Country Evidence and Assessment of Operational Effectiveness

The assessment of oil funds in this section is based on a qualitative analysis of country cases, with a focus on recent experience. The performance of funds is looked at mainly from an operational perspective, focusing on the following: operational rules, integration with the budget, asset and liability management, and transparency.

Operational Rules: Rigidity Versus Flexibility

Many oil funds have relatively rigid operational rules for the deposit and withdrawal of resources.⁴

• Many oil stabilization funds have or have had price- or revenue-contingent deposit and/or withdrawal rules (e.g., Algeria, I.R. of Iran, Libya, Mexico, Russia, Trinidad and Tobago, and Venezuela).

• Most saving funds are revenue-share funds, where a predetermined share of oil or total revenues is deposited in the fund (e.g., Equatorial Guinea, Gabon, and Kuwait).

• By contrast, only a few funds are financing funds, where the operations of the fund are linked directly to the budget’s non-oil deficit (in Norway and Timor-Leste).

The introduction of funds with rigid rules has been based mostly on the expectation that removing “high” oil revenues from the budget would help moderate and/or make expenditures more stable, and would reduce policy discretion. However, rigid operational rules can be inconsistent with actual fiscal policy, particularly if the government is not liquidity constrained (e.g., if it can borrow to fund higher spending). The specification of proper and financially and politically sustainable operational rules has often been complicated by difficulties in identifying permanent and temporary components of oil price changes (Barnett and Vivanco, 2003) and by political economy factors. In addition, an emphasis on oil fund gross assets should not detract attention from assessing the government’s overall net financial position.

A number of countries have dealt with rigid accumulation rules by changing, bypassing, or eliminating them. Tensions have often surfaced in the operation of rigid rules, particularly in situations of significant exogenous changes, shifting policy priorities, or increased spending pressures, or because of broader asset and liability management objectives. In the 1980s and 1990s, the operating rules of funds in the U.S. state of Alaska, the Canadian province of Alberta, and Oman, Papua New Guinea, and other countries were changed, in some cases several times. Some countries (e.g., Kazakhstan, Russia, and Trinidad and Tobago) adjusted upward the reference oil prices that govern deposits to and withdrawals from their oil funds, or changed the revenue base in response to the sustained increase in international oil prices. Mexico’s legislature authorized the depletion of its oil fund in 2002. Venezuela has changed the operating rules of its stabilization fund several times since its creation and suspended its operation for an extended period. Gabon has yet to comply fully with provisions to set aside part of its oil revenue in its Fund for Future Generations. Chad, Ecuador, and Papua New Guinea found their funds operationally or politically unworkable and abolished them.⁵

Provisions for the use of oil fund resources have also been used to moderate the effects of rigid accumulation rules. In several countries, the rules allowed discretionary transfers from the oil fund to the budget (e.g., Bahrain and Libya). In Algeria, the oil fund’s deposit and withdrawal rules were based on a conservative reference oil price of US$19 per barrel between 2000 and 2005, but the authorities simultaneously issued debt to finance the budget, which was then serviced by the oil fund (the spread between the higher interest rate paid on debt and the returns on oil fund assets representing a cost to the government).

Some oil funds have had their resources earmarked for specific purposes. Some earmarking provisions have been based on political economy considerations, such as creating a constituency supportive of the oil fund (e.g., Alaska), making it easier to resist political pressures to use oil revenues inappropriately, or prioritizing the use of resources for special purposes, such as poverty reduction or debt service (e.g., Azerbaijan, Chad, and Ecuador). Earmarking would, in principle, help limit the discretionary powers of governments to reallocate spending inappropriately. However, earmarking also results in resources being placed outside the allocative budget process, which can reduce flexibility, complicate liquidity management, and affect the efficiency of government spending (Potter and Diamond, 1999). In the absence of liquidity constraints, the impact of earmarking is also uncertain because resources are fungible.⁶

• In Alaska, the oil fund pays annual dividends to the population, partly as a safeguard against pressures to spend the oil revenue. In practice, the dividends have come to be seen as entitlements, and the government has borrowed substantially at times to finance increased spending. This accumulation of debt runs against the intended intergenerational transfer of resources.

• A struggle by interest groups to capture resource rents in Ecuador has led to increased earmarking, which has contributed to liquidity problems, made fiscal policy procyclical, and weakened expenditure quality. The explicit earmarking of oil fund revenues to service debt, aimed at improving the net financial position of the government, was controversial and exacerbated political opposition to the fund. In the end, Ecuador replaced the oil fund with a greater degree of revenue earmarking.

Integration with Budget Systems

The operation of an oil fund may be assessed in terms of how well it helps (or hinders) the budget system in meeting its basic objectives. The experience with oil funds points to several key issues, in addition to earmarking and transparency:

• Extrabudgetary spending authority.⁷ This authority may lead to fragmentation of policymaking, a loss in control over expenditure, and reduced efficiency in the allocation of resources. About half of the oil funds have the authority to spend or invest assets domestically separate from the budget system. For example, the resources in the oil funds in Azerbaijan and Kazakhstan can be spent off-budget through presidential directives.⁸ The Libyan oil fund has also financed substantial extrabudgetary spending. The oil funds in the Islamic Republic of Iran and Kuwait may invest or lend to the private domestic economy outside the budget process.

• Creation of “islands of excellence.” When PFM systems are perceived to be weak, as in many developing countries, it is sometimes argued that the creation of a fund with separate procedures and controls might yield better results than the budget. There is little tangible evidence, however, to support the creation of such “islands of excellence.” Moreover, such an approach would also have to consider the potentially negative impact on the development of a national public financial management system, as scarce resources may be diverted to the fund’s management and there also might be less scrutiny of core budget systems as the focus shifts to a single large resource.

• Cash management. Some countries have experienced difficulties in asset and liability management associated with rigid oil fund rules and fragmentation of cash management. In Chad, given concerns about institutional capacity and governance and the objective of putting oil resources to good use, separate cash management systems were established to support a complex arrangement of multiple budgets and an oil fund, with revenues earmarked for specific purposes. Spending pressures in the country’s main operating budget resulted in arrears and costly borrowing, while low-yield assets were being accumulated in the oil fund. In early 2006, the government abolished the oil fund to ease liquidity constraints on its operating budget. In Venezuela, the government could only make deposits into the oil fund (that were mandated by law) in 1999–2000 with recourse to expensive financing, because the budget remained in deficit. In late 2000, the operation of the oil fund was temporarily suspended. In Ecuador, extensive oil revenue earmarking (including to the oil funds) and cash fragmentation contributed to the accumulation of domestic arrears despite large deposit holdings.

Financing funds are integrated with the budget process. These funds provide an explicit link between fiscal policy and the accumulation of financial assets, and address fun-gibility issues. They do not attempt to “discipline” expenditure through the removal of some resources from the budget—the flows in and out of the fund depend on oil revenue and policy decisions embodied in the non-oil fiscal stance. Their establishment has been linked to the desire to enhance transparency and promote public awareness of intertemporal constraints.

• Norway’s oil fund is formally a government account at the central bank that receives the net central government receipts from petroleum activities and transfers to the budget the amounts needed to finance the non-oil deficit. The oil fund has no authority to spend and the decisions on spending and the fiscal policy stance are made within the budget process. In addition, the fund is ruled by stringent transparency and accountability provisions.

• The oil fund in Timor-Leste was designed along the lines of Norway’s fund. It is fully integrated into the central government budget and managed with a high standard of transparency and accountability.

A number of countries have made or are making efforts to better integrate their oil funds with budget systems. These adjustments reflect growing awareness of the potential loss in fiscal control and the importance to public spending efficiency of unifying expenditure policy and subjecting approval and execution of outlays to the same budgetary standards, and of enhancing the efficiency of asset/liability management. For instance, since 2005, Azerbaijan has reported the operations of the oil fund in the annual budget presented to parliament (although parliament does not approve the oil fund’s budget). The rules of the Kazakhstan oil fund have recently been amended to provide better integration with the budget. Alberta discontinued the extrabudgetary operations undertaken by the province’s original oil savings fund in light of the fund’s disappointing performance. The Algerian authorities were moving toward implementing oil fund rules that will increase integration with the budget and transform the existing oil fund into a financing fund.

Asset Management

Oil fund financial balances have increased substantially in recent years. For the countries for which consistent public information is available, oil fund balances rose from US$69 billion in 2000 to about US$323 billion in 2005 (Table 3.1). A simultaneous buildup of deposits and debt, which partially resulted from rigidities in fund accumulation rules, was observed in some countries (e.g., Azerbaijan, Chad, and I.R. of Iran). Other countries were active in reducing debt (e.g., Algeria, Kuwait, Libya, and Russia), and some explicitly tried to avoid the impact on domestic liquidity that would have resulted from repaying domestic debt more rapidly (e.g., Norway), or sought to issue debt to develop the domestic debt markets.

Table 3.1.

Oil Funds: Gross Financial Assets¹

Source: IMF staff estimates.

¹Data on oil fund assets or gross public financial assets are not publicly available for Bahrain, Brunei, Kuwait, Oman, and Qatar

²2004 figures.

³Data on oil fund assets are not available.

Table 3.1.

Oil Funds: Gross Financial Assets¹

		2000		2005
Country	Coverage of Assets	Billion U.S. dollars	Percent of GDP	Billion U.S. dollars	Percent of GDP
Algeria2	Oil fund	—	—	9.9	11.8
Azerbaijan	Oil fund	0.3	5.2	1.4	11.1
Chad	Oil fund	—	—	0.02	0.4
Ecuador	Oil fund	0.0	0.0	0.4	1.2
Equatorial Guinea3	Gross public financial assets	0.1	12.3	2.9	43.5
Gabon	Oil fund	0.0	0.0	0.4	4.3
Iran, Islamic Rep.	Oil fund	5.9	6.2	11.7	7.2
Kazakhstan	Oil fund	—	—	8.0	14.4
Libya3	Gross public financial assets	13.3	40.7	26.0	68.7
Mexico	Oil fund	1.0	0.2	1.5	0.2
Norway	Oil fund	43.7	26.3	206.7	73.8
Russian Federation	Oil fund	—	—	53.0	7.0
Sudan	Oil fund	—	—	0.3	1.0
Timor-Leste	Oil fund	—	—	0.6	171.8
Venezuela	Oil fund	4.6	4.0	0.7	0.6

Source: IMF staff estimates.

¹Data on oil fund assets or gross public financial assets are not publicly available for Bahrain, Brunei, Kuwait, Oman, and Qatar

²2004 figures.

³Data on oil fund assets are not available.

View Table

Table 3.1.

Oil Funds: Gross Financial Assets¹

		2000		2005
Country	Coverage of Assets	Billion U.S. dollars	Percent of GDP	Billion U.S. dollars	Percent of GDP
Algeria2	Oil fund	—	—	9.9	11.8
Azerbaijan	Oil fund	0.3	5.2	1.4	11.1
Chad	Oil fund	—	—	0.02	0.4
Ecuador	Oil fund	0.0	0.0	0.4	1.2
Equatorial Guinea3	Gross public financial assets	0.1	12.3	2.9	43.5
Gabon	Oil fund	0.0	0.0	0.4	4.3
Iran, Islamic Rep.	Oil fund	5.9	6.2	11.7	7.2
Kazakhstan	Oil fund	—	—	8.0	14.4
Libya3	Gross public financial assets	13.3	40.7	26.0	68.7
Mexico	Oil fund	1.0	0.2	1.5	0.2
Norway	Oil fund	43.7	26.3	206.7	73.8
Russian Federation	Oil fund	—	—	53.0	7.0
Sudan	Oil fund	—	—	0.3	1.0
Timor-Leste	Oil fund	—	—	0.6	171.8
Venezuela	Oil fund	4.6	4.0	0.7	0.6

Source: IMF staff estimates.

¹Data on oil fund assets or gross public financial assets are not publicly available for Bahrain, Brunei, Kuwait, Oman, and Qatar

²2004 figures.

³Data on oil fund assets are not available.

Only a few of the oil funds examined have a clear, comprehensive, and transparent investment strategy.

• There is a general preference to place fund assets abroad, mainly to allay fears about appreciation of the domestic currency. Many governments place their deposits at the central bank (e.g., almost all African and Western Hemisphere countries, along with Algeria, Kazakhstan, and Russia), which in some cases acts as the government’s investment agent. Funds in Kuwait and Oman are believed to have some domestic investments, whereas the oil fund in the Islamic Republic of Iran is allowed to invest up to 50 percent of its balance in foreign currency loans to the domestic private sector.

• Returns on the assets held by oil funds varied, but were generally low. Average real returns were below 2 percent in relatively active funds in the first few years of this decade (e.g., Alaska, Alberta, and Azerbaijan; see World Bank, 2006). This was partly due to the sharp fall in returns in international capital markets at the beginning of the decade. Central African Economic and Monetary Community countries, including those with oil funds, have expressed concerns about the remuneration of their deposits at the Bank of Central African States, the regional central bank. In a few countries, oil fund deposits with the central bank do not earn interest, although the government may nonetheless receive income indirectly from central bank dividend payments.

Transparency and Accountability

Transparency and accountability practices for oil funds differ substantially across oil-producing countries. The oversight of oil funds takes several different forms, in particular regarding provisions for compliance by governments and national oil companies with stated deposit and withdrawal rules, audit of the accounts of the fund, whether investment decisions are taken in compliance with an agreed investment framework, and standards for the disclosure of information. The approach to disclosure of oil fund’s assets and investments often mirrors general attitudes toward public sector transparency (World Bank, 2006).

In many countries, information is made available on the operations and financial position of the oil fund, but some countries prefer not to disclose such information. The authorities in a few countries have argued that public disclosure of the extent of official assets might strengthen pressures to spend. For example, the Kuwaiti Reserve Fund for Future Generations is prohibited by law from disclosing its assets and investment strategy (although parliament receives some periodic information which is subsequently reported in the media), and the operations of oil funds in Qatar are not disclosed. This argument, however, can cut both ways—in the absence of information, the public may just as well have exaggerated perceptions of government financial wealth. In addition, lack of information about oil fund operations hampers analysis of the fiscal stance, savings and investment balances, and public and external sustainability and vulnerability.

Use of Fiscal Rules and FRL in Oil-Producing Countries¹⁰

In oil-producing countries, fiscal rules and FRL often enshrine a desire to reduce the procyclicality of fiscal policy and/or to promote long-term savings and sustainability objectives. Although oil funds are more common, fiscal rules and FRL can have a more critical role, because they are intended to constrain overall fiscal policy.

The design of appropriate fiscal rules in oil-producing countries is more challenging than in other countries because oil revenue is highly volatile, uncertain, and dependent on a nonrenewable resource. As such, the applicability in oil-producing countries of fiscal rules frequently used in other countries would be questionable. For instance, rules that target specific overall or primary balances or particular debt ratios to GDP could be highly procyclical—they would transmit oil fluctuations to expenditure and the non-oil balance.

The past experience of oil-producing countries with fiscal rules and FRL has been relatively limited, but a growing number of countries are starting to implement them. There are only a few cases of FRL in oil-producing countries. One of the first and more comprehensive FRL was introduced in the province of Alberta in the early 1990s. Ecuador introduced FRL in 2002, but the main focus was on numerical fiscal rules. Venezuela passed an organic budget law in 1999 as a step toward improving fiscal policy and accountability. Mexico also passed FRL in 2006. In cases where countries have set numerical fiscal rules or guidelines, targets have typically been set on the non-oil balance (Norway and Timor-Leste), the overall balance (Alberta and Mexico), expenditures (Equatorial Guinea), or on several fiscal variables (Ecuador).

Norway and Alberta have adopted different institutional frameworks that have been relatively successful in managing fiscal policy—although both face challenges. Whereas Norway implemented a relatively flexible framework, using the non-oil deficit as an anchor, Alberta introduced comprehensive FRL. Both cases have in common strong institutions and a broad consensus in favor of fiscal discipline.

• Under the fiscal guidelines that Norway introduced in 2001, the central government’s structural non-oil deficit should not exceed 4 percent of the oil fund’s total financial assets, equivalent to the expected long-run real rate of return of the fund’s accumulated financial assets. The guidelines allow deviations for countercyclical fiscal policy and shocks to the value of the oil fund, and were seen as a tool to help set a long-term benchmark for fiscal policy, reduce expenditure pressures, and insulate the budget from oil price volatility. Norway has maintained moderate spending growth during the oil boom, but the framework allows some degree of procyclicality—higher oil prices lead to a larger accumulation of financial assets, which in turn could lead to rising non-oil deficits. The fiscal guideline was met for the first time in 2007.

• Following the deterioration of its fiscal position in the late 1980s, Alberta undertook a significant fiscal adjustment in the early 1990s. The province adopted comprehensive FRL (1993–95) to strengthen fiscal policy, prevent future deficits, and eliminate provincial debt by 2025.¹¹ The rules under the FRL have been tightened over time, requiring a balanced budget every year (since 1999) and no net debt (since 2005). The focus in recent years has shifted to how best to manage the additional oil revenues given rising public pressures for investment spending, and how to avoid an excessively expansionary fiscal policy. This change partly reflects the focus of Alberta’s framework on the overall fiscal balance, which could lead to procyclical policies.

The experience of other oil-producing countries, mainly with fiscal rules, has highlighted the difficulties in implementing effective and durable rules—largely owing to design problems and political economy factors. In particular, fiscal policy concerns have been mostly focused on short-term constraints, resulting in fiscal rules that are too rigid to adjust to economic fluctuations and lack robust political support. These differences have become more evident during the recent oil boom, which has reduced liquidity constraints and made it more difficult for some governments to contain spending pressures.

In several cases, the fiscal rules or frameworks have been weakened over time or ignored. In particular:

• Ecuador’s FRL, introduced in 2002, included three fiscal rules focused on the central government’s non-oil balance, primary expenditure growth in real terms, and the public debt ratio to GDP. The legislation was intended to help improve the fiscal position, manage higher oil revenues, and reduce the procyclicality of expenditures. However, fiscal outcomes have often breached the deficit and spending rules. The limit on the public debt ratio has been met, partly owing to the large rise in oil prices in recent years (and associated increases in nominal GDP). Eventually, as liquidity constraints diminished, growing political and social pressures led to the revision of the FRL in 2005 and a relaxation of the constraints on spending.

• Equatorial Guinea’s expenditure rule, under which current spending should not exceed non-oil revenue, has been consistently breached in recent years. The rule is being reinterpreted as a medium-term objective, and expenditure has been growing substantially faster than non-oil revenue. Given the dramatic increase in the oil sector in Equatorial Guinea in recent years (to more than 80 percent of GDP), the rule no longer provides a realistic benchmark for fiscal policy.

• Venezuela approved an organic law for public finances in 1999, intended to strengthen fiscal policy and reduce expenditure volatility. The law focused on improving the budget process, including the use of a multiyear framework, and introduced fiscal rules for the current balance, expenditure growth, and the public debt. Implementation of the law, however, has been postponed, while expenditures have continued to be highly correlated to oil revenue. In addition, the quality of budgetary institutions has deteriorated, in part because of a proliferation of extrabudgetary funds and quasi-fiscal activities.

Other countries are beginning to develop rules-based frameworks in an attempt to better manage the additional oil revenues. Although it is too early to assess their effectiveness, some of these cases already provide some further evidence of the challenges in designing and implementing such strategies.

• In Nigeria, where a large portion of oil revenue is shared with subnational governments, the federal and state governments have informally adopted an oil-price-based rule since 2004, whereby oil revenue above a reference price is deposited in extrabudgetary accounts.¹² The resources can then be used to finance projects agreed upon by all levels of government. This approach ensures some macro-fiscal coordination and may help contain spending pressures. There are concerns, however, with the transparency of the framework and the potential for undermining the budget as a tool to set priorities. In addition, developments in 2005 and 2006 suggest that the informal framework has not been able to contain mounting expenditure pressures.

• In Azerbaijan, a presidential decree issued in 2004 set a long-term oil revenue management strategy aimed largely at addressing a temporary increase in oil production. The basic principles are the maintenance of constant consumption out of oil wealth in real terms, limiting annual fluctuations in the non-oil deficit to ensure economic stability, and basing investment spending on a public investment plan. However, larger-than-expected revenue increases have led to growing expenditure pressures. The revised 2006 budget envisaged an almost doubling of expenditures and an increase of more than 20 percentage points in the non-oil deficit ratio.

• São Tomé and Príncipe and Timor-Leste have adopted strategies based on the permanent income approach, but with important differences. São Tomé and Príncipe, still years ahead of prospective oil production, adopted an approach based on rules that determine how much can be transferred from the oil fund to the budget. This framework does not effectively constrain the non-oil balance—because the government can borrow—and it might have implications for asset and liability management. Timor-Leste adopted relatively flexible fiscal guidelines, with an emphasis on procedures to ensure transparency and proper management of oil wealth by highlighting the non-oil deficit consistent with the estimated permanent income from oil wealth (net of government debt). The government can propose a budget with a higher non-oil deficit; however, it has to provide a rationale and information on the impact on oil wealth in future years.

• Mexico’s congress approved FRL in early 2006 under which budgets are to aim at a zero overall balance. However, the numerical target does not take into account procyclicality or explicit fiscal sustainability considerations related to the oil revenue.

Some of these experiences highlight the limitations of rule-based frameworks to help manage fiscal policy. Recent large increases in oil revenue have brought about a loosening of budget constraints for oil-producing countries. The new environment has posed a significant test for the effectiveness of rule-based fiscal frameworks. In particular, it has shown that rigid rules, based mainly on short-term considerations, can come under strong pressure and become less relevant for policy purposes, and may ultimately jeopardize the credibility of the fiscal framework. In addition, the experience highlights the need for strong political consensus for FRL or fiscal rules to be effective (Box 2).