IV Operational Aspects of Funds

Rolando Ossowski, Steven Barnett, James Daniel, and Jeffrey Davis
Published Date:
April 2001
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The establishment of an NRF requires decisions about its integration within the fiscal framework and its asset-management strategy. Governance, transparency, and accountability issues also need to be addressed.

The Fund and the Budget

Consideration needs to be given to the integration of the fund within the budget process and to the consequent institutional arrangements.

Integration with the Budget

If a decision is taken to establish a fund, it should be integrated within the budget process in a coherent manner. Proper integration of the fund and the budget helps to maintain a unified control of fiscal policy and avoid problems in expenditure coordination, such as duplication of expenditure or capital spending decisions made without taking into account their impact on future recurrent spending. It also facilitates a consistent prioritization across all government operations.

This would suggest preference for institutional arrangements that maintain a unified control over expenditure, avoiding the emergence of two “budgets,” namely the traditional budget and a separate expenditure program financed by the fund. The separation of spending programs could lead to fiscal management problems. In practice, it may not be clear how spending priorities would be set, or which expenditures would be financed by the fund and which by the budget. Therefore, to address the risks that lands might pose in terms of fragmentation of policymaking and loss of overall fiscal control, it would be important to ensure that spending decisions are taken within the context of the budget and that expenditure is included in the budget in a comprehensive way.

The need for legitimacy and contestability of budgetary resources provides additional reasons why it would be preferable for the resources in the fund to be spent through the normal budgetary approval process. Public resources should be raised and spent in accordance with public demands and for the highest (marginal) value. The legitimacy of the budget is enhanced by legislative approval of the annual appropriation law. This therefore suggests that any off-budget spending that is allowed should remain subject to parliamentary scrutiny and consideration.

Institutional Arrangements for the Fund

Three institutional arrangements may be distinguished that vary according to the degree of integration with the budget.

The Virtual Fund

The existence of a fund need not imply the creation of a new institutional mechanism. A nonrenewable resource “fund” may be a fund in name only. This accounting-only design is referred to as a “virtual fund” because there is no separate institutional structure for the management of the fund, and all revenues and all expenditures are on-budget. Certain resources would be identified as belonging to the fund. These resources could be held in the government’s main account or possibly in a separate account of the government. Restrictions in line with the objectives of the fund would be placed on drawing down the fund’s resources for expenditure. Any drawdown of government deposits, including the fund account, would appear as deficit financing. The assets that “belong to the fund.” however, would be managed like other government assets.

Under a virtual fund arrangement, there would be no earmarking of the fund’s resources for certain items of expenditure. Expenditures would continue to be executed by the relevant line ministries and agencies and would be included in the budget. Correspondingly, allocative decisions at budget time would be taken by the parliament. Thus, a virtual fund design need not hamper fiscal management, and it would be consistent with transparent policy decisions, accountability, and control of expenditures through normal budgetary procedures—provided it is supported by adequate accounting, reporting, and audit procedures (see “Governance, Transparency, and Accountability,” below).

A virtual fund could strengthen the political feasibility and support for saving nonrenewable resource revenues. It could also help to strengthen the incorporation of sound economic principles within the budget process by focusing attention on the nonresource balance and by highlighting that nonrenewable resource revenues are not like other revenues and should, in general, be saved rather than spent.

All Resources Pass Through the Budget

Under this approach, transfers to and from the fund’s account could be explicit line items in the budget. All revenues would be included in the budget, and the amount that is to be saved in the fund would be shown as a transfer to the fund. If there is a need to dissave, or draw down on the fund, this would be shown in the budget as a transfer, and all spending would be done by appropriation. This approach would preserve the unity of the budget, without the restrictive rules that are implicit in the virtual fund.

The resources transferred to the budget could be earmarked for particular expenditures. Earmarking may be seen as making it easier to resist political pressures to use windfalls for less appropriate purposes. However, earmarking would result in resources being placed outside the allocative budget process and might lead to inefficient expenditure and the misuse of resources.15 The impact of earmarking is also uncertain insofar as budgetary resources are fungible.

Off-Budget Expenditure

An extrabudgetary fund may be set up as a separate entity with authority to undertake off-budget expenditure. Arrangements may also include the fund having its own direct sources of revenue. A rationale for this design is the notion that potential overspending might be prevented by keeping resources off-budget. Also, such an approach may be justified as one means to “get around” an inefficient or corrupt system and to deliver more effectively the desired spending policies.

This approach may lead to coordination problems with the budget. Moreover, if spending is undertaken without parliamentary approval and adequate oversight, it could result in nontransparent off-budget practices and give rise to governance concerns. In addition, it remains doubtful on practical grounds whether, if the overall budget system is poor, a better subsystem can be established to deal with windfall proceeds. As illustrated in Box 4.1, in a number of cases the oversight of a fund’s spending has not been fully adequate, and public resources have been misallocated.

If a separate NRF with spending authority is considered, a separate appropriation bill for the fund should be submitted for parliamentary approval. Budget formulation and reporting should focus on a consolidated presentation (inclusive of the operations of the fund), and all the expenditures should be executed by the treasury.

Asset-Management Issues

An NRF could, over time, hold an important share of the public sector’s financial assets. The management of the fund’s capital is therefore a key component of the strategy for the fund. Strategies for managing NRF assets have varied greatly among countries (Table 4.1).

Table 4.1.Asset Management of Selected Funds
Country/StateForeign/Domestic Asset SplitOperational ManagementLevel of Assets1 (percent of GDP)
(Canada)Mainly domesticTreasury’s Investment Management Division10
(United States)Mainly non-Alaskan, including foreignAlaska Permanent Fund Corporation (special private corporation)1052, 3
ChileMainly foreignCentral bank
GRFDomestic and foreignKuwait Investment Authority (since 1982), autonomous government body
RFFGMainly foreignKuwait Investment Authority (since 1982), autonomous government body
KiribatiForeignReserve Fund Investment Committee8003
NorwayEffectively foreign. Held as local currency account at central bank, which manages a counterpart portfolio of foreign assetsCentral bank using private investment managers19
SGRFFAlmost entirely foreignAutonomous government agency12
OFMostly foreignMinistry of Finance4
Papua New GuineaHeld as local currency account at central bankMRSF Board0
VenezuelaForeignCentral bank0.2
Sources: National authorities; and IMF staff.


In percent of gross state product.


For names of funds, see Table 3.1.

Sources: National authorities; and IMF staff.


In percent of gross state product.


For names of funds, see Table 3.1.

Asset-Management Strategy

An asset-management strategy would need to be defined for the fund, including prudential investment rules, targeting desired levels of risk, liquidity, and returns. The fund’s financial operations should be designed to avoid disrupting financial markets and macroeconomic stability. Equally important, the strategy would need to take into account the main objectives of the fund, and in particular the relative emphasis placed on stabilization and savings, in the government’s overall asset-management strategy.

Consideration would need to be given to the appropriate time horizon. For example, the liquidity and maturity of “risk-free” assets would be a relevant consideration. A fund with mainly a stabilization objective that might need to draw down its assets at short notice, for instance during sharp commodity price downturns, would not necessarily view high-quality long-term bonds as “risk free.” Similarly, decisions whether to hold equities in the portfolio might depend on whether the fund’s objectives are seen as mainly related to long-term savings or short-term stabilization. The currency composition of the assets would also be important.

The asset-management strategy should reflect a consolidated portfolio of the government. In addition, the fund’s short-term asset operations should be consistent with, and coordinated with, the debt management operations of the ministry of finance, the treasury’s management of the government’s cash flow, and the financial assets already held as part of the government’s balance sheet. In some cases, difficult choices may need to be made between assets held in the fund and outstanding gross government debt.

Box 4.1.Oil Funds and Extrabudgetary Spending in Nigeria and Venezuela


Before 1995, Nigeria had various types of extra-budgetary funds that were financed by oil revenues and used for off-budget expenditure. Spending from these funds expanded from 4 percent of GDP in 1990 to close to 12 percent of GDP in 1994—more than one-third of the federal budget. Serious problems were experienced as a result of the nontransparent use of off-budget funds. Expenditures were mainly undertaken in various types of investments in the oil sector and other “priority” development projects for which project selection criteria and procedures were lax. Moreover, implementation capacity to manage investment expenditure was inadequate. As a result, a number of large investment projects have required large and costly financing and have had low ex post rates of return.


The Venezuelan Investment Fund (VIF) was established in the mid-1970s to act as the repository of the oil windfall. Its resources were soon diverted toward equity stakes in public enterprises (including in the manufacturing sector), many of which turned out to be loss makers. In recent years, a share of the VIF’s resources has been used to provide cash injections to state companies in the electricity sector. These companies have registered deficits and relied on transfers from the central government and the VIF to finance capital expenditure and meet debt service obligations. In effect, subsidies have been provided off-budget through the use of VIF resources.

A strong case may exist for placing the fund’s accumulated resources abroad. Investing them in domestic nongovernmental financial assets would transmit resource revenue volatility to the economy. In downturns, the withdrawal of domestic deposits could have a contractionary effect on the economy (unless offset by open market operations), while investment in domestic financial assets and monetization of the fund’s flows during upturns could fuel aggregate demand.16 Also, the protection of the competitiveness of the nonresource tradable sector may be a policy objective, which could be helped by the sterilization of savings.

In general, the fund should not invest in the government’s own domestic or foreign liabilities as part of its asset allocation. From a portfolio perspective, such a strategy would make little sense. It would amount to the government issuing debt to itself—with potential costs in terms of transaction fees paid to intermediaries, and in the liquidity of the domestic debt market. Moreover, arrangements whereby the fund holds its own government’s debt could lack transparency.

The fund should not be permitted to borrow or to lend. For the transparent and effective conduct of fiscal policy, it is best for borrowing and lending decisions to be centralized at the ministry of finance, in collaboration with the central bank. Also, the fund’s capital should not be used as collateral for government borrowing.

Domestic Investment Issues

The fund’s resources might be used to undertake domestic investment in physical assets rather than be sterilized abroad. Countries with pressing infrastructural needs or with perceived opportunities for productive domestic investment are particularly likely to consider this option. Such a strategy could also aim at enhancing the competitiveness (and promote the growth) of the nonresource tradable sector; in effect, part of the resource wealth would be given up for the prospect of higher nonresource wealth. There is, however, a danger that such spending may rise to an unsustainable level, or that too quick an increase may result in poor-quality projects.

There are a number of reasons to suggest that an NRF should not undertake domestic capital expenditure directly. First, investment should be guided by overall policy considerations (including medium-term recurrent implications), rather than by the availability of resources in the fund. Second, a perception that resources are readily available for domestic uses could create incentives for rent seeking and make the fund prone to abuse. Third, it may be difficult to assess the effects of the domestic use of resources on aggregate demand and competitiveness if the spending is off-budget. Finally, an NRF with stabilization objectives may need to build up liquid assets to preserve its precautionary objective for budget financing.

Operational Management of Assets

Specific operational asset-management guidelines should govern the allocation of the fund’s resources. The guidelines should be publicized, to allow performance of the fund to be measured relative to them. They should be unambiguous as regards the desired risk-return combination, the proportions to be invested in various types of assets, the geographical mix of assets, and the desired currency composition of the portfolio. There should be clear responsibility for the establishment and implementation of the guidelines. This might rest with the ministry of finance since it is responsible for the overall management of public resources.

There are several options regarding the operational management of the fund’s assets. The ministry of finance could be responsible, or this may be delegated to the central bank. A board, comprising representatives from the government or legislature or both, could be established to manage the fund or to advise the government on the management of the fund. Responsibility for managing the fund’s assets could be assigned directly to an independent Board of Trustees that is answerable to the cabinet and the parliament but is not a political organization. The management of the fund’s assets could be subcontracted to private investment managers, with their selection decided in the same way as procurement for any other government service.

Box 4.2.Norway’s Approach to Asset Management and Transparency

The Ministry of Finance is responsible for the asset management of Norway’s State Petroleum Fund (SPF) and sets the guidelines for the fund’s asset strategy. The ministry has delegated the operational management of the fund’s portfolio to Norges Bank. The SPF is formally a krone-denominated account in Norges Bank, the value of which corresponds to a separate portfolio of foreign assets invested by (and in the name of) Norges Bank.

In the initial years of the activities of the SPF—the first allocation to the fund was made in 1995—asset management was conservative and involved investing the portfolio in low-risk, short-term debt instruments. The primary consideration was the preservation, in real terms, of fund capital. It was deemed prudent to begin with a risk-averse strategy, since losses incurred by the fund by investing in riskier securities would have undermined public confidence in the fund’s activities at an early stage. In addition, in part to slow the appreciation of the krone resulting from the exploitation of oil, but also due to governance considerations, it was decided to invest the entire portfolio abroad with the currency composition decided by Norway’s import weights.

More recently, the authorities have been of the view that, although equities are considered riskier in the short-term, a portfolio combining equities and fixed income assets could give a more stable return over a long-term investment horizon (deemed relevant for the SPF), and yield a higher expected rate of return. As a result, since 1998 between 30 percent and 50 percent of SPF assets is invested in equities. In the last year, as a result of further changes in the asset-management strategy, the fund has been mandated to invest a small portion of its portfolio in environmentally sound companies, and geographic restrictions on the placement of assets have been loosened.

Transparency is a founding principle of the SPF. Norges Bank is required by law to provide information concerning the fund’s management to the public. Comprehensive accounts and data on the SPF’s operations are easily available (including through the Internet) on a timely basis. The quarterly and annual reports provide detailed information on portfolio valuation, composition, returns, management, transfers to and from the budget, market trends, risk exposure, and administrative costs. The SPF’s accounts are regularly audited, and the audit reports are made public. The implementing law and regulations are also made public, and Norges Bank issues frequent press releases on SPF developments.

The operational design of the SPF, under which the fund’s assets represent net government savings, helps increase transparency. Transfers to and from the fund need parliamentary approval, and the fund’s operations are incorporated into the fiscal accounts.

Whichever model is chosen, a clear allocation of responsibilities would be important to ensure that those who manage and oversee the operations of the fund are held accountable. Provisions would need to be drawn up stipulating who is in charge of, and accountable for, setting the fund’s overall investment policy, drawing up operational guidelines, managing the fund’s resources, and evaluating performance (see below). There should be an unambiguous assignment of accountability for the performance of the fund, preferably with one individual answerable to parliament. More broadly, the division of responsibilities among the ministry of finance, the monetary authority, and the fund should be clearly specified.

Governance, Transparency, and Accountability

The rules and operations of an NRF should be transparent and free from political interference. To facilitate this objective and performance evaluation, the law creating the fund should clearly state its rules, purposes, and objectives. Lack of transparency would hamper legitimacy and undermine public support for the fiscal policy objectives that are related to the fund’s operations. It would also allow incentives for lobbying for resources, and pressures to increase spending with positive nonrenewable resource shocks. Therefore, stringent mechanisms should be put in place to ensure accountability and prevent the misuse of resources.

This requires regular and frequent disclosure and reporting on principles governing the fund, its inflows and outflows, and the allocation of assets. Regular interyear reporting should be submitted to the legislature and made widely available to the public, for example, by posting on the Internet, as done by Norway (Box 4.2) and Alaska. In addition, a detailed annual report should be provided to the legislature on the flows into and out of the fund during the year and the allocation of the resources under the fund’s supervision. The report should contain a summary of the asset allocation of the portfolio, summary statistics on the performance of the portfolio during the year, and a critical retrospective on the activities of the fund during the year.

To ensure propriety in the fund’s activities, it will be important to have the fund’s activities audited by an independent agency to supplement the internal audit of the fund. Such an audit should include both financial and performance audits and, if relevant, the procedures for the choice of external managers for the fund. Audit and reporting should cover evaluation of the performance of the fund. Such evaluations should be done by an independent professional company with no financial interest in the outcome.17

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