This Selected Issues paper describes the revenue instability and its consequences for Suriname. It explores some options for policy rules that could be considered in the case of Suriname. The paper analyzes inflation in Suriname from its historical and international perspectives, reviews the monetary policy instruments and the institutional framework, and describes the exchange rate regime and its main developments. The paper also analyzes the type of macroeconomic shocks and the domestic transmission mechanism for Suriname.

Abstract

This Selected Issues paper describes the revenue instability and its consequences for Suriname. It explores some options for policy rules that could be considered in the case of Suriname. The paper analyzes inflation in Suriname from its historical and international perspectives, reviews the monetary policy instruments and the institutional framework, and describes the exchange rate regime and its main developments. The paper also analyzes the type of macroeconomic shocks and the domestic transmission mechanism for Suriname.

I. Fiscal Revenue Instability and Nonrenewable Resources in Suriname1

A. Introduction

1. Suriname’s heavy reliance on fiscal revenue from extractive industries has posed challenges in the past, and may argue for amendments to the fiscal framework. During the past decade, shocks to world market prices for Suriname’s mining output (bauxite and gold) have caused significant volatility in tax revenues, complicating both fiscal and monetary policy management. Coping with revenue volatility and ensuring that the benefits from nonrenewable resources are shared equitably across generations could argue for amending the existing fiscal framework, including by establishing a nonrenewable resource fund (NRF). In other countries, such funds have been used with varying degrees of success to stabilize revenue flow and to ensure that at least a portion of the wealth derived from extractive industries is saved for future generations.

2. In the rest of this chapter, Section B describes the revenue instability and its consequences for Suriname. 2 Section C explores some options for policy rules that could be considered in the case of Suriname. Section D concludes.

B. Fiscal Revenue Instability

Fiscal instability and economic performance

3. The volatility of fiscal revenues from the bauxite sector has contributed significantly to macroeconomic instability in Suriname. During the 1990s, the large movements of world aluminum prices caused similar swings in fiscal revenue and the overall fiscal balance. These were combined with procyclical fiscal expenditure policy responses that accentuated the terms of trade volatility, and the ensuing shortfalls in financing were monetized. This, in turn, caused rapid price inflation and exchange rate depreciation.3

uA01fig01

Suriname: Aluminum Price, Fiscal Revenue, and Fiscal Deficit (1990–2004)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A001

4. The destabilizing effect of revenue volatility was exacerbated by a weak underlying fiscal position. Even under favorable external conditions, the fiscal balance rarely showed a substantial surplus. On average, the fiscal deficit amounted to around 5 percent of GDP during 1990–2004, precluding the possibility of implementing countercyclical fiscal policies.

5. The trend deterioration in competitiveness and exchange rate volatility compounded problems related to fiscal revenue instability. As in many resource-based economies, the strength of the mining sector has contributed to an appreciation of the real exchange rate, contributing to a weakening of the nonmining sector. 4 Suriname also experienced substantial swings in its real exchange rate, with volatility the highest among a group of 21 Western Hemisphere countries during 1991–2003, which likely also dampened investment and growth (Box 1.). As a result, Suriname’s overall annual growth rate averaged only 1.7 percent during 1990–2004, well below that in most other Western Hemisphere countries, as nonmining output grew only by 1.5 percent on average in 1990–2004, even though the mining sector expanded by an annual average rate of 6.6 percent.

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Suriname: REER and Real Economic Growth of Nonmining Sectors (1990–2004)

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A001

1/ Average of 1990–2004 = 100

Real GDP Growth and Real Exchange Rate Volatility in Selected Western Hemisphere countries, 1991-2003

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Sources: IMF, World Economic Outlook; and Information Notice System.

The prospects for mining in Suriname

6. Prospects for Suriname’s bauxite sector appear favorable. Bauxite mining operations tend to provide relatively long-term and stable export revenues compared with other mining ventures. Bauxite reserves in the licensed exploitation areas in the eastern part of the country are estimated at about 800 million tons, which would allow operations for at least another 15–17 years. In addition, Suralco, the major bauxite mining operator in Suriname, is contemplating a large integrated mining, hydropower, and processing project in the western part of the country. This project, which would require a total investment of up to US$3 billion, envisages an alumina refinery (and, eventually, an aluminum smelter) that could start as early as 2007. Bakhuys, the most promising area in the west, is estimated to hold bauxite reserves of about 200–700 million tons. 5

7. Conversely, revenue from recently started gold mining operations is expected to be temporary. Following the start-up of large-scale gold mining operations in the Rosebel mine in 2004, fiscal revenue from gold mining is expected to increase sharply until 2006 and then decrease steadily until 2014, when reserves will be depleted. 6

Real Exchange Rate Volatility and Growth

Real exchange rate volatility can have a negative impact on economic activity and growth. In particular, uncertainty about future competitiveness can dampen investment and capital formation. This point has been illustrated in the context of option pricing models, which show delaying investment is optimal when investment comes along with sunk costs.1 Moreover, exchange rate uncertainty increases the rate of return required to trigger investment, which can exceed the opportunity cost of capital.

Econometric studies have confirmed the negative effect of real exchange rate volatility on capital formation in Latin America and East Asia.2 Moreover, a simple scatter plot of data for Western Hemisphere countries during 1991–2003 demonstrates the negative correlation between the volatility of the real exchange rate and average real GDP growth, with Suriname displaying the highest degree of exchange rate volatility in the region.

These observations illustrate the importance of stable fiscal and monetary policies that avoid real exchange rate fluctuations. In the case of Suriname, investment in the nonmining tradables sector is also characterized by large sunk costs, and the real exchange rate is a critical determinant of profitability in this sector.3 Thus, Suriname’s growth prospects would likely be enhanced by avoiding procyclical fiscal and monetary policy responses, including to shocks to world commodity prices.

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Selected Western Hemisphere Countries: REER Volatility and Average Growth of Real GDP (1991-2003) 1/2/

Citation: IMF Staff Country Reports 2005, 142; 10.5089/9781451835267.002.A001

1/ REER volatility measured as standard deviation. Data source for REER: INS (1990=100 for all countries). Data source for real GDP growth rates: WEO.2/ Sample comprises same group of countries as Table 1.
1 The underlying theoretical framework is developed in Dixit and Pindyck (1995); for an introductory exposition, see Dixit (1992).2 See Serven, Solimano (1994).3 In contrast, the mining sector in Suriname is less affected by real exchange rate uncertainty: Local wages for bauxite mining and processing are contracted in U.S. dollars and paid out in local currency, converted by the central bank at the official exchange rate.

C. Coping with Nonrenewable Resources

8. Revenue stabilization funds have been used in a number of countries to help stabilize fiscal revenues and safeguard resources for future generations.1 While design and rules of operation vary widely, successful cases of nonrenewable resource funds (NRFs) are characterized by a strong medium- to long-term fiscal framework, a prudent stance of fiscal and monetary policies, close integration of the fund’s operations in the budgetary system, and professional and transparent asset management. Since 1995, Norway has operated a petroleum fund that accumulated external assets of about 40 percent of GDP by 2003. 2 Chile’s copper stabilization fund—which is more oriented toward stabilizing fiscal revenues—is widely credited with having successfully allowed the Chilean authorities to manage fiscal policies in the face of commodity price shocks. 3 Botswana exemplifies another successful case of prudent fiscal management of mineral revenues. 4

9. However, revenue stabilization funds also create risks. Some revenue stabilization funds have been less successful due to inconsistency of the fund’s objectives with the underlying fiscal policy regime, inflexible rules that were overridden frequently, and a failure to adjust benchmark prices to lasting changes in world prices. For example, Papua New Guinea’s mineral resource stabilization fund was abandoned in 2000, after failing to durably accumulate external assets and to stabilize the stream of revenues. 5 Oman’s state general reserve fund appears also to have fallen short of expectations, as the fund failed to stabilize procyclical expenditure changes and suffered from frequent rule changes. 6

10. Notwithstanding these caveats, there would seem merit in considering an NRF for Suriname’s bauxite mining sector. A benchmark pricing rule could assist in stabilizing revenues, and excesses over the benchmark price could be set aside in a fund that accumulates external assets. To avoid the depletion of the fund and to assure that funds are safeguarded for future generations, this benchmark pricing rule could be applied asymmetrically, i.e., that revenue shortfalls stemming from alumina prices falling below the benchmark would not be compensated through transfers from the NRF to the current budget. Nonetheless, the benchmark price mechanism would have to be updated regularly, e.g., through the incorporation of futures prices for aluminum, and would have to be upward-sticky and downward-flexible to ensure a constant flow of revenue into the fund.

11. Given the temporary nature of the revenue projected from formal gold mining operations, there is a strong argument for accumulating revenue from this sector in an NRF. This goal could be accomplished by a fiscal rule that would absorb a larger percentage of the tax and royalty revenue in a fund held abroad, while the remainder of the income would provide a stable fiscal income stream. To minimize volatility, all revenue beyond a specified benchmark would accrue to the fund as an accumulation of external assets. 7

D. Conclusion

12. The international experience would seem to suggest that Suriname could benefit from an NRF. This mechanism could help avoid fiscal instability, in turn helping insulate the economy from external shocks by removing the procyclical fiscal policy bias that has characterized Suriname’s macroeconomic policies in the past. This in turn would help avoid real exchange rate instability and thereby improve investment conditions. Finally, an NRF could help ensure that the benefits from the natural resource sector—especially the gold sector—were spread more smoothly over time.

13. However, experiences in other countries show that a successful NRF needs to be firmly integrated into a medium-term fiscal framework and budget planning procedures. NRFs usually fail when transfers to the budget are determined by short-term fiscal policy needs, or necessary expenditure adjustments are not undertaken in the event of permanent shifts in global resource prices. The successful operation of an NRF in Suriname would also require a strengthening of fiscal planning within a medium-term macroeconomic framework.

References

  • Alcoa website as of February 22, 2005:www.alcoa.com/suriname/en/news/news_release/mining.asp

  • Davis, Jeffrey; Ossowski, Rolando; Daniel, James, and Barnett, Steven, 2001, “Stabilization and Savings Funds for Nonrenewable Resources. Experience and Fiscal Policy Implications,IMF Occasional Paper 205.

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  • Dixit, Avinash, 1992,“Investment and Hysteresis,in: Journal of Economic Perspectives, Vol. 6, p. 107132.

  • Dixit,Avinash; Pindyck, Robert S., 1994,“Investment under Uncertainty,” Princeton.

  • IMF, 2003, “Chile: Report on Observance of Standards and Codes-Fiscal Transparency.”

  • IMF, 2004, “Draft Guide on Resource Revenue Transparency.”

  • Martin, Dougal, 2001,“Macroeconomic Developments During the 1990sin:, van Dijck, Pitou (Ed.), “Suriname. The Economy. Prospects for Sustainable Development”, Kingston.

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  • Serven, Luis; Solimano, Andres, 1994, “Striving for Growth after Adjustment: The Role of Capital Formation,” The World Bank.

1

Prepared by Tobias Roy.

2

For an analysis of the monetary impact of volatile aluminum prices, see the chapter on Monetary and Exchange Rate Policy.

3

For a description of commodity-price induced macroeconomic cycles in the 1990s, see Martin (2001). According to Martin, an alumina price boom typically led to an increase in direct tax revenue and a second-round increase in indirect taxes as imports rose. Inflation remained low as the exchange rate faced appreciation pressures. During an alumina price bust, falling revenue from direct and international trade taxes widened the fiscal deficit, triggering a round of monetary fiscal financing, devaluation and inflation, which would then depreciate the real exchange rate and deflate real wages.

4

The real effective exchange rate impact of preponderant mining exports—commonly referred to as “Dutch disease”—leads to elevated relative prices of nontradables compared to tradables. The resulting structural bias favors nontradable services and a large public sector.

5

Information provided on the website of Alcoa.

6

See the chapter on the gold mining sector.

1

In principle, there is a tradeoff in achieving both goals. Revenue stabilization typically chooses a long-term benchmark world price for mining output, and complete revenue stabilization may end up depleting the fund in case of a durable downward shift in world market prices. The nonstationary behavior of prices for mining output, resulting in sudden, but pervasive regime shifts in the price structure, has indeed contributed to the breakdown of many stabilization funds (see the discussion in Davis, Ossowski, et al., 2001, page 4 ff.). To account for such regime shifts, successful stabilization funds would need to incorporate a forward-looking policy rule.

2

In Norway, all fiscal revenue from oil is transferred to the State Petroleum Fund (SPF), which, in turn, transfers back financing to cover the overall fiscal deficit. The SPF operates without oil benchmark prices for determining net transfers, and asset management has been delegated to a separate unit within the central bank, which relies on professional investment companies to manage the equity portfolio of the fund. While this design allows for a substantial degree of fiscal flexibility, it both requires and facilitates a medium- to long-term budgeting process. A transparent asset management policy facilitates public assessment of the fiscal stance and fosters confidence in the fund and in public finances.

3

Established in 1985, Chile’s copper stabilization fund operates on the basis of a reference copper price, which is determined by the authorities and has in the past followed the 10–year moving average of global copper prices. Transfer rules are symmetric around the reference price, and Davis, Ossowski, et al., 2001, found a negative correlation between copper export earnings and expenditure. However, given the comparatively strong fiscal framework and recent improvements in the budgetary process, the fund may become redundant as a separate institutional arrangement (see the IMF’s ROSC on Fiscal Transparency in Chile, 2003, p. 27).

4

Botswana ran large budget surpluses, in particular during the 1990s, and deposited a substantial part of mineral revenues with the central bank, which manages the country’s external assets in a long-term and a short-term fund. The budget surpluses effectively sterilized the monetary impact of the external reserves accumulation by the central bank: The banking system’s net external assets exceeded monetary liabilities by a factor of 2½ in 2003.

5

Frequent rule changes for the operations of the fund led to transfers from the fund that varied almost as much as the resource revenues themselves. In addition, the fund was not well integrated with overall fiscal policy, as budget expenditure was partly financed with debt operations outside the fund (see Davis, Ossowski, et al., 2001, p. 26).

7

The fiscal rule should be applied to all new formal gold mining operations, including those that are not yet foreseen.

Suriname: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Suriname: Aluminum Price, Fiscal Revenue, and Fiscal Deficit (1990–2004)

  • View in gallery

    Suriname: REER and Real Economic Growth of Nonmining Sectors (1990–2004)

  • View in gallery

    Selected Western Hemisphere Countries: REER Volatility and Average Growth of Real GDP (1991-2003) 1/2/