FISCAL SUSTAINABILITY AND NATURAL RESOURCE WEALTH FOR SURINAME1
1. This paper examines methodologies for setting an appropriate fiscal anchor in a natural resource rich country such as Suriname. While the processing of bauxite into alumina was once the key mineral product in Suriname, in recent years it has been surpassed by oil and gold, and all three commodities contribute significantly to fiscal revenues. Thus the fiscal position is heavily exposed to developments in the mineral sector. Although mineral wealth creates opportunity to accelerate a country’s development, it also comes with risks such as enhanced susceptibility to fluctuations in commodity prices which can be large and persistent, exhaustibility of natural resource deposits, a tendency to pro-cyclical fiscal policies that can amplify business cycles, and Dutch disease. This raises the question of how best to set fiscal policy to make use of mineral bounty to support development while at the same time building up buffers to support countercyclical policy and extend the benefits of such resources to future generations (as natural resources are exhaustible).
B. Mineral Resources of Suriname
2. Oil is the largest mineral contributor to fiscal revenues. The country has a near balance in terms of its fuel imports and exports. However Staatsolie, the national oil company, has fairly competitive production costs and therefore is a key contributor to central government revenues both in the form of dividends and taxes. Indeed, oil revenues comprised 29 percent of fiscal revenues in 2012. Proven oil reserves were estimated at 78.8 million barrels in mid-2012, which at current extraction rates should last for 13 years approximately, but it is estimated that recent discoveries have extended this horizon by two additional years. Staatsolie is conducting intense exploration work off shore, both on its own account or through exploration contracts, and the geological conditions of its coastal territory indicate good chances of new findings.
3. However, gold provides two thirds of exports, and its share of government revenue has also grown significantly to 13 percent currently. This has been enabled by the fact that the largest mine, Rosebel, increased its production substantially at the same time as international gold prices reached historically high levels. While there is significant small scale gold mining as well, it remains largely informal and very lightly taxed.2 The gold deposits in Suriname are part of the Guianas Shield which stretches between the Amazonas river in Brazil and the Orinoco river in Venezuela, so reserves appear substantial, only limited by their technical and economic viability. Apart from the Rosebel mine, which has now reached geological formations that are more expensive to mine, there are currently two projects that jointly could in principle double the volumes of production in the next five years or so. One of those projects is sponsored by Iamgold, the owner of Rosebel, and the other by a joint venture between Newmont and Suralco. The viability of those two new projects depends critically on the evolution of the international price for gold, which at present appears to have passed its peak.
4. Bauxite used to be by far the most important natural resource for Suriname, but its importance has declined significantly. Around the time of World War II Suriname was a leading bauxite exporter in the world, producing about 25 percent of the total global production. However, over the following decades, changes in the international market, mainly related to significant increases of supply from other competitor countries and recent low international prices, have led Suriname to lose its market share (currently estimated at less than three percent), and therefore to a diminished relevance of the commodity in the domestic economy as well as for fiscal purposes. It currently accounts for less than 2 percent of fiscal revenues.
C. Fiscally Sustainable Policies for Suriname
5. There are several approaches to help guide fiscal policies in resource-rich economies. This note analyzes two of them: the permanent income hypothesis and the inter-temporal budget constraint method. Under the permanent income model, fiscal authorities estimate the net present value of the natural resource wealth, determine the portion that can be disposed of per period, and design the fiscal policies that would be consistent with those flows. The inter-temporal budget constraint method calculates the fiscal sustainability gap, which implicitly yields the fiscal target that is consistent with the inter-temporal budget constraint (taking the projected flow of mineral revenues and the timing of its exhaustibility into account), and thus can be maintained indefinitely without leading to a need for sudden sharp disruptive adjustments to fiscal policy.
Estimating the mineral wealth of Suriname
6. Estimates of the mineral wealth of a country are inherently subject to large margins of error. In general, total mineral deposits are unknown, and the value of the deposits depends on a volatile long run price outlook. This uncertainty increases the difficulty of maintaining prudent countercyclical policies when commodity prices rise. It is common to have country authorities assuming overoptimistically that upswings in commodity prices are permanent, which leads to procyclical spending initiatives that often have to be scaled back significantly when the upswing ends. Moreover, turning points in the commodity price cycle are notoriously difficult to predict, exposing many commodity exporters to destabilizing boom-bust cycles.
7. A prudent approach to estimating mineral wealth for budget purposes would be based on conservative projections of long run price movements and mineral deposits. Thus, in general, price projections that are persistently well above the historical long run average should be avoided, unless there is a well founded and generally acceptable rationale for doing otherwise. Also, estimates of mineral deposits should be largely based on proven reserves, with probable or possible reserves being given a much lower weight in the estimation. Such an approach minimizes the possibility of over exuberant spending and boom bust cycles, and is conducive to fostering the efficient use of fiscal resources. Moreover, if the mineral wealth turns out to have been underestimated ex post, the result is a stronger fiscal position and an accumulation of buffers that further strengthens macroeconomic stability.
8. For Suriname, the key assumptions underpinning the estimate of mineral wealth are as follows:
• Gold prices follow WEO projections up to 2018, and from then on the price falls gradually at five percent per year until it reaches a level of US$500/ounce, a level consistent with the observed long run average price since 1903.
• It is assumed the gold mines will be commercially exploitable for up to 20 years provided the international price is above US$800 which is estimated to be the break even cost for the mines operating in Suriname. Below that price level production would drop rapidly to zero.
• Fiscal income from informal gold mining (currently small) is not included in the estimation.
• Oil prices are also assumed to follow WEO projections until 2018, but given the additional value added of the extracted oil once the refinery starts operations, a premium of 18 percent is added from 2015 onward. After 2018, prices are assumed to increase by 1.5 percent per year until they reach 150 dollars per barrel (projected by the U.S. Energy Information Administration to be the long term price).3
• Proven reserves of oil are assumed to last for 15 years at the projected levels of production in 2018 and no significant discovery is assumed to take place in the period. The production decline is assumed to be gradual and starts after year ten and continues until year twenty.
• Bauxite-related fiscal revenues have declined to low levels, and so are not a key focus of the estimation of mineral wealth. In any case, bauxite prices are assumed to follow WEO projections until 2018, with volumes similar to current levels. Beyond that, it is assumed that revenues from bauxite as a share of GDP stay at 2018 levels up to 2032, and then taper off to zero by 2050.
• Government tax rates are assumed constant at the 2012 level.
Under those parameters the value of the mineral resources for the central government is calculated as the discounted value of future revenue flows using a 4 percent real discount rate, which yields US$ 5.5 billion, just above the current GDP.
Real Gold and Oil Price Indices
(April 2013 = 100)
Citation: 2013, 341; 10.5089/9781475562354.002.A002
Sources: Federal Reserve, Energy Information Administration, and the National Mining Association.
Oil and Gold Prices
Sources: World Economic Outlook; and U.S. Energy Information Administration.
Oil and Gold Production
Sources: Suriname Authorities; and Fund staff estimates.
The permanent income hypothesis
9. Under the strict definition of the permanent income rule the flows available for consumption should match the returns to the discounted value of the project’s future flows, so that the capital is preserved forever. It is possible, however, to estimate alternative scenarios based on less stringent rules that aim at graduating the spending over a period of time that is long enough to permit a gradual transition to the time in which the natural resources will be depleted. Such rules would also allow the authorities to target sustainable levels of non-mineral fiscal balances.
10. Several options can be considered for the consumption of the estimated mineral wealth, consistent with long run sustainability. In the first instance, the passive scenario (consistent with staff’s baseline macro framework) is where no action is taken in the near term, but the authorities are forced to take corrective action over the long run as mineral revenues dwindle to zero in about 20 years (i.e., the non-mineral deficit is forced to be near zero), or face the need for significantly increasing the public debt. Alternatively, other scenarios show that early fiscal tightening prolongs the time horizon for the consumption of wealth and mitigates the need for large abrupt tightening once mineral revenues run out. A fixed annual nominal consumption consistent with early tightening to a non-mineral deficit target of about 5 percent of GDP would enable the consumption of mineral revenues forever (permanent income hypothesis scenario). Tightening to a target of 6 percent of GDP would exhaust mineral wealth at around 2060, but at that point the annual nominal consumption of mineral revenue would be a small share of GDP, requiring only minor offsetting action. Lower consolidation efforts lead to progressively shorter life of mineral resources. Given the large gap between the fiscal outcome in 2012 and sustainable paths, early and substantial consolidation seems warranted.
Non-mineral Fiscal Deficit/GDP
Source: National authorities, and staff calculations
Inter-temporal budget constraint4
10. A more comprehensive method for evaluating the fiscal stance of a country is to assess fiscal sustainability based on the inter-temporal budget constraint. This is the most generally accepted method, and is based on the standard economic definition of sustainability. It poses the following question: if the authorities decide to take no further fiscal measures from now onward, can they maintain that posture over an infinite horizon? If they can do so, then the inter-temporal budget constraint is satisfied, and the fiscal position is considered sustainable (and the fiscal sustainability gap is then zero). However, in most countries this is not the case, and protracted inaction then typically leads to a situation where the debt-GDP ratio rises continuously without bound, with interest payments taking an ever increasing share of government expenditure. This crowds out non-interest spending and increases the difficulties associated with financing the debt until the government is forced to take drastic action to put the fiscal position on a path consistent with sustainability.
12. The measurement of sustainability gaps thus informs policymakers about the amount of measures needed to get to the point of sustainability. Indeed, reflecting these considerations, the European Commission (EC) has been at the forefront of pushing for the widespread calculation and use of fiscal sustainability gaps, and it is now customary for all EU countries to calculate fiscal sustainability gaps, in coordination with the EC, every few years. The practical experience gained has helped refine the exercise into a credible coherent one that is able to take into account all the major exogenous changes expected to affect the fiscal position over the long run, including the two most common—natural resource depletion and population aging.
13. For simplicity, the current exercise for Suriname excludes population aging. While Suriname’s population is currently young, the old age dependency ratio has been creeping up, and with the planned institution of a nation-wide social safety net, aging pressures are likely to become increasingly significant over the long run. However, incorporating this would require long run projections of population aging and its impact on fiscal spending on pensions and health care which are currently not available. To the extent that aging pressures exist, this would require additional fiscal consolidation measures to maintain sustainability (i.e. the fiscal sustainability gap would be larger).
Estimating the fiscal sustainability gap
14. The starting point for this analysis is the equation defining the evolution of public debt:
Where Bt, r, and Pt, represent the debt stock at the beginning of period t, the discount rate, and the primary surplus in period t, respectively. Dividing equation (1) by nominal GDP gives the following equation:
Where bt and pt represent the debt to GDP ratio at the beginning of period t and the primary surplus to GDP ratio in period t, respectively, and represents the growth rate of GDP, assumed to be constant for algebraic simplicity. Solving equation (2) forward and imposing the no-Ponzi-scheme condition yields the government inter-temporal budget constraint:
For any given fiscal stance (e.g. the current structural primary fiscal balance) and given the outlook for growth and other expected exogenous changes such as demographic change and depletion of natural resources, a “passive” path for the primary balance over an infinite horizon can be estimated. For Suriname, the most substantial changes analyzed in this exercise are due to the evolution of natural resource wealth, which impacts the expected path for fiscal revenues and therefore the passive path for the primary balance. On that basis the sustainability gap in stock terms (which is the total inter-temporal debt in present value terms) is then given by:
And the sustainability gap in flow terms—hereafter simply called the sustainability gap—which is defined as the constant change to the primary balance in percent of GDP such that the sustainability gap in stock terms is zero is thus derived as:
15. Thus, essentially, for a government to satisfy its inter-temporal budget constraint it must run future primary surpluses of sufficient size in present value terms to pay off the initial stock of debt. This is required so that over the long run the government can meet all its obligations. Otherwise, at some point it will become clear that the government cannot meet all its obligations, which will prompt investors to refuse to buy its debt and thus force drastic changes to fiscal policy.
16. Staff’s estimate of Suriname’s sustainability gap is about 14 percent of GDP. This large gap primarily reflects the outlook for mineral revenue, which is expected under staff’s conservative baseline assumptions to decline from around 11 percent of GDP in 2012 to zero over the long run (thus requiring offsetting measures of similar magnitude to satisfy the inter-temporal budget constraint) and the large current fiscal deficit which is adding to debt and will need to be offset by measures.5
17. In a scenario where no corrective measures are taken while mineral revenue is depleted, public debt would mathematically rise to over 700 percent of GDP by 2060 in view of the substantial sustainability gap. Alongside, the primary balance is projected to decline by 11% percentage points to a deficit of 14½ percent of GDP, while the overall fiscal deficit deteriorates by over 74 percentage points to around 78 percent of GDP, the exploding debt stock causes interest payments to rise exponentially, consuming an ever-increasing share of fiscal expenditure. In practice, of course, investors would repudiate Suriname’s debt long before debt rises to such levels, forcing abrupt fiscal tightening to restore sustainability. In contrast, at the opposite extreme, immediate full adjustment implies that gross debt is driven to zero by 2015, with a substantial buildup of government assets thereafter to help offset the depletion of natural resource revenues.
Optimal fiscal consolidation paths
18. The pace of consolidation will reflect the balancing of twin conflicting objectives of reducing both the output and the fiscal sustainability gaps. A model to assess the optimal pace of consolidation is constructed as follows: the authorities are assumed to care about both the sustainability and output gaps, and to prefer that both be zero. However, these objectives are conflicting, in that action to close the sustainability gap (fiscal tightening) comes at the expense of widening the output gap in a negative direction, while on the other hand, action to close the output gap (fiscal loosening) increases the sustainability gap. Thus, over an infinite horizon, the authorities’ problem can be characterized as choosing a path for the fiscal stance that minimizes the following quadratic objective function.
Where Ot, α γ and β, represent the output gap in percent of GDP in period t, the weight placed by the authorities on closing the output gap, the weight placed by the authorities on closing the sustainability gap, and the authorities’ rate of time preference, respectively, with β = 1/(1+r).
19. The output gap is assumed to evolve according to the following equation:
Where ft, λ and ξ, represent, respectively, discretionary fiscal measures taken (in percent of GDP) in period t, an autoregressive parameter on the output gap which determines how long it would take for the output gap to be eliminated through self-repair of the economy rather than fiscal action, and the fiscal multiplier.
20. It is necessary to adjust the sustainability gap formula to reflect discretionary actions. If we adjust equation 5 to take account of discretionary fiscal measures taken in time t, in addition to the “passive” evolution of the primary surplus, this yields:
And some algebraic manipulations reveal that the sustainability gap evolves as follows:
21. Equation 9 confirms that in the normal case where the discount rate exceeds the GDP growth rate, delaying actions to ensure sustainability is costly. The magnitude of the sustainability gap increases over time absent discretionary consolidation measures, since the discount rate (which governs the pace of debt accumulation) exceeds the GDP growth rate (which governs the burden of debt relative to GDP).
22. The authorities’ problem is to choose the size of fiscal measures in time t to minimize the objective function (6) subject to equations (7) and (9). Given the quadratic preferences and linear constraints, we know that the optimal fiscal tightening in any time period is a linear function. We therefore speculate that the fiscal consolidation pace is governed by the following equation:
Where A > 0 and B > 0. Substituting equation (10) into the first order condition of the authorities’ problem, and solving for A and B yields:
23. Thus, the optimal path for fiscal consolidation depends on the initial values for the output and sustainability gaps, the fiscal multiplier, the speed of self-correction of output gaps, the discount and GDP growth rates, and the authorities’ preferences. For Suriname, starting in year 2013, the initial sustainability gap as of 2012 is calculated above at 14 percent of GDP, while it is estimated that the (positive) output gap in 2012 was 0.5 percent of GDP. λ is calibrated to equal 0.5, implying that absent fiscal measures and ceteris paribus, an output gap of 2 percent of GDP is eliminated after six years via spillovers, confidence effects, monetary policy actions, self repair etc. The fiscal multiplier is taken to be relatively small at 0.5, as Suriname is a small and very open economy. The nominal discount rate and long run average nominal GDP growth rate are taken to be 10 percent and 9¼ percent respectively.
24. The authorities’ preference weight parameters are determined based on “revealed preference.” The approach is as follows. We first renormalize the policy function, without loss of generality, by assuming that γ = 1−α, where 0 ≤ α ≤ 1. We then take the value of α to be that which is consistent with the amount of fiscal tightening taken the last time there were similar circumstances with a large need for fiscal tightening (2011). In 2011, starting with an output gap of -0.5 percent and a sustainability gap of about 13 percent, the authorities implemented structural fiscal consolidation of 4 percent of GDP, which is consistent with a value of α of 0.89, and this is the value we use in our exercise.
25. In general, the optimal consolidation path requires significant front-loading of adjustment, but also envisages that full elimination of the sustainability gap takes place over a long horizon. Quadratic preferences mean that the pressure to act to reduce any of the two gaps under consideration increases in nonlinear fashion with the size of that gap. Thus, if the sustainability gap is large enough relative to the output gap, as is the case for Suriname, the optimal immediate fiscal tightening would be one that trades a substantial reduction in the sustainability gap for some negative movement in the output gap. Therefore (subject to the weights in the authorities’ preferences) the larger the sustainability gap, the more optimal it is to front-load adjustment.
26. For Suriname, the model predicts an optimal path where there is fiscal tightening of about 5 percent of GDP in 2013, with the pace of adjustment tapering off significantly thereafter. This would essentially fully offset the slippage of 2012. The initial impact of the structural fiscal tightening measures is however partly offset by the impact of the worsening output gap on revenues, and thus the headline overall balance is projected to only improve by about 3 percent of GDP in 2013, with the remaining improvement to the headline balance coming in later years as the output gap declines toward zero. Over the medium term (i.e. by 2018) the optimal structural fiscal adjustment effort totals 10½ percent of GDP, which would offset a projected 3½ percent of GDP decline in mineral revenues over the period and improve the headline fiscal balance to a surplus of 2½ percent of GDP for 2018. Alongside, the non-mineral deficit declines to 5¼ percent of GDP in 2018. Over the long run the sustainability gap declines steadily, though the pace of decline drops over time, and it is eliminated in 2043. Because of the delay in achieving sustainability, the total amount of measures needed rises slightly above the sustainability gap to 14¼ percent of GDP.
Suriname: Fiscal Sustainability, 2012-60
(Percent of GDP)
Citation: 2013, 341; 10.5089/9781475562354.002.A002
Sources: Authorities data, and Staff calculations.
1/ Baseline incorporates staff medium term baseline projections up to 2018, and assumes no further fiscal adjustment thereafter.
2/ Negative debt reflects the accumulation of assets
D. Final Remarks
27. Both methodologies outlined above indicate a large fiscal adjustment need over the medium and long run. Indeed, the estimated sustainability gap of 14 percent is close to the gap observed as the size of the non-mineral deficit for 2012 which needs to be fully offset in some fashion as mineral revenues dwindle over time. The permanent income hypothesis approach outlined above however envisages a scenario where the bulk of adjustment is done in a single step, by choosing a fixed nominal amount of mineral revenues which should be consumed over the long run, whereas the optimal fiscal consolidation approach seeks to take into account the authorities’ preferences and the costs of spreading out consolidation efforts over a long horizon. Overall, a medium term non-mineral fiscal deficit target in the neighborhood of 5¼ percent of GDP, while ambitious, appears appropriate given the size of the sustainability gap. The scale of required adjustment underscores the need for developing a sound fiscal framework to support consolidation efforts.
28. Given the uncertainties related to the estimation of mineral wealth, fiscal targets would need to be periodically updated. This would allow for appropriate changes to the fiscal target as the outlook for mineral wealth changes over time, but a conservative approach should be consistently used in such assessments to ensure the continued soundness of the fiscal position.
Fritz-KrockowBernhardet.al.2009 “Suriname: Toward Stability and Growth,” International Monetary Fund, Western Hemisphere Department.
International Monetary Fund. 2012 “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries”. IMF Policy Paper.
KandaDaniel2011 “Modeling Optimal Fiscal Consolidation Paths in a Selection of European Countries” IMF Working Paper No 11/164 2011.
U.S. Energy Information Administration. Annual Energy Outlook 2012 Early Release. 2012. www.eia.gov.
Prepared by Mario Mansilla and Daniel Kanda.
Informal gold mining is, however, an important source of employment and income in rural areas. Given its limited fiscal impact, for the purposes of this note the focus is on the formal mining sector.
U.S. Energy Information Administration. Annual Energy Outlook 2012, Early Release. 2012. www.eia.gov
The methodology in the following sections is based on Kanda (2011) and IMF (2012).
Using a somewhat less conservative assumption where the nominal mineral revenue projected for 2018 is maintained thereafter only slightly reduces the sustainability gap to 13¾ percent of GDP, as that nominal value declines continuously as a share of GDP over the long run.