Treasuries were to decrease in a given month by $100 billion, five-year Treasury rates would rise by about 40 to 60 basis points in the short-run, with a long-run effect of about 20 basis points.

Domestic implications

What does all this mean for the accumulation of sovereign wealth in oil-exporting countries, at least in the medium term?

The low price environment is likely to test the relationship between governments in oil-exporting countries and their sovereign wealth funds. Absent cuts in public expenditures, governments will likely be transferring less revenue than before to these funds. At the same time, pressures to draw down on sovereign wealth funds’ assets will probably rise.

Among Middle East oil exporters, only the United Arab Emirates, Qatar, and Kuwait’s fiscal buffers will last for over 25 years on current fiscal plans and oil price projections, according to our estimates. Bahrain and Yemen will exhaust them in the next two years, while most other countries will run out of buffers in four to seven years.

Even though they’ll still be able to borrow to finance their spending, governments of these oil-exporting countries would probably do well to tighten their belts if they hope to achieve the dual objective of sharing oil wealth equitably with future generations and economic stabilization.

Sovereign investor models. A new report.

From the Harvard Kennedy School and Center for International Development at Harvard University, a new report has coming out by Khalid A. Alsweilem (The Belfer Center for Science and International Affairs Harvard Kennedy School), Angela Cummine (British Academy Post-doctoral Fellow University of Oxford), Malan Rietveld (Investec Investment Institute & The Center for International Development Harvard Kennedy School) and Katherine Tweedie (Investec Investment Institute).

Sovereign investor models: Institutions and policies for managing sovereign wealth

The primary aim of the report is to identify the leading practices among existing funds and establish an analytical framework for assessing the critical policy and institutional aspects that legislators, policymakers and practitioners need to consider in establishing a new SWF or reforming an existing one.

The authors credit the academic research and experts they've used to write report, which includes work from people at OxCARRE. 

NRGI: "Why Sovereign Wealth Funds Should Not Invest at Home"

Over at NRGI an interesting post from Andrew Bauer [linkedin.com] on the allocation of SWF funds for investing abroad or at home.

SWFs, as savings mechanisms for macroeconomic management, should not be the vehicles of such direct spending. If there is under-investment in the domestic economy, a far better way to remedy the situation is to enact fiscal rules that allocate resource revenues more appropriately between the budget and a SWF.

This reminds me to our experience during the Workshop in Azerbaijan [oxcarre.blogspot.com], where its Fund SOFAZ is allocated the duty to spend and invest on projects that one typically would find in the government budget.

Read on here [resourcegovernance.org], or here [blog-pfm.imf.org].

New Research: On the relationship between resource funds, governance and institutions

New research from Stella Tsani (repec), of the The Centre for Euro-Asian Studies, University of Reading,

On the relationship between resource funds, governance and institutions: Evidence from quantile regression analysis

abstract:

This paper uses quantile regression estimation techniques so as to investigate the relationship between resource funds, governance and institutional quality by paying special attention to the distribution of the latter. The estimation results indicate that resource funds are associated with better governance and institutions. The positive correlation is identified for the entire distribution of governance and institutional quality variables indicating that resource-rich countries can benefit from the establishment of resource funds, irrespective of whether they are found at the lower or at the upper end of the ranking of governance and institutional performance. The results offer evidence in support of the view that resource funds are valid tools of insulation against the “resource curse” as manifested through governance and institutional quality deterioration. Resource funds may support policy making and strengthen governance and institutional formations not only in countries with good governance and institutions but also in countries which lag behind in the latter.

Paper published in Resources Policy [sciencedirect.com], it follows up on an earlier paper [sciencedirect.com] of her also published in Resources Policy.

FT Special report on Azerbaijan

Since our visit to Baku [oxcarre.blogspot.com] a few weeks ago, we gained additional interests in the developments in Azerbaijan. Today, the Financial Times issued a Special Report on the country. available here [FT.com], with the main tag line:
Reform offers the best hope for national stability

Everybody loves SWF

FT's Gillian Tett comments [FT.com] on the sudden popularity of Sovereign Wealth Fund constructs, including among western countries. She notes in particular that the UK Treasurer Osborne announced to set up one in his autumn statement [FT.com]:

we’re announcing a new Sovereign Wealth Fund for the North of England so that the shale gas resources of the North are used to invest in the future of the North.

The revenues of shale gas are for now still largely illusionary. The question why the UK didn't set up a SWF for for their real revenues from the North sea was discussed in the Guardian [oxcarre.blogspot.com] not too long ago. On the OxCARRE [oxcarre.ox.ac.uk] website you'll find further research on Sovereign Wealth Funds and optimal savings of commodity export revenues.

New OxCARRRE Research: Emergence of Sovereign Wealth Funds

Newly posted at the OxCARRE Research papers, from Jean-François Carpantier (University of Luxembourg) and Wessel Vermeulen (OxCARRE)

Emergence of Sovereign Wealth Funds

Abstract:

This paper tests the theoretically founded hypothesis that the surge of SWF establishments is determined by three main factors: 1) the existence of natural resources profits, 2) the government structure and 3) the ability to invest usefully in the domestic economy. We test this hypothesis on a sample of 20 countries that established an SWF in the period 1998-2008 by comparing them to the roughly 100 countries that did not set up a fund in the same period. We find evidence for all three factors. The results suggest that SWFs tend to be established in countries that run an autocratic regime and have difficulties finding suitable opportunities for domestic investments. We do not find the net foreign asset position of a country to be similarly related to the explanatory variables, indicating that the establishment of an SWF is distinct from a national accounting result. We argue that our results indicate that it is relevant to study how an SWF interacts with the domestic economy and government policy.