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)| false Davis, J., R. Ossowski, J. Daniel, and S. Barnett, 2003, “ Stabilization and Savings Funds for Nonrenewable Resources: Experience and Fiscal Policy Implications”, in , Daviset al. Fiscal Policy Formulation and Implementation in Oil-Producing Countries, Chapter 11, pp. 273– 315, IMF, Washington, D.C..
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Purfield, C., 2005, “Managing Revenue Volatility in a Small Island Economy: The Case of Kiribati,” IMF Working Paper No. 05/154, Washington, D.C.
We would like to thank Jeffrey Davis, Hali Edison, Rolando Ossowski, Catriona Purfield, John Thornton, Holger van Eden, and Mauricio Villafuerte. An earlier version of the paper served as a background paper for the PFTAC conference on “Trust Funds and Superannuation Funds in the Pacific Island Countries”, September 12-13, 2007 in Fiji. The authors are responsible for all remaining errors.
This is more evident for natural resource funds (e.g., oil funds), where part of higher natural resource fiscal receipts are transformed into financial assets, but could also involve funds built up from foreign grants and privatization receipts. SWFs could also be created out of domestically-based receipts and fiscal surpluses not directly linked to foreign exchange inflows, but this tends to be unusual.
The paper is focused on the main funds in the PICs; although several economies have a series of earmarked funds/accounts that fulfill a narrow and specific goal (e.g., Papua New Guinea, Marshall Islands, Tuvalu). In particular, this paper does not look at pension funds.
For the purpose of this paper, Timor-Leste will also be included in the Pacific Island group.
For instance, sugar in Fiji, fish licenses in Kiribati; oil, copper, gold, coffee, and cocoa in Papua New Guinea; and timber, palm oil, and fish in the Solomon Islands (Appendix Table A.1).
Fishing and tourism have been identified in many island economies as potential growth drivers but significant constraints have prevented PICs from fully capitalizing on these opportunities (including geographic isolation, lack of tourism infrastructure, a limited pool of skilled labor, and a growing threat of overfishing).
Volatility is estimated as the standard deviation of revenue as a share of GDP, as the objective is to compare the degree of volatility relative to the size of the economy. For example, a sharp decline (increase) in revenue would likely lead to a comparable decline (increase) in expenditure and/or borrowing, both of which would have an impact on the economy.
For example, self-assessment procedures for income taxes are uncommon, audit programs are often not comprehensive, use of single taxpayer identification numbers is sparse, and few countries have modern computer systems.
In part, the volatility in revenue from fishing licenses also reflects exchange rate movements, as the licenses are set in foreign currency (usually U.S. dollars).
E.g., in Micronesia, public sector employment accounts for about half of total employment and wages in the public sector are two times higher than in the private sector. Public wages represent more than 40 percent of GDP in Kiribati and between 20-25 percent of GDP in the Marshall Islands, Micronesia, and Palau.
That is, there is a positive correlation between an economy’s exposure to international trade and the size of its government. This is often explained by the risk-reducing role that government spending plays in economies exposed to a significant amount of external risk. The relationship between openness and government size is strongest when terms-of-trade risk is highest, which is the case for a few PICs.
The CTFs of the Marshall Islands and of Micronesia operate only as savings funds until FY2023 (the expectation is for both countries to have assets that generate returns high enough to fully replace U.S. budgetary grants in FY2024). However, in principle, the authorities can make new deposits (in addition to the initial required deposit) in the CTFs and withdraw those funds at any time.
With these objectives in mind, the CTFs of the Marshall Islands and Micronesia consist of three accounts: a long-term savings account “A”, a buffer savings account “B”, and a disbursement account “C”. Initial contributions are deposited into, and investment income accrues to, account A. Investment returns in excess of 6 percent per year are deposited in account C, which will operate as a stabilization account from FY2024 onwards. This account is capped at three times the projected FY2024 transfer from the CTF needed to fully replace U.S. budgetary grants; overflows return to account A. Account B, which will only be created in 2022, will receive all previous year’s investment income from account A, transfer to the budget an amount equal to the real value of FY2023 U.S. budgetary grants, then transfer any remaining funds, firstly to account C if it has not reached its cap, and secondly back to account A. In case account A investment income is insufficient to provide account B with the funds needed for the budgetary transfers, account C will be used.
Responsibilities include advising the Tuvalu government on its budgets, assessing Tuvalu’s economic development, and providing a recommendation to the Board on the size of any distribution from the TF to the budget.
A fourth board member, from the United Kingdom, existed until 2003, when the U.K. withdrew from the rank of donors. The European Union has an observer status at the board in recognition of its indirect TF contribution.
Although the authorities have hired foreign managers to operate the fund, as in the other CTFs.
For instance, for the CTFs, the trustee must: (i) be selected from among trust institutions organized in the United States, (ii) have a net worth in excess of $100 million, (iii) have at least 10 years experience as a custodian of financial assets, and (iv) have experience in managing trust funds of at least $500 million (GAO, 2007). Timor-Leste and Tuvalu require their advisory committees to include qualified economists and financial experts as members.
A key element under Timor-Leste’s existing fiscal framework is to ensure a long-term sustainable fiscal position, by setting as a guideline the principle that the non-oil deficit should be consistent with the estimated permanent income from oil wealth (net of government debt).
As shown in Appendix Table A.2 in recent years, Kiribati’s deficit has averaged above 30 percent of GDP a year, financed not only by withdrawals from the RERF, but also depletion of cash reserves outside the fund. Crowe (2007) estimates that the large fiscal deficits may not be consistent with preserving the real per capita value of its RERF, and could lead to the depletion of the fund’s assets.
Only in recent years have the transfers from the TTF to the CIF (to finance the budget) become significant as a share of total revenue.
In addition, at present levels of the CTF assets, it is unlikely that the fund could generate $15 million per year permanently.
The Tonga government sued an investment manager of its fund and, after a settlement, managed to receive a marginal compensation. The value of Nauru’s NPRT assets is reported to have decrease by more than 90 percent between 1991 and 2006. In part it reflected the sale of real estate to repay public debt. The authorities expect that the Nauru fund will have a residual value of around A$60 million following the end of the receivership process currently under way. The Government of Nauru is developing a new trust arrangement to replace the NPRT and is also considering the creation of a separate national trust fund to hold government revenues with a goal similar to that of Tuvalu’s TTF.
The authorities can deviate from the benchmark, but need to explain the reasons to parliament.
In PNG, while the fund closed in 2001, cash management problems and overall PFM weaknesses remain and the country continued to have deposits earmarked for projects while borrowing expensively to finance the deficit. However, in recent years, the fiscal position has improved and the authorities have started to reduce public debt.
Tuvalu’s fiscal guidelines require: (i) balanced budgets on average over the medium-term; (ii) budget deficits below 3 percent of GDP; (iii) assets in the CIF above 16 percent of the TTF’s assets over any four-year period; (iv) drawdown from the CIF that is compatible with the TTF’s sustainability; and (v) external debt below 60 percent of GDP. Most of the benchmarks have not been met, partly reflecting design issues with the targets and the high revenue volatility.
In the case of the Federated States of Micronesia, the main source of immediate pressures is the finances of some of its states. The Marshal Islands has been unable to meet loan repayments to the Asian Development Bank since FY2006—the ADB holds around 68 percent of the countries major liabilities (ADB, 2006).
For example, according to a sample in IMF (2007), assets in oil funds are generally well below 100 percent of GDP, with the exception of Timor-Leste.
In general, assets have been invested in fixed-income instruments, such as U.S. Treasury bonds.
Real annual returns (using the Australian CPI as a deflator) from 1988 to 2005 for Tuvalu’s sovereign wealth fund ranged from -8.5 (in 2001) to 21.7 (in 1997) and averaged 6.3 percent but with a standard deviation of 8.6 percent (TTFAC, 2006). Management fees should be taken into account in assessing real returns as they can have a significant impact on long-term cumulative returns.
In the case of Tuvalu’s fund, the average real return of 6.3 percent compares favorably to (i) its 5-year performance benchmark of 4.5 percent; (ii) returns on 10-year Australian government bonds (4.6 percent); and (iii) investment in a 70/30 weighted portfolio of the Standard & Poor’s Australian Stock Exchange 200 index and 10-year Australian government bonds (5.9 percent). However, it underperforms, in terms of means, a portfolio that is 100 percent invested in the S&P ASX 200 index (7.8 percent). Tuvalu’s fund volatility has been on par with that of a portfolio consisting of 70/30 S&P ASX 200 and 10-year Australian government bond.
There have been delays in setting up the funds, including selecting professional management, and in providing complete, audited, and timely reports as required by the Trust Fund agreements with the U.S.. In addition, under the agreement, a joint committee (U.S. and Marshall Islands/Micronesia) was supposed to assess the performance of the Fund vis-à-vis key policy objectives—this has not been done.
For example, the Papua New Guinea’s MRSF net position was not known, as external borrowing using the MRSF assets as collateral was not fully disclosed. Tonga’s TF financial transparency requirements were repeatedly not enforced, audits did not meet international standards, and no audit was published after 1999 (Jimenez de Lucio, 2003).
Bertram (1986) argues that the small Pacific islands will likely always be dependent on capital inflows (remittances and foreign aid) and, as such, should not be trying to reach self-reliance. Nevertheless, even in cases where the islands are likely to remain to some degree dependent on aid, structural reforms and improved fiscal management could help improve growth prospects and reduce vulnerabilities.
The IMF’s “Code of Good Practices on Fiscal Transparency” and the “Guide on Resource Revenue Transparency” provide guidelines on transparency regarding management of public assets, including resource funds—which, in general, can be applied to the sovereign wealth funds.
The simplest form of MTFs is a medium-term fiscal framework (MTFF), which involves a statement of fiscal policy objectives, consistent medium-term macroeconomic projections, and setting aggregate fiscal targets with a view to ensure macro-stability and address long-term sustainability considerations. Even a simple MTFF can provide a framework to link long-term perspectives with the annual budgets and promote greater accountability. More advanced forms of MTFs include medium-term budget frameworks and medium-term expenditure frameworks. Both require greater capacity and fundamental changes in the way budgets are prepared. See IMF (2007) for more discussion on gradual implementation of different modalities according to capacity constraints.