Russian Federation: Selected Issues
Author: International Monetary Fund
Publication Date:
30 May 2003
eISBN:
9781451833065
Language:
English
Keywords:
ISCR; CR; Russia; nominal exchange rate; disinflation; monetary policy; oil fund; oil price; fund performance; public debt-to-GDP ratio; debt position; Oil prices; Fiscal rules; Oil
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This Selected Issues paper examines the potential costs of faster disinflation in Russia, drawing on the experience of European transition countries. The paper analyzes this experience, discusses factors contributing to the persistence of moderate inflation, and quantifies the disinflation costs in these countries. It compares the Russian economy with the sample countries. The paper concludes that a relatively rapid reduction of core inflation from above 10 percent in 2002 to less than 5 percent in 2004 would be beneficial for the Russian economy.

Abstract

This Selected Issues paper examines the potential costs of faster disinflation in Russia, drawing on the experience of European transition countries. The paper analyzes this experience, discusses factors contributing to the persistence of moderate inflation, and quantifies the disinflation costs in these countries. It compares the Russian economy with the sample countries. The paper concludes that a relatively rapid reduction of core inflation from above 10 percent in 2002 to less than 5 percent in 2004 would be beneficial for the Russian economy.

V. Medium-Term Fiscal Stance and the Potential Role of an Oil Stabilization Fund1

  • Russia’s fiscal position appears sustainable over the long term, although severe adverse shocks could result in significant liquidity constraints. Prudent fiscal policy will also be necessary in support of an overall macroeconomic framework that lessens tensions between the exchange rate and inflation objectives.

  • Accordingly, the authorities should initially target a balanced budget, on the basis of a world oil price of about $20/bbl. This target could be relaxed to cover the costs of major structural reforms and infrastructure investments once they are initiated in earnest.

  • To help shield government expenditure from the impact of volatile oil revenues, the budget target could be set out in a fiscal rule as follows: surpluses would be accumulated during periods of high oil prices, and deficits accommodated during periods of low oil prices. The rule may include some flexibility for discretionary policy, and ideally would be asymmetric: underlying fiscal policy would adjust more rapidly to oil price downturns than to increases.

  • The fiscal rule could be supported by the introduction of an oil stabilization fund. The fund would need to be transparent, fully integrated with the budget, and governed by a sound asset management strategy. Norway’s oil fund could serve as a useful model.

A. Introduction

1. Russia’s economic rebound since the 1998 crisis has been facilitated by a dramatic improvement in the fiscal position, with the general government balance improving by 11 percent of GDP from 1997 to 2001. A sharp rise in world oil prices supported this improvement, with revenue from the oil and gas sector rising by about 3 percent of GDP over the period. Tightened spending, however, played a larger role in the strengthening of the fiscal balance, with non-interest expenditure of the general government contracting by more than 8 percent of GDP

2. In 2002, however, the balance of the general government fell by 2½ percent of GDP compared to 2001 due to a similar rise in non-interest expenditure. For 2003, the overall balance of the general government is expected to improve due to higher oil prices, although non-interest spending is projected to rise by ½ percent of GDP.

3. This relaxation of fiscal policy—the non-oil balance has deteriorated by 4 percent of GDP since 2000—raises the question of the appropriate medium-term fiscal stance, and whether a looser fiscal policy is appropriate in light of potential shocks and the authorities’ overall macroeconomic objectives. Under current projections, Russia is expected to continue a rapid accumulation of foreign reserves in the near future, and a tighter fiscal policy would help sterilize part of the reserves accumulation and mitigate potential inflationary pressures. In recent years, the rapid remonetization of the economy has muted inflationary pressures. However, the extent of further remonetization is unclear, and the Central Bank of Russia’s capacity to assume a much heavier sterilization burden remains limited.

4. The following section of this paper re-examines Russia’s medium term fiscal outlook in light of these concerns, and proposes a baseline fiscal position that addresses the vulnerabilities and potential demands on public expenditure in the period ahead, while ensuring a fiscal stance consistent with the objectives of the macroeconomic framework. The paper then considers whether Russia would benefit from introducing a fiscal rule, specifically one calling for a balanced budget, adjusted for the price of oil.2 Russia’s budget and the economy have both become more dependent on the oil sector in the last several years, and thus fluctuations in the price of oil could prove destabilizing to the macroeconomic situation. A budget balance adjusted for the oil price would serve a stabilization function; periods of high prices would call for the accumulation of surpluses, and correspondingly, low prices would entail deficits.3

5. As an extension of the discussion of a potential fiscal rule, the final part of the paper considers the advantages and disadvantages for Russia of establishing an oil fund, whereby proceeds from the oil sector would be separately identified and managed. Such a fund could help reinforce the benefits of a fiscal rule in neutralizing the effect of oil revenue fluctuations on the budget. An oil fund might also bring some additional political economy advantages in terms of insulating oil revenues from short-term political demands. The paper also examines which type of oil fund might be most appropriate for Russia, and highlights important design issues in setting up such a fund.

B. Identification of an Appropriate Medium-Term Fiscal Stance

Debt Sustainability and Potential Vulnerability Factors

6. A debt sustainability analysis carried out last year for Russia (SM/02/63, Sup. 1, 02/22/02) found that Russia’s fiscal position will likely be sustainable, but nonetheless remains vulnerable to a sharp downturn in world energy prices. The analysis concluded that Russia should be targeting a fiscal deficit of 1-2 percent of GDP over the medium and long term; public sector debt ratios would decline fairly rapidly, with federal government debt falling to about 30 percent of GDP by 2005. This scenario was predicated on the assumption that economic developments in Russia would gradually resemble those in advanced transition countries and emerging markets.4

7. An update of this analysis on the basis of a revised macroeconomic framework indicates that Russia’s public debt-to-GDP ratio would decline rapidly under a baseline scenario of solid real GDP growth, moderate interest rates, and the world oil price falling to about $21/bbl, with fiscal policy targeted to be in surplus over the medium term (Tables 5.1 and 5.2). A tightening of underlying fiscal policy is assumed in 2004, to offset some of the deterioration in the non-oil balance since 2000. Revenue as a share of GDP is projected to decline moderately, and then stabilize over the medium term in line with movements in the world oil price, while noninterest spending as a share of GDP is expected to drop by more than 3 percent of GDP in 2004-05, before rising gradually in the outer years, offsetting the fall in interest payments.

Table 5.1.

Baseline and Lowcase Scenarios: Projections for 2007

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Table 5.2.

Russian Federation; Public Sector Debt Sustainability Framework, I997-2010

(In percent of GDP, unless otherwise indicted)

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Gross debt of the general government.

Derived as [(r-π(l+g) - g + αε(l+r)]/(l+g+π+gπ)) times previous period debt ratio, with r - interest rate; π = growth rate of GDP deflator; g - real GDP growth rate; α - share of foreign-currency denominated debt; and ε - nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/as r - π (1+g) and the real growth contribution as-g.

The exchange rate contribution is derived from Ihc numerator in footnote 2/as αε(l+r).

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

8. Extending this analysis would also entail consideration of key risk factors that may undermine Russia’s debt dynamics. The most immediate vulnerability factor for the fiscal position is the world price of oil. Russia’s fiscal revenues are highly sensitive to world oil prices, particularly following changes to the tax regime introduced in 2002;5 a $l/bbl. drop in prices lowers revenue by 0.4—0.45 percent of GDP.6 An additional risk factor for Russia is the possibility of significantly lower economic growth. Contributing factors to lower growth could include a slower pace of reform and correspondingly lower investment levels; a shift in investor sentiment regarding Russia’s economic prospects; and a lower oil price.7 Although not considered in this paper, other risk factors could include a significant weakening of the fiscal position due to greater political pressure for tax reductions or higher spending, and potential pension liabilities.

9. The sustainability analysis was also carried out under a lowcase scenario with the following assumptions: (i) an oil price that falls to $15/bbl. in 2004, and drops further to $12/bbl. in 2005, before stabilizing at $15/bbl. in 2007; (ii) real GDP growth that falls to 2 percent in 2004 and then 1 percent in 2005, before rising to 3 percent by 2008; and (iii) an exchange rate that adjusts to keep a minimum reserve coverage of 100 percent of short-term debt. Under this scenario, the fiscal deficit widens to 2½ percent of GDP in 2004 due to lower revenues and higher interest payments. Some fiscal adjustment is assumed, with non-interest expenditure falling by a total of about 5½ percent of GDP. Russia’s debt-to-GDP ratio initially rises, but remains at about 35 percent of GDP (Figure 5.1, Table 5.3). Thus, the fiscal position is sustainable over the long term, taking into account potential vulnerability to an oil price decline and contingent on some fiscal adjustment, although Russia would be highly vulnerable to additional shocks.

Figure 5.1:
Figure 5.1:

Public Debt-to-GDP Ratios

Citation: IMF Staff Country Reports 2003, 146; 10.5089/9781451833065.002.A005

Table 5.3.

Russia: Pablic Sector Debt Sustainability Framework, 1997-2010

(In percent of GUP, unless otherwise indicated)

article image

Gross debt of the general government.

Derived as [(r-π(l+g) - g + αε(l+r)]/(l+g+π+gπ)) times previous period debt ratio, with r - interest rate; π = growth rate of GDP deflator; g - real GDP growth rate; α - share of foreign-currency denominated debt; and ε - nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/as r - π (1+g) and the real growth contribution as-g.

The exchange rate contribution is derived from Ihc numerator in footnote 2/as αε(l+r).

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

Liquidity Constraints

10. Irrespective of the movements in debt ratios over the long term, the risk factors could have a more immediate impact if they result in Russia facing short-term liquidity constraints and a resulting payments crisis. Thus, while the long-term debt position appears sustainable, Russia could be vulnerable to short-term liquidity crunches in the context of adverse shocks.

11. Under the baseline scenario, Russia’s gross financing needs remain at about 3 percent of GDP (Figure 5.2).8 However, under the lowcase scenario, gross financing needs increase to 9 percent of GDP by 2008. In subsequent years, financing needs may increase even further as official debt is replaced with commercial debt and maturities are shortened under pressure of the uncertainty. Given the small size of the Russia domestic debt market, domestic issuance might only be able to finance a small part of this financing need. Gross financing needs for the budget during the 1996-98 period totaled 7-9 percent of GDP. Although there are some arguments for why Russia could fulfill higher financing needs than before the crisis—for example, the stock of debt as a share of GDP is now lower—Russia may nonetheless face relatively tight financing limits. This suggests limited margin for error, and leaves little room to adjust the fiscal stance through lower taxation or higher expenditure levels in the context of the structural reform agenda.

Figure 5.2:
Figure 5.2:

Gross Financing Needs

Citation: IMF Staff Country Reports 2003, 146; 10.5089/9781451833065.002.A005

12. This concern is further underscored by the sensitivity of borrowing costs to financing needs. The recent examples of Argentina and Brazil illustrate the non-linearity of external borrowing costs for many emerging market countries. Small increases in gross financing needs resulted in huge increases in spreads, as market sentiment shifted rapidly. Circumstances for each country differ, including their debt dynamics, sensitivity to shocks, and perceived willingness to adjust. However, these cases suggest that countries, including Russia, should err on the side of caution in considering a widening of gross financing needs.

Figure 5.3a:
Figure 5.3a:

Argentina

Citation: IMF Staff Country Reports 2003, 146; 10.5089/9781451833065.002.A005

Figure 5.3b:
Figure 5.3b:

Brazil

Citation: IMF Staff Country Reports 2003, 146; 10.5089/9781451833065.002.A005

Medium-term budget target

13. Russia’s debt position is currently sustainable, even under a scenario of a serious shock, most notably to the oil price and growth. Such a shock could potentially present Russia with significant liquidity constraints and potentially much higher borrowing costs, although a rapid fiscal adjustment would likely be sufficient to reduce financing needs to levels compatible with available financing. However, Russia’s important structural reform program could stall in the future if resources were not available to finance needed but costly structural reforms. This would argue for maintaining a more prudent fiscal position to ensure some margin in the event of adverse shocks.

14. Perhaps of more immediate relevance for Russia, in light of projections under the baseline scenario, is that a restrained fiscal policy in the period ahead is needed to support the overall macroeconomic framework. The continuation of the good fortune which in part has allowed Russia to pursue multiple and potentially conflicting macroeconomic objectives is uncertain. Fiscal restraint therefore becomes increasingly important in ensuring a continued reduction in inflation and in helping to slow the real appreciation of the ruble by reducing pressures on non-tradable goods prices.

15. On this basis, a proposed target would be a balanced budget, constructed around an oil price at the long-run average of about $207bbl. This balanced budget target would imply that fiscal policy in 2004—adjusted for oil at $20/bbl—would need to be tighter than in 2003. The projected surplus would ensure greater consistency with the authorities’ macroeconomic objectives, and maintaining this stance over the medium term would allow room for financing the structural reforms and infrastructure investment necessary to modernize and diversify Russia’s economy, and ultimately to reduce vulnerabilities.

C. A Potential Fiscal Rule for Russia

Advantages and Disadvantages of a Fiscal Rule

16. The sensitivity of Russia’s budget to fluctuations in oil receipts, and the attractiveness of such receipts for interest groups that might want access to the financial resources, suggests that a rules-based fiscal policy could be an appropriate option for Russia. A fiscal rule might lessen discretionary intervention, and support the conduct of countercyclical fiscal policy centered around the fiscal balance target articulated above.

17. In this respect, the strongest argument for a fiscal rule is based on political economy considerations. Cross-country evidence suggests that democratic governments have a deficit bias and that a discretionary approach to fiscal policy is often time inconsistent (Kopits, 2001; Taylor, 2000). In the presence of a fiscal rule, public and legislative debate revolves around expenditure priorities and tax structure, but not the overall stance of fiscal policy. Accordingly, the introduction of fiscal rules can depoliticize fiscal policy and restrict the influence of interest groups.

18. For emerging market economies, the advantages of fiscal rules are stronger. As the capital account is gradually opened up, the more disciplined policy stance and greater credibility associated with fiscal rules can help a country avoid, or at least better withstand, the rapid shifts in sentiment and capital movements that can lead to a financial crisis (Kopits, 2001). Fiscal rules in Brazil and Peru have, arguably, placed these countries in a better position to weather financial turbulence than if the rules had not been adopted.

19. Similarly, a fiscal rule would be very useful if Russia were to move towards inflation targeting. A rules-based fiscal policy would prevent fiscal dominance and could buttress the institutional arrangements to ensure the presence of appropriate conditions for implementation of inflation targeting.

20. There are several important arguments against fiscal rules. The first is that some discretion is necessary to achieve fiscal policy goals, in particular in fine-tuning fiscal policy to offset shocks that cannot be fully accommodated by automatic stabilizers. On a more practical level, fiscal rules may be of little significance. Many governments have committed themselves to, and then implemented, sound fiscal policies in the absence of a fiscal rule; this is particularly notable among OECD countries (e.g., the United States during the 1990s). And, many governments have circumvented fiscal rules in place, or pursued unsound fiscal policies in the presence of rules.9

21. Nonetheless, those countries that have successfully maintained sound fiscal policies in the absence of rules have most often had a long history of credible and transparent fiscal policy, coupled with strong public institutions. In addition, while fiscal rules can be circumvented, this can largely be mitigated by a tighter definition of the rule. Similarly, the fact that rules deprive the authorities of discretion in responding to short-term shocks can be addressed by including adjustors or bands, within which the authorities would have discretion to respond to shocks.

22. Russia has a very recent history of sound fiscal policy. Credibility in overall macroeconomic management, in particular in the fiscal area, is gradually being established, but concerns remain both about how durable the political consensus is for sound policy, and the strength of fiscal agencies and institutions,10 In this light, a fiscal rule is potentially a useful tool in enabling Russia to continue to make progress towards stabilization, and to better ensure in the period ahead a stable fiscal framework and preservation of any windfall gains from the oil sector.

23. A fiscal rule for Russia could be adopted formally through legislation, which would likely require amending the Budget Code. This approach would have the benefit of preventing any “escape” from the rule. Alternatively, the rule could be articulated as government policy, without having formal legislative backing. In this case, the rule could underpin the formulation of the budget and the medium-term budget framework, but would not be legally binding. The obvious disadvantage of such a non-binding rule is that policy makers may choose to ignore it.

The Balance Budget Rule

24. A fiscal rule for Russia would need to reflect Russia’s vulnerabilities to shocks outlined above, and ensure that a mechanism is in place to insulate the budget from fluctuating oil sector receipts. The proposed target indicator would be the general government budget balance (Box 1). In line with the discussion above on the appropriate fiscal stance, the rule would target a balanced budget under the scenario of oil prices at the 10-year average of about $20/bbI, pending the initiation of the structural reform program. The baseline oil price would be a moving average—reset, for example, every year—and thus gradually reflect current movements in prices.

25. The design of the rule would need to insulate the budget from fluctuations in the oil price. Accordingly, if oil prices exceed $20/bbl, the resulting gains—as measured by the additional tax receipts directly accruing from the oil sector—would be saved, producing a budget surplus; if prices fall below the target, fiscal policy would target a deficit. This would keep the nonoil budget deficit of the general government constant at about 5 percent of GDP and ensure a stable fiscal policy. There is some evidence that Russia had been implicitly following such a fiscal rule from 1999-2001 (Figure 5.4), but then deviated in 2002, reflecting the loosening of underlying fiscal policy.

Figure 5.4:
Figure 5.4:

General Government Fiscal Balance, 1997-2002

(in percent of GDP)

Citation: IMF Staff Country Reports 2003, 146; 10.5089/9781451833065.002.A005

1/ Assumes a balanced budget when the WEO oil price in US$20 based; a surplus equal to the additional oil revenues when the oil price is above US$20; and a corresponding deficit when the oil price is below U5$20

Measures of the Fiscal Balance

The general government budget balance is a comprehensive and simple measure of fiscal performance; it has the benefit of being easily monitorable and understood, and thus as serving as the basis for the fiscal rule. However, a rule could be defined in terms of other fiscal flow or stock indicators. An example of a stock indicator would be the debt to GDP ratio, although this suffers from a range of measurement problems, including valuation changes. For flow indicators, the primary balance has some advantages in that it excludes interest expenses, which are not under the control of the authorities, but it does not have the operational simplicity of the overall balance. A rule on the nonoil balance would better isolate the discretionary policy decisions of the government from developments in the oil/gas sector, but also suffers from potential measurement problems.

Ideally, the rule would target the general government to capture the broadest level of fiscal activity. In Russia, however, the Ministry of Finance only controls the federal government budget, with no direct control over the local and regional government budgets, or the extrabudgetary funds (primarily the pension fund). A mitigating factor is that the subnational governments and extrabudgetary funds have relatively limited borrowing authority, which is broadly controlled by the federal government. Thus, the fiscal rule could target the federal budget alone, or include an adjustor to offset anticipated deficits in local/regional governments and the extrabudgetary funds.

26. A sustained drop in the world price of oil would appear only slowly in the average price on which the budget is based. Accordingly, it would be prudent to ensure that the rule called for some fiscal adjustment in the event that oil prices drop below the long-term average for an extended period. One suggestion would be that the targeted fiscal deficit in the year following the oil price drop reflect a fiscal adjustment equivalent to one half of the difference between the long-term average and the actual oil price.

27. To allow for some discretion in fiscal policy to accommodate fluctuations in the cycle, the rule could also include a band of, for example, ½-1 percent of GDP around the target within which the budget balance could fall. Adjusting the budget balance for the oil price is an imperfect means of mimicking a cyclically-adjusted budget balance approach. The band would allow for some discretionary policy as warranted by macroeconomic conditions.

D. An Oil Fund for Russia

Considerations

28. A fiscal rule defined in the manner outlined above could be supplemented by the introduction of an “oil fund”, which would serve to further identify and isolate resources accruing from the oil sector.11 Oil funds are usually established to neutralize the macroeconomic and fiscal impact of fluctuating oil revenues, and/or to boost public savings to smooth out consumption of an exhaustible resource. Although these objectives could just as well be accomplished through rules-based or even discretionary fiscal policy, an oil fund might prove advantageous for Russia, primarily for political economy reasons.12

29. Isolating revenues from the oil sector in an oil fund could serve as a firewall in deterring political interest groups from making claims on the resources and increasing the pressure for procyclical fiscal policy. By being formally if not institutionally separate, policy makers would be in a stronger position to argue that greater oil revenues should not allow a general loosening of fiscal policy. Similarly, an oil fund could potentially foster greater transparency and accountability in the management of oil receipts by ensuring that they are not mixed with general budgetary resources.

30. In addition, an oil fund could help mitigate potential Dutch disease effects, a common problem in countries experiencing sustained inflows. Sustained progress in the nonoil sector would benefit Russia greatly, but this would be hampered by a strong rise in the price of nontradables and associated real appreciation of the ruble induced by a higher nonoil budget deficit. An oil fund could help limit pressure on the real exchange rate during a period of high oil prices, as some of the windfall revenue would be saved. While this could be accomplished by the proposed fiscal rule, a fund would provide greater assurance that oil-related receipts could be managed separately from other budgetary resources.

31. Some countries, faced with the depletion of natural resources in the not-distant future and with concern for intergenerational equity, have opted for funds to boost savings and smooth consumption over the long term; this was one of the prime motivations of the fund established in Norway.13 However, the exhaustion of Russia’s oil and gas resources is difficult to envisage in the foreseeable future (Box 5.2), and thus the aim of the proposed oil fund would not be to directly serve as a vehicle to steadily accumulate savings over the long term, but rather to help neutralize the impact of fluctuations in oil sector receipts.

Long-Term Prospects for Russia’s Oil and Gas Sector

With some of the largest hydrocarbon reserves in the world, there is little threat to the sustainability of Russia’s oil and gas output in the foreseeable future. Proved oil reserves currently total about 20 years of current output, and gas reserves total about 80 years of output, almost a third of worldwide gas reserves.1 These figures—which are significantly higher than the corresponding ratios for OECD hydrocarbon resources—have remained roughly constant in recent years as extraction rates have been offset by the identification of additional reserves.

In addition, the ratio of reserves to output is unlikely to fall significantly in coming years, even as production rises. Not included in these totals are resources already discovered and surveyed in the Soviet period which remain to be assessed and tapped. Key areas where resources have been discovered but not assessed include offshore resources in the Barents and Caspian seas, and onshore resources, for example in Eastern Siberia.2 Continued exploration bolstered by ongoing technological improvements will augment discovered resources, and allow their commercial exploitation. These efforts are led by the large Russian petroleum firms, which have ambitious exploration programs in place.

Some caveats apply. If oil prices slump over the long run, the extraction of some identified reserves might not be commercially viable, with a corresponding disincentive for further exploration. Also, long run prospects in the sector will entail Russia boosting export capacity infrastructure for both oil and gas. Some oil sector analysts have suggested that by the end of this decade, as exploration moves to areas that pose more challenging technical difficulties for extraction, Russian oil firms will need to increasingly involve foreign partners for their technical expertise and financial resources. The recent decision by British Petroleum to participate in a Russian venture is an encouraging step in this regard. Analysts have also suggested that continued delays in the restructuring of Gazprom could dampen output and exploration prospects in the gas sector.

1British Petroleum (2002).2Renaissance Capital (2002).

Design of an Oil Fund

32. This section summarizes the key issues in designing an oil fund to ensure that the fund serves the macroeconomic stabilization objectives, but does not create governance problems or difficulties in fiscal management. While the precise nature of an oil fund could take several forms, it should be based on full transparency and accountability. The operations of the fund should be fully open, based on explicit guidelines, and free from political interference. Accountability would be ensured by requiring regular audits of the fund, which would submitted to parliament and published.

33. As outlined below, an oil fund for Russia, paired with the fiscal rule discussed earlier, would likely be most successful as a “virtual fund.” Such a fund is not a distinct institutional entity; rather it is separate only from an accounting standpoint. Transfers into and out of the fund would reflect solely the budget surplus or deficit stemming from the fiscal rule discussed above.14 This would avoid the potential problem encountered in some other countries, where transfers to the fund have to be financed from other sources if the budget balance is insufficient to make the transfers called for by the guidelines governing the fund. Ideally, the fund would be established no later than the beginning of 2004; this would have the benefit of coinciding with the start of the 2004 budget, and, in the current period of high oil prices, ensure that the fund is able to begin by establishing a stock of assets.

34. Norway’s oil fund could serve as a useful example for Russia (Box 5.3). Institutionally, it is fully integrated within the budget, and thus functions as a virtual fund. The key advantage of Norway’s fund is the transparency it brings to resources from the oil sector, which are explicitly identified while remaining integrated within the overall budget.

Oil Fund and the Fiscal Framework

35. A stabilization fund for Russia should be fully integrated with the budget, and not set up as a separate institution. This would allow greater coherence in budgetary planning and more effective expenditure control than would exist under a fund separate from the budgetary process. In addition, a fund fully integrated with the budget would enhance transparency by ensuring that the oversight applied to the budget would equally apply to the resources in the fund. Experience in many countries indicates that institutionally-separate funds have not been successful in deterring political pressures for greater public expenditure. Moreover, these funds have led to coordination problems by introducing a dual budget system, and have been particularly susceptible to governance weaknesses.

36. Similarly, the resources from the fund should not be earmarked for specific expenditure categories. Spending priorities are best identified in the context of a medium-term budgetary framework, which the Russian authorities now have in place. Earmarking risks the fragmentation of fiscal policy and the rise of extrabudgetary spending, potentially undermining the efficiency of public expenditure.

37. The fund should be established by law. Its operating procedures, including rules for transfers to and from the budget, the respective roles of the government ministries, and oversight through audits, should all be specified and approved by parliament. In line with the model of the Norway Fund, the fund should be under the control of the Ministry of Finance. The CBR could be delegated the responsibility of asset management, under the oversight of parliament and, where appropriate, with the use of outside asset managers. The resources of the fund would be in a sub-account of the Ministry of Finance at the CBR.

38. Debt management should be left outside the rules and operations of the fund. Thus, while it would not be precluded that resources from the fund could be used to pay down external debts, from the standpoint of optimal debt management, it would be best to leave these decisions to the Ministry of Finance, which with the approval of the cabinet or parliament, could direct resources from the fund to debt payments on a discretionary basis rather than as determined by a rule. Attempting to design a rule that would govern when resources from the fund would be directed to debt repayment would likely prove extremely complicated, require frequent revisions, and unnecessarily tie the hands of the Ministry of Finance.

Asset Management

39. The asset management of the fund will need to be fully transparent, and consistent with best practices. Investments of the fund should be restricted to foreign investments in order to ensure that petroleum inflows are sterilized, prevent the distortion of the local capital structure, and avoid political decisions influencing investment allocations. Other countries with stabilization funds permitting resources from the fund to be invested domestically have encountered low rates of return on domestic investments and significant governance problems.15

40. Clear investment guidelines will need to be established to circumscribe the investments of the fund. Investment guidelines outline the respective shares of fixed income instruments and equities, the maturity and currency profile of investments, and the regional allocation; these guidelines should be made publicly available. In the case of Russia, which would aim for a stabilization rather than savings fund, investments would likely have a short time-horizon. In this respect, investments should be restricted to financial instruments to ensure liquidity of the portfolio, enhance diversification, and allow easier evaluation of fund performance. Also, for diversification reasons, the fund should be prevented from investing in Russian government debt traded on international markets. Financial advisors could be engaged to assist in developing the investment guidelines.

41. Suitable benchmarks will need to be established, against which performance of the fund could be measured. This allows a closer evaluation of the risks in the investment decisions, and enables a better assessment of fund performance. While it is proposed that the CBR be responsible for the day-to-day management of the fund, specific investment decisions should be delegated to outside managers for the portions of the fund under “active management” (i.e., those parts of the fund not invested in indexes). The performance of outside managers would need to be evaluated on the basis of tightly-defined benchmarks.

Norway’s Oil Fund

The Norwegian Government Petroleum Fund is often cited as an example of a successful oil fund and a possible model for Russia. This fund was established in 1990 to smooth short-term fluctuations in revenue, and to ensure that financial resources accruing from the sector are available for future generations.1 The income of the fund consists of the net cash flow from petroleum activities plus the return on the fund’s investments. Expenditures of the fund are the transfers to cover the non-oil budget deficit. The Ministry of Finance is responsible for the fund, and has delegated operational management to the central bank. Operations of the fund are fully transparent and subject to parliamentary oversight.

A central feature of the fund is that revenue from the oil sector accruing to the central government is transferred to the fund; subsequently, deficits in the nonoil budget are financed by transfers from the balances in the fund. The fund is not a distinct institution, and thus the transfers are just transactions between two government accounts at the central bank. Moreover, transactions with the fund are not meant to address the government’s short-term borrowing needs, which instead are met through the issuance of short-term government debt.

The fund maintains an explicit asset management strategy to manage any accumulated surpluses. The Ministry of Finance sets the investment guidelines, implemented by the central bank, which also carries out appropriate risk management practices. Assets from the fund are invested only outside Norway, with 60 percent of the fund invested in bonds and 40 percent in equities. Parliament is informed of any significant changes to the investment guidelines, and outside experts are used to carry out independent performance measurements of the fund.

Until 2002, Norway’s fund did not maintain any constraints on fiscal policy. Thus, although it was set up to manage surpluses from the oil sector and ensure higher savings, there was no rule to ensure that fiscal policy produced surpluses or generated public savings higher than would be the case in the absence of the fund. However, since 2002 the Norwegian authorities have established a fiscal rule setting the structural deficit of the nonoil central government equal to the real return on the petroleum fund. This change was introduced to clarify the fiscal stance in the period ahead and to address growing political pressures to spend a greater share of the oil wealth. This fiscal rule is aimed at preserving the real value of the financial assets, and is based only on verifiable accumulated financial assets. However, in the event that oil prices do not decline substantially, the rule implies rapidly rising non-oil deficits in line with the income from the increasing stock of assets in the petroleum fund.2

1Hovland (2002); Skancke (2002).2IMF (2002b).

References

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  • Kwon,G., Post-crisis Fiscal Revenue Developments in Russia: From an Oil Perspective, Public Finance and Management, forthcoming (2003).

  • Renaissance Capital, Russia Oil and Gas Yearbook 2002, Moscow (July 2002).

  • Skancke,M., Fiscal Policy and Petroleum Fund Management in Norway, paper presented at IMF conference on Fiscal Policy Formulation and Implementation in Oil Producing Countries, Wash. D.C (June 2002).

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  • Taylor,J., Reassessing Discretionary Fiscal Policy, Book of Economic Perspectives (U.S.), 14, No. 3 (Summer 2000)

1

Prepared by Mark Lewis (EU2).

2

Unless otherwise indicated, oil prices in this paper refer to the IMF’s World Economic Outlook (WEO) composite oil price (simple average of prices for Brent, Dubai, and West Texas Intermediate). The benchmark price for Russian oil is that of Urals crude, which currently represents about 95 percent of the WEO price. Also, references in this paper to the oil sector and oil revenues are inclusive of the gas sector. Movements in world gas prices generally track those of crude oil with a lag of three to six months.

3

The output shocks that have characterized Russia’s transition have also obscured any evidence of economic cycles. Coupled with poor data on capacity utilization, this renders efforts to estimate output gaps for Russia, or a cyclically-adjusted fiscal balance, not only difficult but also prone to large errors.

4

Key assumptions included: real GDP growth of 5-6 percent; real interest rates of 6½ percent; and a WEO oil price of $19/bbl.

5

Russia derives revenue from the oil and gas sector through a range of taxes and fees, which vary with how sensitive they are to the world price of oil. The oil export tariff and extraction tax are directly linked to world prices, with the export tariff and excises on exports of gas, dividends from state oil companies, and the corporate profit tax from oil and gas companies largely moving in line with world oil prices. Collections from a range of other taxes, including excises on oil products, VAT, and royalties, vary much less with movements in world prices (Kwon, 2003).

6

This relationship is nonlinear, with oil price movements having a larger impact on revenue at higher prices, and could shift substantially in the event of large movements in macroeconomic variables such as inflation and the exchange rate.

7

Over the short term, real GDP growth in Russia is strongly correlated with oil export earnings. Over the longer term, this link is less clear and may in fact be the inverse due to the impact of potential Dutch disease effects on growth prospects in the nonoil sector.

8

Gross financing needs comprise the fiscal deficit, plus amortization on medium and long-term public debt and the stock of short-term public debt.

9

Many U.S. state governments are required to maintain balanced budgets, which did not prevent them from pursuing very pro-cyclical policies during the 1990s. A number of these governments are now faced with the need to contract fiscal policy in the context of a sluggish economy.

10

Concerns regarding fiscal agencies at the federal level are multiplied at the regional level.

11

The macroeconomic justification for oil funds, and their track record, are ambiguous (Davis et al., 2001).

12

Many of the factors that contributed in recent years to a political consensus in favor of sound fiscal policy may no longer be compelling, as reflected in the weakening of the fiscal position in 2002. In particular, the shock of the 1998 fiscal crisis may be wearing off.

13

Skancke (2002); see Davis et al (2001) and Fasano (2000) for other country examples of oil funds.

14

On this basis, income from the fund would accrue to the general government budget, and thus for a given target surplus/deficit, would allow higher expenditure than in the absence of the fund income.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Russian Federation: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2003: Issue 146
Publisher:
International Monetary Fund
ISBN:
9781451833065
ISSN:
1934-7685
Pages:
110
DOI:
https://doi.org/10.5089/9781451833065.002

Public Debt-to-GDP Ratios

Gross Financing Needs

Argentina

Brazil

General Government Fiscal Balance, 1997-2002

(in percent of GDP)