New Research: Do Resource-Rich Countries Suffer from a Lack of Fiscal Discipline?

Michael Bleaney [University of Nottingham] and Håvard Halland [World Bank] write on

Do Resource-Rich Countries Suffer from a Lack of Fiscal Discipline?

Abstract:

Fiscal indicators for resource-rich and resource-poor lowand middle-income countries are compared using annual data from 1996 to 2012. Resource richness is defined by export composition: fuel greater than a 25 percent share and/or ores and metals greater than a 10 percent share. Fuel exporters have a significantly better general government fiscal balance than the rest of the sample, and higher revenues and expenditures, which are approximately evenly split between extra consumption expenditure and extra capital expenditure. Only about a quarter of their extra revenue goes into extra consumption expenditure, and this proportion has been lower since 2005. Fuel exporters’ expenditure reacts with a lag to oil price fluctuations. There are no significant differences between ores and metals exporters and resource-poor countries, or between new and old resource exporters, in aggregate expenditures and revenues. Ores and metals exporters spend more on investment and less on government consumption. Some individual country cases are briefly discussed. 

A paper from the World Bank's Governance Global Practice Group, Policy Research Working Paper 7552, available here [pdf, worldbank.org]

New OxCARRE Research: Using Natural Resources for Development: Why Has It Proven So Difficult?

OxCARRE's Director Tony Venables writes on

Using Natural Resources for Development: Why Has It Proven So Difficult?

Forthcoming in the Journal of Economic Perspectives

Abstract

Developing economies have found it hard to use natural resource wealth to improve their economic performance. Utilising resource endowments is a multi-stage economic and political problem that requires private investment to discover and extract the resource, fiscal regimes to capture revenue, judicious spending and investment decisions, and policies to manage volatility and mitigate adverse impacts on the rest of the economy. Experience is mixed, with some successes (such as Botswana and Malaysia) and more failures. This paper reviews the challenges that are faced in successfully managing resource wealth, the evidence on country performance, and the reasons for disappointing results. 

Available from the OxCARRE website, here [pdf]

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.

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.

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].

Sliding oil price and the solvency of governments

As the oil price continues to slide to lower levels, the potential effects on government finances becomes more evident, especially since the slide does not appear very likely to be reversed majorly [FT.com] in the near future. (Opec did not cut [FT.com], but the major new supply from unconventional oil in North America such as fracking and the Canadian oil sands is not profitably at the current levels. It is only natural that the this new production will be cut [econbrowser.com] if prices do not increase for other reasons.)

One major difference in how countries may handle this new reality comes from their exchange rate regime. Although the Russian rouble appears to be impacted most [FT.com], or at least receives the most attention, all currencies of oil exporting countries with flexible exchange rates have been tracking the fall of the oil price [FT.com]. In fact, the Russian central recently stopped defending the currency against depreciation recently making it in fact more free floating than previously. The fall in real revenues in terms of their domestic currencies is mitigated by the depreciated currencies. Since governments have a major part of their expenses in the local currencies, the impact of the fall in oil price is partially offset by simultaneous nominal exchange rate depreciation. However, debts to external creditors, in particular those denominated in foreign currency, will become harder to finance. So even countries with floating exchange rates will probably make some adjustments to their budgets.

In contrast, the Venezuelan Peso is fixed against the US dollar. As the central government is heavily reliant on the oil revenues for squaring its budget, the impact of the oil price is stronger [FT.com] relative to the floating exchange countries. Prices of it's bonds have tumbled, reaching an annual yield of close to 20%. Venezuela is reported as having argued the most strongly for an OPEC production cut in order to support the price, but countries that argued for this lost the decision as OPEC decided to leave production unchanged [FT.com].

It should be noted that the oil price dynamics functions more like a looking glass that reveals the true characteristics of governments and an economy. Although Norway may have to make some changes in their budget, their massive savings funds allows them any adjustment to be smooth and balanced. The decisions to manage revenues in this way have been taken years ago, exactly to account for a volatile oil price. The recent Russian assertiveness into its western neighbours, with the EU and US response just adds to the nervousness of the economic prospects. That Venezuela has been mismanaged for years becomes only clearer as the government runs out of cash to finance its unfortunate welfare programs.