Journal Issue

2. A Fiscal Framework to Support Growth and Manage Dependence on Natural Resource Revenues

Ahmed Al-Darwish, Naif Alghaith, Alberto Behar, Tim Callen, Pragyan Deb, Amgad Hegazy, Padamja Khandelwal, Malika Pant, and Haonan Qu
Published Date:
March 2015
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Tim Callen and Haonan Qu 

Saudi Arabia derives more than 90 percent of its fiscal revenue from oil. Key challenges for fiscal policymakers are to insulate the economy and the budget from large fluctuations in oil prices, ensure that oil revenue is efficiently used for development purposes, and safeguard sufficient revenue for future generations. This chapter looks at the current fiscal framework in Saudi Arabia, analyzes the efficiency of public investment, and draws on the experience of other commodity-exporting countries to consider a set of reforms that would strengthen the fiscal framework in Saudi Arabia.

Overview of Key Fiscal Policy Challenges in Saudi Arabia

Fiscal policy plays a crucial role in Saudi Arabia as the main vehicle through which the country’s oil wealth is converted into economic outcomes and distributed for the benefit of the population. Over the past several decades, government spending on infrastructure, education, and social programs has transformed the economy and supported higher living standards. The volatility of oil revenue, however, has posed challenges for fiscal management. Oil prices are volatile and price swings can be large and long-lasting. Saudi Arabia, with its spare production capacity, also helps manage the balance between supply and demand in the global oil market, and consequently sees swings in the volume of its oil exports.

Fiscal policy in Saudi Arabia has three distinct goals relating to development, stabilization, and intergenerational equity:

  • The developmental goal involves making expenditure decisions with a view to long-term economic growth. Investments are made in physical and human capital to support growth and development. It is important that these investments efficiently meet the country’s development goals.

  • The stabilization goal relates to smoothing the impact of oil price swings or other shocks on the domestic non-oil economy. With the fixed exchange rate limiting the ability of monetary policy to respond, fiscal policy is the first line of defense in managing shocks.

  • The intergenerational equity goal considers the nonrenewable nature of oil as a resource in the face of the country’s dependence on oil revenue.

Typically, oil and mineral producers see higher volatility in government revenues and expenditures than nonresource-rich countries. This volatility often translates into weaker and more volatile growth performance than in nonresource rich countries (Figure 2.1). In Saudi Arabia, there has been a clear improvement in fiscal management over the past decade and a noticeable decline in the volatility of government spending. Nevertheless managing volatility remains a key challenge. Indeed, with uncertainties about how the demand and supply balance in the global oil market will evolve in the coming years, designing a framework that will best support fiscal policy management in the face of uncertain oil revenue is critical if the country is to meet its development and growth objectives.

Figure 2.1.Volatility of Real Resource Revenue and Expenditure

(Coefficient of variation, average: 1992–2011)

1 Real total revenue.

Source: IMF, World Economic Outlook; and IMF staff estimates.

Fiscal Rules and Medium-Term Budget Frameworks

Across the world, there has been a move toward a greater reliance on fiscal rules and medium-term budget frameworks to help manage fiscal policy challenges. In 2013, 81 countries had adopted some type of fiscal rule, with budget balance and debt rules being the most common (Figure 2.2). Medium-term budget frameworks have been introduced in 61 countries.

Figure 2.2.Countries That Have Adopted Fiscal Rules1

(Number of countries)

Source: IMF Fiscal Affairs Department, Fiscal Rules Database.

1 Figure includes both national and supranational fiscal rules.

The advantages of fiscal rules are that they provide sustainable, predictable, and stable fiscal policy. They can correct any lack of incentive in the collective decision-making process to contain spending pressures, strengthen the position of the Ministry of Finance in guarding fiscal discipline, and signal the fiscal policy intentions of the government to citizens and financial markets. This in turn creates more certainty for businesses and should encourage investment and employment. International experience shows that countries with fiscal rules tend to run larger primary balances.

However, fiscal rules have disadvantages as well. The lack of flexibility can be an issue in the face of large shocks such as the global financial crisis, and if the rules are jettisoned at these times there is a loss of credibility. A rule may also result in a focus on aggregate spending, rather than the composition of spending, and may induce the government to reduce easy-to-cut items like public investment to meet its target. Further, unless there is a strong political commitment to the rule, efforts will be made to circumvent it through off-budget spending, creative accounting, and reduced transparency.

The attractiveness of medium-term budget frameworks is that they can help plan, manage, and prioritize revenue and expenditure over a medium-term (three- to five-year) horizon. Annual budgets are not necessarily optimal for fiscal outcomes. Determining fiscal policy on an annual basis can result in incremental decisions rather than strategic choices, lead to overspending if the future implications of decisions made today are not taken into account, result in fiscal risks not being identified in time, and mean that the budget is not well-linked to the management of expenditure performance, which requires a medium-term focus.

Indeed, a fiscal anchor and a medium-term budget framework reinforce each other. A fiscal anchor provides clarity and specificity to fiscal policy by providing a top-down objective over a medium-term horizon, enhances the commitment and political ownership of the medium-term budget framework, and communicates in broad terms the government’s fiscal policy intentions. Conversely, the medium-term budget framework provides the budget allocation and control process to deliver the objective established in the rule. It gives strength to the fiscal anchor by translating it into real decisions, demonstrates ahead of time whether government policy is consistent with the anchor or whether policy actions are needed, and provides the lead time for taking decisions that are needed to meet the requirements of the fiscal anchor.

Experiences in Commodity-Exporting Countries

The challenges of fiscal management in oil- and mineral-exporting countries are different than those challenges in other countries given the volatility of the main revenue source. A medium-term horizon is particularly important to prevent volatile annual revenues from translating into expenditure fluctuations that can destabilize the economy and reduce the quality of government spending. During upturns, these frameworks can help governments resist the natural pressure to increase spending when revenues are high and surpluses are large. During downturns, frameworks can help protect priority expenditures and maintain the strategic focus of policy plans. Setting and adhering to medium-term spending plans thus increases the chances that short-term spending pressures do not jeopardize long-term fiscal objectives.

It is therefore worth looking in more detail at a sample of oil- and mineral-exporting countries to assess their experiences with fiscal rules and medium-term budget frameworks. Five countries are considered in turn: Chile, Mexico, Mongolia, Norway, and Russia.

Chile has a long history of using fiscal rules and institutional frameworks to help manage the fiscal impact of its large copper exports. Chiles established the Copper Stabilization Fund in the late 1980s, introduced a structural balance rule in 2001 and revised it in 2005, and enacted a Fiscal Responsibility Law in 2006. Committees of experts determine the reference (10-year ahead forecast) copper price and potential GDP to be used in the structural budget calculation. Under Chile’s framework, the draft budget must contain medium-term (four-year) budget projections based on medium-term projections for GDP and commodity prices. Every new administration must present, within 90 days of taking office, its target for the structural balance for the duration of its term. Expenditures are budgeted in line with structural revenues and the structural balance target. The implementation of the rule has changed over time—from 2001–07, a constant target for the structural balance was set at a surplus of 1 percent of GDP in 2008, the target was 0.5 percent of GDP; and in 2009, the target was zero and a de facto escape clause was introduced to accommodate countercyclical measures. The current administration has specified a medium-term target of structural balance by 2018 from a deficit of 1 percent of GDP in 2014. A Fiscal Council that started operating in June 2013 oversees the existing committees on potential GDP and the long-run copper price. Two funds have been set up, the stabilization fund (ESSF) which covers fiscal deficits and amortizations, and the pension reserve fund (PRF) which is earmarked to cover a fraction of pension outlays starting in 2016.

The experience with fiscal rules in Chile is generally viewed as a success, and the rule is well understood by the public and market participants. Fiscal policy has helped shield the economy from large swings in copper prices, expenditure volatility is comparatively low, and the fiscal position is strong compared to peer countries. Chile handled the global financial crisis well, using assets from the stabilization fund as a fiscal buffer. At the same time, amid the commodity boom in the early 2000s, the reference copper price was often revised up significantly, creating room for strong expenditure growth despite the fact the economy was already operating broadly at full capacity.

Managing its oil revenues has been a key issue for Mexico over the past decade. The country introduced a fiscal responsibility law (FRL) in 2006, and modified it in 2008. A balanced budget on a cash basis was established in the FRL, with an escape clause to be triggered during economic downturns (this clause was used from 2010–12). The rule applies to the federal public sector, which includes the central government, social security, and key public enterprises (e.g., the oil company, PEMEX, and the electricity company, CFE). The rule was revised in 2009 to exclude PEMEX investment, and the target was moved from budget balance to a 2 percent of GDP deficit. While the fiscal rule helped reduce deficits, anchored macroeconomic stability, and proved flexible enough for a countercyclical response to the global financial crisis, it also had drawbacks. Expenditures increased rapidly during good years, while the rule did not limit borrowing by the broader public sector. In response to the first of these issues, an expenditure growth rule has recently been introduced. Under the rule, “structural current spending” growth (i.e., primary current spending less that governed by automatic rules such as pensions, electricity subsidies, and revenue-sharing transfers to state and local governments) cannot be higher than potential growth (which is estimated by the Secretary of Finance). A target for the broader public sector borrowing requirement has also been introduced under the FRL in addition to the budget balance.

Mongolia has a large and growing mineral sector, and fiscal revenues are expected to rise substantially. The country experienced a substantial decline in mineral revenues during 2007-09, which led to a crisis and exposed weaknesses in fiscal management (poor public investment planning, large untargeted social expenditures, and extreme neglect of infrastructure maintenance). Since the crisis, Mongolia has introduced a fiscal stability law (implemented in 2013) and a fiscal stability fund, and has undertaken complementary public financial management reforms. The fiscal stability law contains three fiscal rules: a ceiling on the structural fiscal deficit of 2 percent of GDP as of 2013; a cap on expenditure growth based on nonmineral GDP growth as of 2013; and a debt ceiling. Structural revenues are calculated as a moving average of major mineral prices, with the prices calculated over a 16-year period (12 previous years, the current year, and three future years, using price forecasts from the IMF and other internationally reputable financial institutions). The expenditure rule is linked to the growth of nonmineral GDP (the greater of the current year or the average over the past 12 years). The fiscal framework is supported by a stabilization fund—when mineral revenues exceed structural mineral revenues, the difference has to be placed in the stabilization fund, and when they fall short, the fund can be used to finance the deficit.

Norway established a new fiscal framework in 2001 to manage its oil revenues. The fiscal framework was designed to achieve four goals—macroeconomic stability, fiscal sustainability, intergenerational equity, and efficiency of resource use—and based on three institutional pillars—a structural fiscal rule, a sovereign wealth fund, and the full integration of that fund into the government budget. Net cash flows from oil and gas are transferred to the Global Government Pension Fund. The fiscal rule ties the non-oil fiscal deficit to the investment returns of the pension fund, with the average transfer made at an imputed 4 percent real return on investments. The rule is flexible, however, and additional transfers are allowed for countercyclical stabilization and expenditure smoothing. This means that transfers from the pension fund may be higher than expected returns during a downturn and lower during an upturn. The framework has seen a large build-up in assets. Nevertheless, there are still challenges. The pension fund is currently growing much faster than the economy, implying a steady fiscal stimulus. However, when oil and gas revenues start to decline, there will be lower inflows to finance future commitments.

Russia has a fiscal framework to manage its oil and gas revenues. The previous framework, which started in 2007 and had a long-term non-oil deficit target of 4.7 percent of GDP, was suspended in April 2009 due to the global financial crisis, and then formally abolished in 2012. Under a new framework approved in December 2012 and implemented in 2013, federal government expenditures are capped at benchmark oil revenues plus federal non-oil revenues (including privatization receipts) plus a net borrowing limit of 1 percent of GDP. Benchmark oil revenues are calculated according to a 10-year backward-looking oil price rule (a five-year average used in 2013 will gradually be increased to a 10-year average by 2018). When the oil price is above the benchmark price, the additional revenues are saved in the Oil Reserve Fund. When that fund reaches 7 percent of GDP, 50 percent of additional allocations are allotted to the National Wealth Fund and 50 percent to infrastructure projects. When oil prices are below the benchmark, the Oil Reserve Fund is tapped to maintain expenditures. If there is a prolonged decline in oil prices (the actual oil price is below the benchmark for the previous three years), the benchmark price is reset to equal the three-year backward-looking average. In any event, expenditures cannot be lower than what is legislated in the previous budget, which acts as a floor for federal expenditures.

Summary: Commodity-Exporting Countries

In sum, a reliance on commodity revenues imposes unique fiscal policy challenges in terms of how to handle the volatility and exhaustibility of the primary revenue source. These challenges have prompted significant policy innovation, and while no single model has emerged, the five countries discussed above have a number of common characteristics in terms of how their fiscal frameworks have evolved.

  • First, there has been a general move toward a medium-term expenditure framework to improve the planning and efficiency of spending.

  • Second, there has been experimentation with some form of fiscal anchor (structural fiscal balance rules, expenditure ceilings, or a combination of the two) that seeks to decouple expenditures from revenue volatility, although rigid rules have not worked.

  • Third, the countries have established stabilization and sovereign wealth funds to provide resources to smooth expenditures in the face of revenue volatility and to save for future generations.

The country experiences highlight some of the specific design issues that need to be considered when implementing a fiscal anchor. What price information should be used to calculate structural revenues? What should be the structural balance target? Should escape clauses be built in? What should be the level of coverage—central government or broader? In terms of price information, using a short backward-looking horizon tracks prices and picks turning points well, but generates more volatility in expenditures (Figure 2.3). A longer backward horizon results in smoother expenditure, but will systematically undershoot or overshoot prices if the trend changes. Incorporating forward prices in theory is useful, but in practice futures prices are poor predictors of what will happen to prices going forward. Where a fiscal rule is used, countries have opted either for a long time horizon to calculate the price (Mongolia, Russia) or to assign a committee (Chile) to establish the price. The choice of the structural balance target is also important. A structural surplus means that there is an intention to accumulate resources for future generations.

Figure 2.3.Standard Deviation of Oil Prices, 2000–10

(U.S. dollars)

Source: IMF staff estimates.

In terms of frameworks for managing natural resource wealth, countries have often opted for a fiscal stabilization fund to shield the budget from revenue uncertainty and volatility and to meet fiscal emergencies (such as responding to natural disasters), and for a sovereign wealth fund to address long-term demographic challenges (pensions, healthcare) and intergenerational equity considerations. This allows for investment strategies to be tailored to the different objectives of the funds, with the stabilization fund needing to be more liquid.

Public Investment Management in Oil-Exporting Countries

With fiscal policy being the main vehicle through which oil wealth is channeled into the domestic economy, it is important that public spending efficiently meet the country’s development goals. As in most other oil-exporting countries, high oil prices have facilitated higher public spending in Saudi Arabia, including on investment projects (Figure 2.4). Capital spending grew by 24 percent on average annually in nominal terms from 2000–08, increasing by about 3 percentage points of GDP, on the back of a prolonged period of high oil revenue. Saudi Arabia further boosted capital spending during the height of the global financial crisis in 2009 and through a fiscal stimulus package in 2011. Capital expenditure averaged over 11 percent of GDP between 2009 and 2013. In turn, the Saudi Arabian economy has grown strongly; during 2000–13, non-oil output growth averaged over 7 percent annually.

Figure 2.4.Public Capital Expenditure, 2001–121

(Percent of GDP)

Sources: IMF, World Economic Outlook; and IMF staff calculations

1 Refers to general government and excludes oil-related investment of public companies.

2 Includes countries where the oil exports share in total exports is above 15 percent.

3 Emerging markets in IMF definition excludes China and MCD oil exporters.

Large public investments in Saudi Arabia over the past decade have improved the quality of infrastructure as part of the government’s strategy to diversify the economy. These investments have resulted in an improved ranking for infrastructure quality in the World Economic Forum’s (WEF) Global Competitiveness Report from 41 in 2008/09 to 31 in 2013/14 (Figure 2.5). Saudi Arabia’s infrastructure quality is strong in the areas of roads and telecommunications, but weaker in railroads, ports, and airports, where a large number of investment projects are in progress.

Figure 2.5.World Competitiveness Indicators, 20131

(Index: 1=minimum, 7=maximum)

Source: World Economic Forum, Global Competitiveness Index.

1 Railroad score of GCC is set to that of Saudi Arabia due to lack of data for the other GCC countries. Mobile subscriptions scores are rescaled with a maximum of 7 relative to the highest score in advanced economies.

A key question is whether the large public investments that have been made have been efficient. While this is difficult to answer, a comparison can be made of the estimated real public capital stock per capita and the infrastructure quality index (Figure 2.6). This suggests that Saudi Arabia compares quite favorably in terms of the investment/quality combination, although it appears less efficient than economies such as Canada, Norway, and Singapore.

Figure 2.6.Public Capital Stocks and Infrastructure

Sources: World Economic Forum, Global Competitiveness Report; and author’s calculations.

The efficiency of public investment in Saudi Arabia can be assessed using two alternative techniques that measure countries’ effectiveness in transforming inputs (money) into outputs (infrastructure). Specifically, efficiency is measured using a Data Envelopment Analysis (DEA) and a Partial Free Disposal Hull (PFDH) (see Appendix 2.1).4

In the calculations, two alternative output measures are used: one is an infrastructure quality measure, approximated by using the infrastructure subcomponent of the WEF’s Global Competitiveness Indicators; the other is an infrastructural quantity index, constructed on the basis of data on telephone lines, electricity, and roads from the World Bank’s World Development Indicators.5 Inputs are measured as the public capital stock, with GDP per capita used as a control variable (a two inputs-one output approach). A higher estimated score implies greater efficiency. For each of the two methods, final score estimates are the average of the two scores from the two alternative output measures. Both the PFDH and the DEA results show that Saudi Arabia’s score is near the global average score, but is lower than some advanced economies with strong institutions such as Canada, Chile, Norway, and Australia (Figure 2.7).

Figure 2.7.DEA and PFDH Scores

Source: IMF staff estimates.

1 Oil exporting countries with strong institutions as determined by high WGI indicators (90+) - Australia, Canada, Chile, and Norway.

Note: DEA = Data Envelopment Analysis; PFDH = Partial Free Disposal Hull; GCC = Gulf Cooperation Council; WGI = Worldwide Governance Indicators.

A Fiscal Reform Agenda for Saudi Arabia

The fiscal position in Saudi Arabia is very strong, with government debt virtually eliminated and substantial assets accumulated. From this position of strength, now is a good time to consider further reforms that will help the government meet its fiscal objectives in the period ahead. With respect to stabilization, Saudi Arabia has become more stable in the last two decades, but the volatility of macroeconomic outcomes continues to be above levels in advanced economies. Furthermore, recent expansions in fiscal spending risk overcommitting future budgets to high expenditure levels that might prove unsustainable in the face of a persistent negative oil price shock. This could jeopardize intergenerational equity and lead the government to undertake abrupt expenditure cuts to ensure sustainability, thus undermining the developmental objective of fiscal policy and exacerbating procyclicality. Finally, while public investment efficiency appears reasonable in Saudi Arabia, it remains below that of many countries, suggesting room for improvement. Increased efficiency would provide better resource allocation and complement the government’s goal of developing a more diversified economy.

The Saudi Arabian budget is put together using a top-down and a bottom-up approach. The budget oil price is decided by a committee through a consultative process that includes the Ministry of Oil, Ministry of Economy and Planning, and Ministry of Finance (MoF). The annual budget by the Ministry of Finance follows a top-down procedure in which the economic assumptions, fiscal policies, and expenditure ceilings are determined by the Supreme Economic Council (top-down approach), while line ministries submit their expenditure plans to the MoF and negotiations between the MoF and the ministries ensure budgeted spending is kept within the overall spending envelope (bottom-up process). The three-year rolling ceiling on the government investment program acts as a limit on future capital commitments by line ministries. Carry-over of expenditures from one year to the next is limited to certain projects and categories of expenditures. The annual budget includes a contingency reserve, and procedures for transfers from this reserve are set out in the annual budget decree. The budget is announced in late December with the publication of a short statement that includes information on the broad revenue and expenditure parameters, but not an estimate of the previous year’s budget outcome. A common chart of accounts and budget classification is being developed in accordance with the IMF’s Government Finance Statistics Manual 2001 together with the implementation of a new government financial management information system (GFMIS) to aid budget preparation and analysis.

Over the past decade, revenue and expenditure estimates in the budget have been conservative. Revenue and expenditure out-turns have exceeded budgeted amounts by substantial margins (Figure 2.8). This has been due in large part to conservative assumptions about oil prices and revenues and the subsequent spending of the additional revenues during the year. In turn, this has meant that the published budget has provided only a limited guide to the likely fiscal stance. While the government is not required to publish a supplementary budget, any increase or decrease in budget items during the year must be approved by the Council of Ministers.

Figure 2.8.Total Revenues and Expenditures, 2000–12

(Billions of Saudi Arabian riyals)

Source: IMF staff estimates.

Given the objectives to further reduce volatility, improve the efficiency of public investment, and increasing savings for stabilization and equity purposes, three possible areas of reform could be considered: (i) introduction of a formal medium-term fiscal framework; (ii) establishment of a fiscal anchor; and (iii) evaluation of the public investment management process.

A Medium-Term Fiscal Framework

There would be benefits to Saudi Arabia setting its fiscal policy decisions within a broader medium-term framework to help secure the effective implementation of its fiscal policy objectives. This framework would include:

  • A medium-term fiscal framework that sets the overall quantitative fiscal objectives in terms of the balance and net worth for three to five years, and demonstrates the consistency of the government’s policies with those objectives given projected macroeconomic variables, oil prices, and demographics.

  • A fiscal policy strategy document that translates the medium-term fiscal framework into a statement on medium-term fiscal policy priorities. This document could also contain fiscal risk analysis, indicating the sensitivity of fiscal plans to varying assumptions regarding the economy, contingent liabilities, or uncertain events.

  • A medium-term budget framework setting out the government’s expenditure plans and objectives in multi-year perspective, and in line with available fiscal space. In the Saudi Arabian context, such a framework would provide the link between the five-year development plan and the annual budget.

  • The annual budget, which remains the basis for legal appropriations of expenditure but should be consistent with all of the above.

The annual budget is the starting point for effective medium-term budgeting. At present, the budget is a relatively poor guide to actual fiscal outcomes because revenue and spending outcomes are typically far above the initial estimates. Extending the budget horizon to two or three years only makes sense if there is a reliable point of departure—i.e., a firm annual budget. From a technical point of view, this means that the MoF should include in the budget the best possible estimates. Good estimates require a sound understanding of how parameters drive annual expenditure, but also involve making repeated comparisons between the budget and the actual budget execution out-turn—both in-year and soon after the end of the fiscal year. To reduce budget uncertainty, the authorities should: (i) strengthen the capacity to cost existing and new policies to ensure that the budget is an adequate reflection of expected costs; (ii) adhere more closely to the adopted budget even if oil prices turn out to be different from what was budgeted; and (iii) enhance fiscal reporting on in-year budget out-turns (frequency, timeliness, and analysis). Furthermore, while the use of lower-than-actual/expected oil prices in budget preparations provides policymakers with a useful buffer, using more realistic oil price assumptions would enhance policy planning and budget transparency.

Developing a medium-term framework would enable policymakers to evaluate the sustainability of the budget. For example, it would allow for evaluation of the impact of a gradually growing expenditure mass—particularly if concentrated in current expenditures that are difficult to unwind—on the budget over the medium term. To enhance the predictability of spending decisions and assist the planning process, a goal could be that the five-year development plan be updated regularly and that these updates be linked to the annual budgets on a rolling basis.

Implementing a medium-term fiscal framework would need parallel efforts to enhance macroeconomic forecasting. A reliable assessment of how the economy will develop over the next couple of years is the basis for the decisions on what the right budget policies are and what the impact of those policies will be. The establishment of the macro-fiscal unit in the Ministry of Finance would help facilitate these changes as long as it is appropriately staffed.

A Fiscal Anchor

In terms of a formal fiscal anchor to support a medium-term budget framework, the balance of arguments is less clear. While a well-designed anchor can improve fiscal performance, help constrain expenditure pressures, and signal policy intentions, the Saudi fiscal track record has been good without an explicit fiscal rule. Further, Saudi Arabia has a fixed exchange rate, which means that fiscal policy is the primary macroeconomic policy tool. Consequently, retaining some fiscal policy discretion is warranted.

Nevertheless, there would be benefits to incorporating some of the elements of a structural budget rule as a policy guide to support the medium-term budget framework. Anchoring the framework on an estimate of structural revenues would delink expenditure decisions from revenue volatility and provide better guidance to line ministries when they are developing their medium-term expenditure plans. The expenditure envelope would be set according to the estimate of structural revenues and an overall target for the structural balance.

There are a number of design issues to consider, including the determination of the oil price to be used and the appropriate target for the structural fiscal balance. For the oil price, a five-year backward-looking price rule would strike a balance between having low volatility and adjusting within a reasonable timeframe to new market trends in the price (Figure 2.9). While consideration could be given to using longer backward-looking rule as in Mongolia and Russia, this could be overly conservative for Saudi Arabia given the already well-established fiscal buffers. On the output side, Saudi Arabia is one of the few countries with spare production capacity, and consideration would need to be given to how structural oil output would be determined. There is no country experience on how to do this, so a simple average of past output is likely the best option (Figure 2.10). In terms of the target for the structural balance, given that Saudi Arabia needs to save more for intergenerational equity purposes, a surplus target could be set in a way to generate sufficient savings to finance future government deficits when the country’s oil reserve is exhausted.

Figure 2.9.Oil Prices, 2003–13

(In U.S. dollars per barrel)

Source: IMF staff estimates.

Figure 2.10.Structural Revenue and Expenditure Decomposition, 2003–13

(Percent of non-oil GDP)

Source: IMF staff estimates.

Strengthening the Framework for Public Investment

A review of public investment management processes could improve public investment efficiency in Saudi Arabia. Given the large size of public projects, greater investment efficiency will provide better resource allocation and boost the growth dividend for the country’s economy. The example of Norway (Box 2.1) illustrates the potential benefits of a strengthened public investment management process in terms of cost savings on projects. The first step would be a review of the public investment management process from appraisal and selection to implementation and ex-post evaluation to ensure that it is fully meeting the government’s objectives.

Box 2.1.Norwegian Governance Framework for Public Investment Projects

The Ministry of Finance in Norway initiated the development of an obligatory Quality Assurance Scheme (QAS) as a governance framework in 2000. Following a series of unsuccessful major projects and repeated project overspending during the 1980 and 1990s, the Ministry of Finance introduced a mandatory external assessment for all state-financed projects over US$500 million. The goal was to ensure improved quality-at-entry by establishing a system in which politics and administration is well divided, with the interplay between these two sides well understood. The QAS was stipulated in the national budget law.

The two stages of the QAS help ensure that any project undergoes a comprehensive analysis before being approved. Measures are taken to ensure the quality of documentation (i) prior to the cabinet’s decision regarding conceptual solution and (ii) prior to the Parliament’s approval of the project’s cost frame. The first “gateway” focuses on the rationale of the project, which covers the early choice of concept and strategy, the decision to initiate project pre-planning, and examination of many alternatives. The second “gateway” is undertaken by the end of the planning phase, before a formal submission is made to Parliament. It is documented in a report containing the consultant’s advice on a cost frame for the project.

Evidence indicates that the QAS has had a positive effect with a remarkable cost savings. One study shows that 32 of the 40 projects submitted to QAS in the period 2000–09 and implemented during 2000–12, were completed within or below the cost frame (Samset and Volden 2003). The total net saving for the projects was estimated at about 7 percent of the total investment, which represents notable progress compared with the 1990s.

Norway: Deviation between Final Project Cost and Project Budget

(40 projects in total, percent)

This two-stage process provides a tool for control from the top: Parliament–government–ministry–agency. In between the two stages, there are several coordination forums where the Ministry of Finance brings together key interested parties for discussions, often resulting in common understanding and definition of terms and professional standards. As of 2013, the scheme had been used for 160 projects.

Appendix 2.1. Data Envelope Analysis and Partial Free Disposal Hull as a Nonparametric Methodology

Efficiency is assessed using a cross-country approach that measures the effectiveness of spending in producing outcomes. The relative efficiency of spending inputs and outcomes in each country is assessed using a Data Envelopment Analysis (DEA) technique. Based on the assumption of a convex production possibilities set, an “efficiency frontier” is constructed as the linear combination of efficient input and output combinations in the cross-country sample. The term “envelopment” stems from the fact that the production frontier envelops the set of observations. Figure A2.1 illustrates an efficiency frontier that connects points A through D as these countries dominate other input-output pairs, such as countries E and F in the interior. The efficiency score is computed by measuring the distance between a country and the efficiency frontier, defined as a linear combination of the best practice observations.

Figure A2.1.Efficiency Frontier under the DEA Concept

Source: IMF staff estimates.

While DEA does not require an assumption about the empirical distribution of the efficiency term, the approach has some shortcomings. Thus, DEA is a powerful tool to assess spending efficiency. However, DEA as a nonparametric relative measure of efficiency is highly sensitive to sample selection and measurement error. As a result, outliers can exert a large effect on the efficiency scores and the shape of the frontier. For this reason, proper sample selection is critical to ensure that cross-country input-output bundles are comparable.

To deal with the issues of the sensitivity to measurement errors and outliers, the efficiency analysis can be supplemented by a partial frontier method. This method generalizes a Partial Free Disposal Hull (PFDH)—a nonconvex and staircase frontier—by adding a layer of randomness to the computation of the efficiency scores. Instead of benchmarking a country relative to the best-performing peer in the sample, the method compares each country against the best performer in a sample of peers that produce at least the same amount of output. The sample is randomly drawn with replacement.


    SamsetKnut and GroHolst Volden. 2003. “Investing for Impact—Lessons with the Norwegian State Project Model and the First Investment Projects That Have Been Subjected to External Quality Assurance.Norwegian University of Science and Technology.

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