Prepared by David J. Ordoobadi.
The State Petroleum Fund’s guidelines envisage that the SPF may be used to finance the non-oil budget deficit and one half of the increase in the net lending of the state banks.
A more detailed discussion on the evolution of Norway’s competitiveness is provided in Appendix IV of SM/95/17, January 1995.
Norway’s foreign reserves are split into two pools: a hedging and an investment portfolio. Norges Bank has designed the hedging portfolio to immunize Norway’s foreign debt from currency and interest rate fluctuations by holding bonds in the same size, currency, and maturity as the foreign debt. The hedging portfolio will be used to pay off the foreign debt as it matures. The longest outstanding foreign bond is scheduled to mature by end-1998.
Duration is a measure of the sensitivity of the price of a bond to interest rate fluctuations. It is calculated as the time-weighted average of the bond payments as a percentage of the bond price, and represents the weighted average time to full recovery of principal and interest.
Further details on the Oslo criteria and other estimates of the resource requirements to smooth the transition to the post-oil era are provided in the background paper on Norway’s long-term fiscal challenge.
Five possible paths of fiscal consolidation have been considered: a one time tightening of 2.9 percent of GDP; a consolidation of 3.2 percent over ten years; 4 percent over 25 years; 5.1 percent of GDP implemented pari passu with the expected increase in social security expenditures; and 7.6 percent of GDP over 80 years.
Assuming a long-run GDP growth rate of 2.2 percent and a 4 percent real return on its portfolio, the SPF could finance a non-oil deficit of up to 3.2 percent of GDP and remain at a constant 180 percent of GDP. This (somewhat ambitious) target rate of return has obvious implications for the type of portfolio the SPF would need to hold.
Since 1900, real return have averaged 6 percent for U.S. stocks 2 percent for U.S. bonds, and 1 percent for U.S. Treasury bills. Since 1919, the average annual real returns on U.K. equities, gilts and Treasury bills have been 7 percent, 1.4 percent and 1 percent respectively.
The benchmark is a relative--rather than an absolute--performance measure. An investor that weights each asset in a portfolio at the midpoint of the ranges for that asset would take no risk vis-à-vis the benchmark, since both it and the portfolio would move together with the market. The portfolio would, of course, still face an absolute loss as a result of market movements.