ANNEX Conceptual Framework: An Intergenerational Model
The optimum spread of oil revenue can be analyzed in the context of a simple intergenerational model of maximization of a social welfare W, with representative citizens in periods t and t+1 with similar utility functions U and consuming c(t) and c(t+1), respectively. Citizens of the current generation (N) have an income Γ(t) generated from transfers received from the government. For simplicity, the oil sector is under government control, and there is no production in the non-oil sector. The current generation saves F(t) in favor of the next generation, whose population is N(l+η), where η is the population growth rate. The government perceives a rent on oil resources in terms of royalties and other taxes. The problem is to find c(t) and c(t+1) that are solutions to the following intergenerational optimization problem:
where β is a discount factor indicating the time preference and r the market interest rate.38
Optimal consumption levels in t and t+l are functions of the income per capita and the time preference parameter β. While both consumption sets are affected positively by the income, the impact of β on c(t) is negative while it is positive on c(t+1), underscoring the role played by β in determining the savings of the current generation in favor of the future generation (saving by the current generation is an increasing function of β). The consumption by the future generation depends on the consumption of the current generation, as indicated by relation (8):
The equitable consumption path, where consumption is equal across generations, is given by β = (1+η)/(1+r). In this context, the higher the population growth rate, the larger will be the resources set aside for future generations so as to ensure equitable wealth redistribution across generations. When β > (1+η)/(1+r), the current generation cares for future generations to the extent that it saves enough so as to allow higher consumption by them. When β < (1+η)/(1+r), the current generation saves less for future generations, thereby lowering their consumption.
If one interprets Γ(t) as the oil wealth, that is, the discounted government revenue derived from oil reserves, the analysis has profound fiscal policy and intergenerational welfare implications. Depending on the value of β, the government will seek intergenerational equity or will favor the current or future generations. Current government policies (deficits or surpluses) are indications of the weight the government gives to the current generation as against future generations.
For plausible values of β (i.e., almost or exceeding one) current generations should generate fiscal surpluses derived from oil resources and accumulate financial assets that would replace the oil wealth after the depletion of oil reserves. The return on these financial assets would later on help finance the fiscal deficits run by future generations.
Alier, Max and Kaufman, Martin, 1999, “Nonrenewable Resources: A Case for Persistent Fiscal Surpluses,” IMF Working Paper 99/44 Washington: International Monetary Fund.
Blanchard, Olivier, Jean-Claude Chouraqui, Robert P. Hagemann, and Nicola Sartor, 1990, “The Sustainability of Fiscal Policy: New Answers to an Old Question,” OECD Economic Studies, No. 15 (Autumn), pp. 7– 36.
Buiter, Willem H., “Aspects of Fiscal Performance in Some Transition Economies Under Fund-Supported Programs,” IMF Working Paper 97/31 (Washington: International Monetary Fund).
Chalk Nigel, 1998, “Fiscal Sustainability with Non-Renewable Resources,” IMF Working Paper 98/26 (Washington: International Monetary Fund).
Davis Jeffrey M. and others, 2001 Stabilization and Savings Funds for Nonrenewable Resources-Experience and Fiscal Policy Implications, IMF Occasional Paper No. 205 (Washington: International Monetary Fund).
Gerson, Philip, 1998, “The Impact of Fiscal Policy Variables on Output Growth,” IMF Working Paper 98/1 (Washington: International Monetary Fund).
Liuksila, Claire, Alejandro Garcia, and Sheila Bassett, 1994, “Fiscal Policy Sustainability in Oil-Producing Countries,” IMF Working Paper 94/137 (Washington: International Monetary Fund).
Nuven, Diep, 1994, “Linkages in Price Level and Inflation Rate Between CFA Franc Zone Countries and France.” IMF Working Paper 94/93. (Washington: International Monetary Fund).
Odedokun, M. O., 1997, “Dynamics of Inflation In Sub-Saharan Africa: The Role of Foreign Inflation, Official and Parallel Market Exchange Rates, and Monetary Growth,” Applied Financial Economics, Vol. 7 (August), pp. 395– 402.
Tersman, Gunnar, 1991, “Oil, National Wealth and Current and Future Consumption Possibilities,” IMF Working Paper 91/60 (Washington: International Monetary Fund).
Zee, Howell H., 1998, “The Sustainability and optimality of Government Debt,” Staff Papers, International Monetary Fund, Vol. 35 (December), pp. 658– 85.
This section has been prepared by Joseph Ntamatungiro.
In 1982, the implicit interest rate averaged 14 percent (22 percent for floating rates and 8 percent for fixed rates). In 1979, the average maturity of Gabon’s debt was about three years.
Until the early 1980s, bank loans and export credits represented the bulk of Gabon’s external debt. Since then, the debt composition changed somewhat in favor of bilateral loans (mainly Paris Club creditors), with somewhat longer maturities.
Seigniorage in CFA franc countries is limited by the requirement that central bank financing (statutory advance) during period t should not exceed 20 percent of revenues collected in period t-l. However, since no limit is set on the government borrowing from commercial banks, there is a risk of crowding out the private sector. Such a risk is alleviated by the setting of targets on net bank credit to government under the BEAC’s monetary programming exercise, as well as in the context of Fund-supported programs.
The accumulation of domestic payments arrears had a negative impact on private investment and the local banking system. Following a comprehensive audit in 1999, the government has stepped up their clearance, notably in the context of commercial agreements with domestic creditors (so-called securitization).
The issue of the desirable level of the debt-to-GDP ratio is addressed in Subsections D and E.
The second term of (6b) is close to (d0 − dn)/n, i.e., the debt reduction divided by the number of years to achieve it.
b is more sensitive to the difference between g and r than to levels.
The ratio of 40 percent of GDP corresponds to about 70 percent of non-oil GDP. A debt-to-GDP ratio of 70 percent is one of the four convergence criteria required by the CEMAC. As underlined in the next subsection, a debt ratio based on the non-oil GDP would be more relevant, especially in view of the projected decline in oil production.
Oil currently contributes 40 percent of Gabon’s GDP, about half of total government revenue and three quarters of exports.
For a framework for the optimal exploitation of irreplaceable resources, see Hotelling (1931). Caution should be exercised in valuing oil resources, since the volatility of oil prices or exchange rate depreciations could lead the government into an unsustainable consumption path based on a poor valuation. Accordingly, the value of oil wealth should be reexamined continuously (see Tersman (1991) in the case of Norway).
For an analysis of the experience of policies in a number of oil producing countries, see Liuksila, Garcia, and Basssett (1994). The authors noted the headway made in Mexico, Egypt, and Indonesia in the diversification of sources of government revenue; however, while the experience was mixed in the cases of Nigeria and Venezuela.
Another reason to keep the set-aside oil income in international assets is to protect these resources from political spending pressures and to insulate the domestic economy from volatility of oil revenues (see Davis and others (2001)).
The current analysis does not deal with precautionary policies aimed at smoothing oil revenue (excess oil revenue saved to be used when oil revenue is below the permanent income level), including the use of market-based hedging instruments. Limitations to the use of futures markets or options as hedging tools include (i) the basis risk; (ii) inadequate expertise; (iii) difficulty to pay deposit and margin calls, and premiums; and (iv) the fact that the government is not always the producer/seller of oil resources.
For a conceptual framework for intergenerational welfare optimization, see the annex at the end of this section.
For a finite horizon (T) for the exploitation of oil resources, the oil wealth amounts to Vot = Tot([(1+λ)(1+e)/(1+r)]T−t+1−1)/[(1+λ)(1+e)/(1+r)−1].
Net foreign assets of the central bank are not included in the government’s net position, given their past volatility and their current low level (negative during 1998-99 and less than 3 percent of GDP during 2000-01). Similarly, privatization proceeds were not included, with past experience indicating that they have barely covered restructuring costs.
This assumption may be restrictive as it assumes the absence of new oil discoveries.
In the following discussion, no inflation is assumed in the long run. Therefore, projections for interest rates and GDP growth rates make no difference between nominal and real rates.
It is assumed that the best estimate of future prices is the current price (EtPt+j = Pt).
Chalk (1998) uses the term “core deficit” in his analysis for countries producing nonrenewable resources.
For a discussion on the setting up and the use of savings funds for nonrenewable resources, see Davis and others (2001) and Liuksila, Garcia, and Bassett (1994). The literature indicates that the constitution of savings funds is not a panacea as it has not been successful in disconnecting expenditure decisions from oil revenue developments. Liuksila, Garcia, and Bassett also show how oil contingency mechanism funds established by Venezuela had limited success due in part to pressing expenditure needs and to the diversion of resources.
Higher production and oil prices would improve Gabon’s financial prospects; however, they would not fundamentally change the thrust of the analysis.
As noted above, oil-based income transfers and wealth can either be constant in per capita terms, that is, growing over time at the same rate as population growth, or constant relative to GDP, that is, growing over time at the same rate as real GDP.
Given the short maturities that characterize Gabon’s debt, a primary surplus of 2.7 percent of non-oil GDP might not be sufficient to service the debt in the medium term. Debt relief from external creditors would be necessary to spread the debt repayment over a longer period and to facilitate the constitution of savings in the FFG during the initial years. Also, depending on the level of the return on FFG resources relative to interest payments on debt, the government might allocate more oil revenue for debt repayment.
For a log utility function, the solution to this problem is
c(t) = [Γ(t)/N]/(1+β)
c(t+1) = [(1+r)Γ(t)/N(1+η)]β/(1+β)
F(t) = Γ(t)β/(1+β).