Abstract
This Article IV Consultation reports that the main challenge is to maintain macroeconomic stability in substantial demand shock from the construction of two major liquefied natural gas projects. The global downturn had only a mild impact, as growth was supported by still strong terms of trade, a financial sector insulated from global capital markets, and an increase in public expenditure. IMF staff stressed that monetary policy needed to be focused on emerging inflation pressures and act preemptively to avoid high inflation from becoming entrenched in expectations.
I. Managing Windfall Revenues from LNG Projects in Papua New Guinea1
A. Background
1. In Papua New Guinea, the economy has been highly exposed to commodity price fluctuations owing to the importance of minerals such as gold and oil in both export and public revenue. Mineral revenues have been an important source of government revenues amounting to over 10 percent of GDP in 2008 (about 40 percent of government revenue). Adhering to the Medium-Term Fiscal Strategy (MTFS) during the boom period of rising commodity prices resulted in the overall fiscal balance improving from below 2 percent of GDP in 2004 to nearly 9 percent in 2007 and the nonmineral fiscal deficit remaining close to its MTFS target of 8 percent of GDP.
2. While mineral revenues are projected to drop from 2009 onward, Papua New Guinea is developing another natural resource—liquefied natural gas (LNG), which could bring a substantial revenue stream in the future. In December 2009, two sizable LNG projects by an Exxon-led joint venture and by an Interoil-led joint venture, respectively, were approved by the government. The former is assumed to start construction in 2010 and production around 2014 with a project life of about 30 years. The latter is expected to start construction in 2011 and production around 2015 with a project life of at least 25 years. These new gas projects would bring challenges in managing massive revenues, which could lead to Dutch disease problems (i.e., losses in competitiveness) in the rest of the economy.2
3. Given the policy challenges facing Papua New Guinean and their interest in the operation of a sovereign wealth fund (SWF), this chapter reviews other country experiences in managing large natural resource revenues. By doing so, it draws lessons that could be relevant to Papua New Guinea with a focus on best principles for the design and operation of natural resource funds. Based on international experience, how to integrate an SWF into PNG’s fiscal framework is also discussed.
B. Fiscal Institutions to Manage Natural Resource Revenue
4. Countries with sizable natural resources can benefit substantially from natural resource revenues, but some characteristics of such revenues—volatility, uncertainty, and exhaustibility, and the fact that they largely originate from abroad—have posed substantial challenges to policymakers. For instance, many natural resource-producing countries have found it difficult to smooth government expenditure and decouple it from the short-term volatility of natural resource revenues using standard budget processes.
5. Against this background, a number of natural resource-rich countries have established special fiscal institutions aimed at enhancing fiscal management. Special fiscal institutions include sovereign wealth funds (SWFs), fiscal rules, and fiscal responsibility legislation (FRL). Special fiscal institutions have been seen as potentially helpful instruments. The following provides a brief description of special fiscal institutions.
6. Sovereign Wealth Funds (SWFs): A general characteristic of SWFs is that they are government accounts or entities that receive inflows related to the exploitation of nonrenewable natural resources. In fact, SWFs can take various forms ranging from separate (financial) institutions with substantial discretion and autonomy to funds that in practice are little more than a government account. The general justification for such funds is that some share of government revenues derived from the exploitation of natural resources should be put aside for when these revenues decline, either because the commodity price has fallen and/or because the resource has been depleted.
7. Fiscal Rules and Fiscal Responsibility Legislation (FRL): Fiscal rules are defined, in a macroeconomic context, as institutional mechanisms that are intended to permanently shape fiscal policy design and implementation. They are often enshrined in constitutional or legal provisions, such as FRL. In oil-producing countries, fiscal rules and FRL often stipulate numerical and procedural rules to reduce pro-cyclicality of fiscal policy and/or to promote long-term savings and sustainability objectives. Fiscal rules and FRL are intended to constrain overall fiscal policy.
8. The international evidence suggests a prevalence of SWFs relative to fiscal rules or FRL in natural resource producing countries. For example, 21 out of 31 oil-producing countries examined in Ossowski and others (2008) had established oil funds up to 2005, while only a few introduced explicit fiscal rules on aggregates like fiscal balance, public debt, non-oil balance, or government expenditure.
9. As country experiences suggest, special fiscal institutions (such as SWFs) themselves are not a panacea, but need to be integrated into a sound fiscal policy framework. In fact, in some countries with special fiscal institutions, government spending followed commodity revenues without averting procyclicality of fiscal policy, and no meaningful difference has been found in the behavior of spending relative to similar countries without special fiscal institutions (Davis and others, 2001). In other countries with special fiscal institutions, government spending did not follow commodity revenues, but this was the case before and after the establishment of special fiscal institutions (Ossowski and others, 2008). Those experiences suggest that the design of appropriate institutions and fiscal frameworks is crucial to effectively manage volatile, uncertain, and exhaustible natural resource revenues. The following section focuses on international experiences with SWFs framed around their policy objectives and operational rules.
C. Sovereign Wealth Funds (SWFs)
Policy Objectives
10. In response to the challenges to fiscal policy management brought about by natural resource revenues, SWFs have been aimed at achieving one or multiple policy objectives:
Macroeconomic stabilization: to help to smooth government expenditure in view of volatile and unpredictable natural resource revenue, contributing to short-term macroeconomic stability and avoiding deterioration in the quality of public spending. This is the typical objective behind stabilization funds.
Avoidance of surge in domestic liquidity: to help constrain domestic liquidity in the face of a surge in natural resource revenue and contain asset price appreciation.
Avoidance of Dutch disease: to counteract upward pressure on and volatility in the real exchange rate, which affect the competitiveness of the nonresource tradable sectors.
Financial savings: to build up wealth for future generations, ensuring intergenerational equity and long-term fiscal sustainability. This is the typical objective behind saving funds.
Asset management: to help manage (rising) financial assets accrued from natural resource revenue.
Fiscal transparency: to enhance transparency and governance and to promote public awareness of government financial constraints over the long term.
Design of SWFs
11. Given the basic characteristics of SWFs’ policy objectives, the following sections review critical issues based on international experiences and their associated lessons for the design of SWFs. We focus on the following issues: deposit/withdrawal operational rules, integration with the budget process, asset management, and transparency and accountability.
1. Operational Rules
12. SWFs’ activities are guided by operational rules. They typically cover specific principles for depositing revenue into the fund, withdrawing resources for direct spending or to make transfers to the budget, investing the fund’s financial assets (to increase returns), and providing information about revenue inflows and changes in financial assets. One critical caveat to be made at this point is that SWFs’ operational rules should not be confused with fiscal rules, which, as was explained earlier, aim to ensure macroeconomic stability and fiscal sustainability. Therefore, SWFs and their operational rules should be seen as tools to help implement (broader) fiscal rules.
Deposit and withdrawal rules
13. SWFs’ deposit and withdrawal rules typically differ depending on the type of SWF, as follows:
14. Stabilization funds usually have contingent rules, which determine the amount of resources that should be deposited in the fund or that can be withdrawn from it, depending on whether the market commodity price or revenue is higher or lower than thresholds. Such thresholds or reference values, usually preannounced, are typically based on fixed commodity prices or on formula that may be linked to past observations (such as historical moving-average prices) or forecasts of future prices.
15. On the other hand, saving funds have frequently relied on non-contingent rules—revenue-share rules—which may stipulate that revenues amounting to a fixed share of resource revenues or of total revenues be deposited in the fund independently of resource market and overall fiscal developments. Withdrawals from saving funds can be based on various schemes, including the “bird-in-hand” rule and the “permanent income” approach. The former would limit withdrawals from the fund only to the financial yield from the fund’s accumulated financial assets. This is a very conservative approach in which the fund transfers a substantial share of the mineral wealth to future generations. Under the permanent income approach, based on the permanent income hypothesis developed by Friedman, government mineral or net wealth—mineral wealth plus net financial assets—is withdrawn at a gradual pace that ensures a share for each generation according to some social welfare criteria.
16. Financing funds, which can have both stabilization and saving objectives, imply much more flexible operational rules. In financing funds, typically little more than a government account, net inflows effectively mirror the overall budget balance. Under the rules in place, the budget is required to transfer to the fund net mineral revenues. In turn, the fund finances the budget’s non-mineral deficit through a reverse transfer. The fund’s net flows are linked to the overall fiscal surplus or deficit. In this way, a financing fund provides an explicit and transparent link between fiscal policy and asset accumulation. Changes in the assets held by the fund correspond to those in the overall net financial asset position of the government (see Box I.1 for examples).
Financing Funds; Norway and Timor-Leste
Oil funds in Norway and Timor-Leste are seen to have exemplary features and operations. Both funds are financing funds.
Norway. Norway’s oil fund was established in 1990 and renamed the Government Pension Fund-Global (GPF) in 2006. The GPF’s objective is to support government saving and promote an intergenerational transfer of resources. All of the government’s net income from oil/gas revenue is fed into the GPF, from which transfers are made to the budget to finance the non-oil fiscal deficit. The fiscal guideline, introduced in 2001, requires a non-oil structural central government deficit of around 4 percent of the assets of the GPS, which is derived from the estimated long-run real rate of return. The oil fund is formally a government account at the central bank that receives the net central government receipts from petroleum activities and transfers to the budget the amounts needed to finance the non-oil deficit. The GPF is fully integrated into the budgetary process without authority to spend, and the decisions on spending and the fiscal policy stance are made within the budget process.
Timor-Leste. The Petroleum Fund (PF) was established in 2005, based on the Norwegian model, with technical assistance provided by the IMF. It aims at limiting the risk of Dutch disease, sheltering the budget from unstable commodity prices and associated swings in government spending, and avoiding rent seeking. All Timor-Leste’s revenue from petroleum operations is paid into the fund, and the fund also retains all investment income (net of management expenses). Transfers from the fund can only be made to the central government budget. To preserve the real value of the country’s petroleum wealth, such withdrawals from the fund are guided by the estimated sustainable income (ESI), which is calculated, every year, as 3 percent of the sum of the fund balance and the present value of expected future petroleum receipts. The operational guideline is flexible. The ESI is a benchmark to guide the level of saving rather than a legal obligation. Withdrawing more than the ESI (3 percent of the sum of the fund balance and the present value of expected future petroleum receipts) requires the government to provide parliament with a detailed explanation of why it is in the long-term interests of the country.
Rigidity versus flexibility
17. Many SWFs rely on relatively rigid operational rules for accumulation and withdrawal of resources. The main rationale of rigid operational rules is to remove high resource revenues from the budget and thereby help moderate and stabilize government expenditure, reducing policy discretion. However, this is a caveat worth taking into account: rules regarding channeling revenues out of and into the fund do not of themselves control spending or deficits at the government level. In particular, if the government is not liquidity constrained (including through arrears), it could borrow or run down assets to finance higher expenditure, as resources are fungible. Thus, if there is insufficient control of expenditures or deficits outside the fund, the advantages of operating a fund that stabilizes resource revenue available to the budget would be limited. The achievement of actual expenditure smoothing therefore requires additional fiscal policy decisions besides the operation of a fund.
18. Aside from the liquidity constraint argument, the international evidence suggests that a number of countries have had difficulties in specifying and implementing rigid rules that are financially and politically sustainable because of difficulties in identifying permanent and temporary components of commodity price changes and also because of political economy factors. Moreover, tensions have often surfaced in the operation of funds with rigid rules, particularly in situations of significant exogenous changes, shifting policy priorities, or increased spending pressures, and conflicting asset and liability management objectives.
19. As a result, in a number of cases, rigid fund rules have been changed,3 bypassed,4 and suspended.5 In some extreme cases, funds were eliminated altogether (e.g. Chad and Ecuador) because of accumulation of arrears and/or cash management problems in the context of increased spending pressures. In the case of Papua New Guinea’s former Mineral Resource Stabilization Fund (MRSF), which was established in 1974, both relaxed operational rules and poor integration with budget and fiscal policy led to large fiscal deficits and public debt. Rules on deposits and withdrawals were changed over time in the face of budgetary pressures.6 Moreover, the assets were used as collateral for new borrowing and to repay debt. The MRSF subsequently closed in 2001.
20. Therefore, the operational rules of SWFs need to allow them to function effectively within an appropriate overall framework for economic management. Clear and stable rules need to allow for flexibility in their operations. Flexibility would be harnessed when the SWF links its operational rules explicitly and transparently with a broader fiscal policy framework, as in financing funds.
2. Integration with the Budget Process
21. Another important consideration for the proper design of SWFs’ operational rules in general, and withdrawal rules in particular, refers to their integration with the budget. The budget is the key instrument to provide a comprehensive picture of fiscal activities and ensure that all competing demands are taken into account in deciding government spending allocations. International experience with SWFs has brought to the fore the dangers of granting funds the capacity to spend on their own, of earmarking revenue from funds, and even of undertaking investments domestically that cannot be distinguished from budgetary operations.
Extrabudgetary spending
22. The granting of spending authority to SWFs undermines the principle of unified control over spending through off-budget expenditure. If such off-budget outlays are undertaken without parliamentary approval and adequate oversight, it could result in non-transparent off-budget practices and give rise to governance concerns in budget process. Allowing off-budget spending also undermines the stabilization objective. Therefore, it is important to ensure that all spending decisions are taken within the context of the budget, and that expenditure is included in the budget in a comprehensive way. Extrabudgetary spending practice was prevalent in the oil funds of Azerbaijan, Kazakhstan, and Libya (with some recent efforts to eradicate it).
Revenue earmarking
23. Some oil funds have had their resources earmarked for specific purposes such as poverty reduction or debt service, but earmarking tends to result in resources being allocated outside the budget process, which can reduce flexibility, complicate liquidity management, and affect the efficiency of government spending.
Ecuador. Several oil-related funds with extremely complex revenue earmarking rules limited the margin for budget flexibility and led to fragmented cash management. In fact, while other public sector entities were accruing substantial deposits at the central bank since oil-related revenue transfers were in excess of their spending responsibilities, the central government had to have tight fiscal policy because it did not have sufficient resources to cover its operations while having limited access to other financing sources.
Alaska. The oil fund pays annual dividends to the population, partly as a safeguard against pressures to spend the oil revenue. In practice, the dividends have come to be seen as entitlements, and the government has borrowed substantially at times to finance increased spending. This accumulation of debt runs against the intended intergenerational transfer of resources.
Financial investments by SWFs in the domestic economy
24. A few countries allow SWFs to invest domestically. However, the use of SWF resources to invest in domestic markets raises a range of economic and governance issues.
In terms of potential macroeconomic impact, such operations may imply the injection (or monetization) of resources originally from abroad into the domestic economy, with impacts on interest rates, the real exchange rate, and asset prices. Therefore, if an SWF is created as means of limiting Dutch disease problems, allowing it to invest domestically might defeat its purpose.
From a fiscal perspective, there is a risk that those financial investments have policy motivations and include quasi-fiscal elements (e.g., subsidies to preferred sectors) or, in more extreme cases, that they are simply off-budget government spending operations masked as financial investments. Ideally, the quasi-fiscal activities inherent in such investments should be quantified and reflected separately in budget documentation and fiscal accounts. Experiences of Iran and Venezuela can be mentioned as examples: the Iranian oil fund provides loans in foreign currency to private entrepreneurs through domestic commercial banks, leading to ineffectiveness in maintaining macroeconomic stability; in the 1970s, the Venezuelan Investment Fund diverted its resources toward equity stakes in public enterprises, which turned out to be loss makers, effectively providing off-budget subsidies.
From a governance perspective, a critical issue is whether SWFs are able to invest purely on commercial grounds, or whether they will be much more susceptible to political pressures than when investing overseas.
25. To summarize, the above practices—extrabudgetary spending, revenue earmarking, and domestic financial investments—can be problematic and may lead to fragmentation of policymaking, reduced efficiency in resource allocation, spending rigidities, reduced fiscal transparency, and complicated cash management. Such flaws in fiscal management could undermine the macroeconomic stabilization objective of SWFs.
3. Asset Management
26. An SWF could hold an important share of the public sector’s financial assets aimed at achieving critical policy objectives, like fiscal stabilization, avoidance of Dutch disease, and intergenerational equity. Therefore, the management of fund’s assets should be a critical component of its operational strategy. An asset management strategy would need to be defined within the broader context of the government’s overall asset and liability management strategy. Such a strategy will need to be based specifically on benchmark levels of risk and return as implied by the overall policy framework and the government preferences and, more generally, on sound asset management principles.
27. Two particular aspects, and associated practices, are worth emphasizing in this area: short-term liquidity management and the design of investment strategies.
Liquidity management
28. Governments need to have available enough resources to meet their (short-term) spending needs and plans. In the presence of an SWF as a key repository of government financial assets, there is a risk that rigid operational rules lead to a fragmentation of cash management and difficulties in financing government’s day-to-day operations. One particular example in this regard is Chad, where separate cash management systems were established to support a complex arrangement of multiple budgets and an oil fund, with revenues earmarked for specific purposes. The budget execution system was not well adapted to monitor such fragmented systems and the government ended up facing liquidity shortages and a proliferation of arrears. The accumulation of arrears was a contributing factor to the elimination of the oil fund.
Investment strategies
29. The formulation of investment strategies for the accrued financial assets—the so-called strategic asset allocation—should depend on and should be consistent with SWF’s operational objectives and broader macroeconomic and fiscal policy objectives.
30. The type of financial instruments and their currency, maturity, and level of riskiness should be aligned with SWF’s objectives, the level of assets accrued (both in absolute and relative terms), and even the authorities’ institutional capacity. Stabilization funds should be generally conservative in their strategic asset allocations (SAA), using shorter investment horizons and low risk-return profiles, or other instruments that vary inversely with the risk the fund is meant to cover. The same rationale could apply in a country that is highly dependent on the returns on SWF assets. By contrast, SWFs with long-term objectives, such as saving funds, may seek to maximize returns while also aiming to preserve a certain amount of capital, in real terms, so that the purchasing power of the funds is guaranteed. They may therefore have longer investment horizons and riskier investment strategies.
31. Some new funds (for example, Timor-Leste, Marshall Islands, and Micronesia) have adopted prudent investment strategies that are similar to those followed to manage foreign exchange reserves. A prudent approach is likely to be preferable at the early stages of SWF implementation, particularly when institutional capacity and experience are still limited. This stands in sharp contrast with the experience in some Pacific Island Countries, where weak asset management led to substantial financial losses and severely jeopardized fiscal sustainability (see Le Borgne and Medas, 2007):
Nauru. The asset portfolio of the Phosphate Royalties Trust Fund (established in 1968) was mostly invested in lumpy real estate projects.
Tonga. The portfolio of the Tonga Trust Fund (established in 1988) consisted entirely of investments in three U.S. companies operating in the life insurance, energy, and internet businesses.
32. While very little is publicly known about operations and management of the above funds, the undiversified investments, together with mismanagement and the use of assets as leverage for borrowing, resulted in large financial losses. These experiences show the importance of ensuring that the asset management strategy for SWFs is consistent with the underlying policy objectives and the country’s capacity to manage and monitor investments.
33. As stated earlier, and because of macroeconomic and governance concerns, there is a general preference for strategic asset allocations around foreign assets, as investing abroad could avoid imparting volatility to the domestic economy and also mitigate the appreciation of the currency protecting the competitiveness of the overall tradable sector.
4. Transparency and Accountability
Disclosure and reporting
34. An SWF is first and foremost a guardian of public financial assets; it can also provide the scope and means through which fiscal action can be taken. Therefore, stringent transparency and accountability provisions are critical to enhance any SWFs’ legitimacy and prevent a misuse of resources.
35. In terms of transparency, the requirements for an SWF should be similar to those of other entities that are responsible for government functions as summarized in guidelines by the IMF and OECD.7 Of particular relevance to SWFs are provisions dealing with holdings of government assets, the reporting of revenues and expenditures, and comprehensive disclosure of information about the size and type of financial assets and the gross flows of revenue and spending. The IMF Fiscal Transparency Code also emphasizes the need to clearly specify roles and responsibilities for the holding of financial assets, implying the need for legal frameworks and regulatory documents that include an unambiguous statement of SWF’s objectives and mechanisms for ensuring accountability. In addition, disclosure requirements extend to the governance arrangements framing the SWF’s relationships with other public institutions, as well as the operational rules and asset management strategies. Accessibility and timeliness of information are other important aspects of fiscal accountability; SWFs should regularly publish their audited balance sheets, operations and performance. SWF’s revenue, borrowing, spending, and performance should also be provided in the government’s budget documentation.
36. The evidence shows that transparency and accountability practices differ substantially across countries. In many countries, (e.g., Norway, Timor-Leste, and Tuvalu) information is made available on the operations and financial position of the SWFs, but some countries prefer not to disclose such information, for example, arguing that public disclosure of the extent of official assets might strengthen pressures to spend.8 However, in the absence of information, the public may just as well have exaggerated perceptions of government financial wealth. In addition, lack of information about SWF’s operation hampers analysis of the fiscal stance, savings and investment balances, and public and external sustainability and vulnerability. In this context, a representative group of SWFs elaborated some generally-accepted principles and practices, called the Santiago Principles,9 to make their objectives, institutional and governance structures, and investment practices visible.10
Institutional framework
37. The institutional framework of an SWF has a bearing on the fund’s transparency and accountability levels. A separate framework or institutional setup can potentially weaken transparency and accountability. Where funds are set up as separate public entities (e.g., Temasek in Singapore and the Kuwait Investment Authority in Kuwait), with or without authority to undertake off-budget expenditure and maintain their own sources of revenue, specific coordination mechanisms would be needed. At a broad level, the fund’s legal framework and corporate governance arrangements can help to frame the institutional relationships among funds, governments, and central banks. There should be clear guidelines for any large operations of the fund involving intervention in the foreign exchange markets or domestic market operations, including coordination with the monetary authorities.
D. Key Lessons for Papua New Guinea
38. Based on the review of international experience, particularly regarding the workings of SWFs, the following lessons can be extracted for Papua New Guinea and its challenge to manage (potentially growing and large) natural resource revenue:
Integrating an SWF into the Macro Framework
39. Given potentially large future revenue from LNG projects, the fiscal policy framework (including the current Medium-Term Fiscal Strategy) might need to be modified. The fiscal policy framework should be the critical anchor for the formulation of medium-term plans and annual budgets, as well as for the design and operation of special fiscal institutions like SWFs. The fiscal policy framework should be aimed at delinking government spending from volatile revenue originating from abroad in line with the economy’s absorptive capacity and the government ability to spend well in the short term, and taking into account long-term exhaustibility of resources. The relative priority given to those various policy dimensions (i.e., basically the decision about how much to consume now out of mineral resources) would need to be carefully considered; since this is not obvious, some flexibility in the framework will be required.
40. The current Medium-Term Fiscal Strategy (MTFS) provides a useful starting point for integrating an SWF into the macro framework. The MTFS, which was approved in July 2008, is designed to reduce the impact of volatile mineral revenues on government spending and the economy as a whole with a rule constraining the non-mineral fiscal deficit to be no more than 8 percent of GDP. Under the MTFS, “normal revenues” are defined as the sum of non-mineral revenues and “normal” mineral revenues—the mineral revenues that would be expected without a commodity-price boom or about 4 percent of GDP. “Ongoing spending,” which includes recurrent and development spending, should be kept in line with “normal revenues.” Mineral revenues above 4 percent of GDP should be used for one-off transactions: debt reduction (30 percent) and additional public investment (70 percent). Amounts not used for debt reduction would accumulate in trust accounts, which the government holds largely in private banks, to be drawn over time for development needs. Although the MTFS has yielded substantial benefits, there is no mechanism to ensure that annual level of the non-mineral deficit is consistent with the cyclical position of the economy and thus fiscal policy can still be procyclical. In addition, the horizon over which normal mineral revenue is determined does not account for resource depletion and therefore does not ensure the long-term sustainability of recurrent spending.
41. The modifications to the current fiscal framework (how much to spend) should take several dimensions into account, such as:
long-term fiscal sustainability, which is particularly critical under a limited horizon for natural resource reserves;
the institutional capacity to spend and the quality of spending;
the impact on domestic demand, and eventual pressures on inflation, real exchange rates, international competitiveness, and banking credit to the private sector; and
the degree of uncertainty about future natural resource revenue, with a higher degree of uncertainty forcing the accumulation of more precautionary savings and thus a more conservative fiscal policy.
42. Some specific features derived from other natural resource-dependent countries’ fiscal frameworks could be useful for PNG. In Timor-Leste, the fiscal framework focuses on intergenerational equity by using only the permanent income (the estimated sustainable income) from the oil/gas wealth to finance the non-oil fiscal deficit. In Norway, fiscal policy is based on a fiscal guideline—over the cycle, the non-oil deficit should average 4 percent of the financial wealth accumulated in the oil fund (approximately equal to the average real rate of return on financial investments), implying limited use of oil wealth in the short term but increasing over time. By contrast, in Chile, the focus is on short-term demand management and spending smoothing through the implementation of the structural balance rule that adjusts the fiscal balance both from short-term fluctuations in copper prices (structural copper revenue) through long-term copper prices and from cyclical changes in economic activity. Many of these features should be considered in designing a new PNG fiscal framework, based on the relative importance between short-term demand management and long-term intergenerational equity.
43. As in Timor-Leste, spending from the fund in PNG should guarantee intergenerational equity. To ensure that funds remain available to finance a portion of public spending long after LNG reserves has been depleted, the pace of spending from the fund should be based in part on the permanent income approach. The magnitude of the trend non-mineral deficit embedded in the framework will need to reflect this. In determining the trend non-mineral deficit, it will also be important to account for uncertainty about future mineral revenues. Further, with public spending falling primarily on the non-mineral sector, the trend non-mineral deficit should be consistent with the sustainable or trend growth in this sector. This will also help ensure that spending grows in line with the institutional capacity to spend effectively.
44. Like the funds in Norway and Chile, the cyclical position of the economy will need to determine the level of the non-mineral deficit relative to its trend each year. To maintain macroeconomic stability, it will be essential that public spending from mineral resource wealth does not result in domestic demand exceeding the economy’s supply capacity. The available capacity in the economy to absorb public spending will vary from year to year. Thus the framework will need to incorporate a process for determining the annual level of the non-mineral deficit, relative to its trend, consistent with the expected spare capacity in the economy in the coming year.
The Design of an SWF
45. A financing fund is recommended and should be integrated into the fiscal policy framework. An SWF, if created, should function effectively within the fiscal policy framework and should be linked explicitly and transparently to the budget. A financing fund is to be preferred since it provides an explicit and transparent link between fiscal policy and asset accumulation. Financing funds, in addition to avoiding rigid operational rules for deposit and withdrawal of resources that have characterized other types of funds, have also the advantage of operating either as a stabilization fund, a saving fund, or both. This could be useful because the pace of accumulation of financial assets will depend on mineral revenue developments together with the evolution of the non-mineral deficit. All spending decisions should take place within the budget process, avoiding the use of SWF assets directly for one-off or extrabudgetary spending. The fiscal policy framework (and not SWF’s withdrawal rules) should deal with potential deviations from original fiscal plans: justification for ad-hoc operations involving use of SWF resources would have to be subject to parliament scrutiny.
46. Stringent transparency and accountability provisions are critical to enhance any SWFs’ legitimacy and prevent a misuse of resources. Rules and operations of an SWF should be transparent and free from political interference. Clear and publicly accessible corporate governance arrangements that frame the SWF’s relationship with other public institutions should be prepared. In terms of transparency, the requirements for an SWF should be similar to those of other entities that are responsible for government functions as summarized in guidelines by the IMF and OECD: SWFs should disclose the size and type of financial assets and the gross flows of revenue and spending; audited balance sheets, operations and performance, should be regularly published. Investment strategies should be consistent with the government risk tolerance and risk management capacity. It would be prudent to start from conservative investment strategies at an early stage. To ensure transparency, reports on its performance should be published.
47. There are strong cases for investing the SWF’s accumulated resources abroad. Such a policy would help protect the competitiveness of the non-resource sector by sterilizing government savings (out of mineral resource revenue originating from abroad). The main transmission channel for natural resource revenues to the economy is fiscal policy, for example, through government spending. However, SWFs (financial) investment policies can be of relevance from a macroeconomic perspective. This is currently the case in Papua New Guinea, where accumulated mineral revenues are being held in government’s “trust fund accounts” in private banks: allowing additional liquidity to be immediately deposited in private banks accelerates private sector credit and complicates the conduct of monetary policy by creating pressures on inflation (and potentially leading to real exchange rate appreciations and reduced competitiveness in the tradable sector) and/or by increasing central bank’s quasi-fiscal losses derived from mopping up “excess” liquidity. In addition, investing abroad would help avoid potential governance problems that could arise from a mandate to invest in domestic markets.
Appendix 1.1. Objectives and Design Features of Sovereign Wealth Funds (Selected Countries)
| Country or State Name/Date Established | Stated Objective(s) Main Features | Integration in the Overall Fiscal Framework and Budget | Modification or Suspension Flexibility in the framework |
|---|---|---|---|
| Norway Government Petroleum Fund, 1990. From 2006, Government Pension Fund-Global (GPF-G). | Stabilization and saving Financing fund; a government account at the central bank | The fund is fully integrated with the budget. Net central government cash flows from petroleum activities and the return on fund investments are deposited into the fund. Transfers to the budget are made to finance the non-oil deficit (approved by parliament). Fiscal policy, which regulates the flows to/from the Fund, is anchored in fiscal guidelines (effective from the 2002 budget) that state that the structural non-oil budget deficit shall correspond to 4 percent (the expected long-run rate of return in real terms) of the GPF-G assets. | The Petroleum Fund was renamed as the GPF-G in 2006 as part of a broader pension reform highlighting its role in meeting the rapid rise in public pension expenditures in future years (but not earmarking its resources for those or any other purposes). Core elements of the fiscal guidelines are relatively simple and allow flexibility in fiscal policy since the non-oil budget deficit can temporarily deviate from the 4-percent rule over the business cycle or in the event of extraordinary changes in the value of the GPF-G. |
| Timor-Leste Petroleum Fund, 2005. | Stabilization and saving Financing fund | The fund is fully integrated with the budget. All government oil/gas revenue and the return on fund investments are deposited into the fund. Transfers to the budget are made to finance the non-oil deficit (approved by parliament) to the extent to which the transfer does not exceed the estimated sustainable income (ESI), which is calculated as defined in the law. | The framework of the Petroleum Fund Law is flexible to allow withdrawals exceeding the ESI as long as a justification is presented to parliament with a detailed explanation of why it is in the long-term interests of the country. |
| Alaska Alaska Permanent Fund, 1976 | Saving | 50 percent of mineral revenues (increased from 25 percent in 1980) are deposited in the fund. It pays annual dividend to the population based on a fraction of the fund’s realized earnings. | |
| Algeria Revenue Regulation Fund (RRF), 2000. | Stabilization A government account in local currency at the central bank | The fund receives residual oil revenue after budget allocation based on benchmark price as well as exceptional advances by the central bank for debt amortization. Resources can be used to finance the budget if hydrocarbon revenue outcome is less than budgeted or to reduce national debt. No withdrawals allowed if assets fall below US$10 billion. | |
| Azerbaijan State Oil Fund of the Republic of Azerbaijan (SOFAZ), 1999. | stabilization and saving | The fund receives only the part of oil revenue that is associated with the post-Soviet oil and gas production fields. SOFAZ finances projects included in the Public Investment Programme, which is submitted to Parliament together with annual consolidated budget (state budget plus SOFAZ’s budget). | |
| Chad Fund for Future Generations (FFG), 1999. | Saving | 10 percent of royalties and dividends after debt service related to pipeline borrowing were to be deposited in the fund. When total oil revenue lower or equal to 10 percent of previous year tax and nontax revenue, withdrawals were made but could not exceed revenue accrued in previous year. | The FFG was abolished in 2006 to streamline the fiscal policy framework and to increase flexibility in the government’s liquidity management. |
| Ecuador Savings and Contingency Fund (FAC), 2005. | Stabilization | Inflows are mainly 20 percent of revenue from heavy crude oil exports. Resources are to be used if (1) actual oil revenue is below budgeted level or (2) a national emergency is declared. | |
| Stabilization Fund for Investment and Debt Reduction (FEIREP), 2002. | Stabilization and saving | The fund receives revenue from heavy crude oil and 45 percent of light crude revenue in excess of budgeted amount. FEIREP funds were used as follows: (i) 70 percent to repay debt; (ii) 20 percent for stabilization purposes; (iii) 10 percent to finance budgeted health and education spending. | Abolished in 2005. |
| Iran, Islamic Rep. Oil Stabilization Fund (OSF), 2000. | Stabilization and to finance on lending by commercial banks. | Residual oil revenue after budget allocation based on benchmark price up to a certain limit is deposited in the fund. Transfers to budget are made if oil revenue outcome is less than budgeted. Up to half of the fund’s assets can be used for lending foreign exchange to domestic private entrepreneurs in priority sectors via commercial banks, and to state-owned companies, given limited their access to foreign borrowing. | In 2007/08, the government converted some of the OSF deposits at selected state-owned commercial banks into equity to strengthen their capital. |
| Kuwait General Reserve Fund (GRF), 1960. | Stabilization and saving | The GRF receives all revenues including all oil revenues, from which all budgetary expenditures are paid. | |
| Reserve Fund for Future Generations (RFFG), 1976. | Saving | 10 percent of total government revenue including revenue of the GRF is transferred to the RFFG, which also retains its investment income. Discretionary transfers to the budget, with parliament approval, are repaid along with accrued interests. | |
| Libya Oil Reserve Fund (ORF), 1995. | Stabilization and saving | Oil revenues exceeding those corresponding to the reference oil price in budget law is deposited to the ORF. Discretionary transfers are made both to the budget and to finance extrabudgetary spending. | The Libyan Investment Authority was established in 2006 (started operations in June 2007) to manage the government’s financial assets, including the ORF. |
| Russian Federation Reserve Fund (RF) and National Wealth Fund (NWF), 2008 | RF; Stabilization NWF; Saving to finance the deficits of the Pension Fund | Oil and gas revenues in excess of budget allocation are deposited in the RF until the RF’s balance reaches 10 percent of GDP. Excess resources will then be transferred to the NWF. RF assets can be withdrawn to cover financing needs in case the amount of oil and gas revenues is not sufficient for the budget purposes. The RF assets could also be withdrawn for early debt repayment. Until 2013, withdrawals from the RF should be approved by the federal budget law for the corresponding fiscal year and planning period. From 2013, the current Budget Code imposes a limit on the non-oil/gas deficit of the federal government equivalent to 4.7 percent of GDP. (However, the government is discussing shifting the deadline for imposing this limit to 2015) | The former oil stabilization fund (established in 2004 as a stabilization fund) was redesigned into the Reserve Fund (RF) and the National Welfare Fund (NWF) in January 2008. The fund rules have been temporarily suspended until 2013, to directly finance fiscal deficits using oil revenue after the global crisis. |
| Tuvalu Tuvalu Trust Fund, 1987, and later the Consolidated Investment Fund (CIF) and the Tuvalu Trust Fund (TTF). | CIF; Stabilization TTF; Saving Government accounts | Windfall revenue and ad-hoc donor assistance are deposited in the TTF, from which transfers are made to the CIF when the market value of the fund exceeds the maintained value, being the real value as measured by the Australian CPI. Withdrawals from the CIF are at discretion of the Ministry of Finance, although there is a target minimum balance (by a guideline) of 16 percent of the TTF’s maintained value. | The fund was initially designed for long-term fiscal sustainability. As stabilization needs also became more pressing, in 1993, a stabilization account (later transformed into the Consolidated Investment Fund) was added to the saving account (later called Tuvalu Trust Fund). |
| Country or State Name/Date Established | Stated Objective(s) Main Features | Integration in the Overall Fiscal Framework and Budget | Modification or Suspension Flexibility in the framework |
|---|---|---|---|
| Norway Government Petroleum Fund, 1990. From 2006, Government Pension Fund-Global (GPF-G). | Stabilization and saving Financing fund; a government account at the central bank | The fund is fully integrated with the budget. Net central government cash flows from petroleum activities and the return on fund investments are deposited into the fund. Transfers to the budget are made to finance the non-oil deficit (approved by parliament). Fiscal policy, which regulates the flows to/from the Fund, is anchored in fiscal guidelines (effective from the 2002 budget) that state that the structural non-oil budget deficit shall correspond to 4 percent (the expected long-run rate of return in real terms) of the GPF-G assets. | The Petroleum Fund was renamed as the GPF-G in 2006 as part of a broader pension reform highlighting its role in meeting the rapid rise in public pension expenditures in future years (but not earmarking its resources for those or any other purposes). Core elements of the fiscal guidelines are relatively simple and allow flexibility in fiscal policy since the non-oil budget deficit can temporarily deviate from the 4-percent rule over the business cycle or in the event of extraordinary changes in the value of the GPF-G. |
| Timor-Leste Petroleum Fund, 2005. | Stabilization and saving Financing fund | The fund is fully integrated with the budget. All government oil/gas revenue and the return on fund investments are deposited into the fund. Transfers to the budget are made to finance the non-oil deficit (approved by parliament) to the extent to which the transfer does not exceed the estimated sustainable income (ESI), which is calculated as defined in the law. | The framework of the Petroleum Fund Law is flexible to allow withdrawals exceeding the ESI as long as a justification is presented to parliament with a detailed explanation of why it is in the long-term interests of the country. |
| Alaska Alaska Permanent Fund, 1976 | Saving | 50 percent of mineral revenues (increased from 25 percent in 1980) are deposited in the fund. It pays annual dividend to the population based on a fraction of the fund’s realized earnings. | |
| Algeria Revenue Regulation Fund (RRF), 2000. | Stabilization A government account in local currency at the central bank | The fund receives residual oil revenue after budget allocation based on benchmark price as well as exceptional advances by the central bank for debt amortization. Resources can be used to finance the budget if hydrocarbon revenue outcome is less than budgeted or to reduce national debt. No withdrawals allowed if assets fall below US$10 billion. | |
| Azerbaijan State Oil Fund of the Republic of Azerbaijan (SOFAZ), 1999. | stabilization and saving | The fund receives only the part of oil revenue that is associated with the post-Soviet oil and gas production fields. SOFAZ finances projects included in the Public Investment Programme, which is submitted to Parliament together with annual consolidated budget (state budget plus SOFAZ’s budget). | |
| Chad Fund for Future Generations (FFG), 1999. | Saving | 10 percent of royalties and dividends after debt service related to pipeline borrowing were to be deposited in the fund. When total oil revenue lower or equal to 10 percent of previous year tax and nontax revenue, withdrawals were made but could not exceed revenue accrued in previous year. | The FFG was abolished in 2006 to streamline the fiscal policy framework and to increase flexibility in the government’s liquidity management. |
| Ecuador Savings and Contingency Fund (FAC), 2005. | Stabilization | Inflows are mainly 20 percent of revenue from heavy crude oil exports. Resources are to be used if (1) actual oil revenue is below budgeted level or (2) a national emergency is declared. | |
| Stabilization Fund for Investment and Debt Reduction (FEIREP), 2002. | Stabilization and saving | The fund receives revenue from heavy crude oil and 45 percent of light crude revenue in excess of budgeted amount. FEIREP funds were used as follows: (i) 70 percent to repay debt; (ii) 20 percent for stabilization purposes; (iii) 10 percent to finance budgeted health and education spending. | Abolished in 2005. |
| Iran, Islamic Rep. Oil Stabilization Fund (OSF), 2000. | Stabilization and to finance on lending by commercial banks. | Residual oil revenue after budget allocation based on benchmark price up to a certain limit is deposited in the fund. Transfers to budget are made if oil revenue outcome is less than budgeted. Up to half of the fund’s assets can be used for lending foreign exchange to domestic private entrepreneurs in priority sectors via commercial banks, and to state-owned companies, given limited their access to foreign borrowing. | In 2007/08, the government converted some of the OSF deposits at selected state-owned commercial banks into equity to strengthen their capital. |
| Kuwait General Reserve Fund (GRF), 1960. | Stabilization and saving | The GRF receives all revenues including all oil revenues, from which all budgetary expenditures are paid. | |
| Reserve Fund for Future Generations (RFFG), 1976. | Saving | 10 percent of total government revenue including revenue of the GRF is transferred to the RFFG, which also retains its investment income. Discretionary transfers to the budget, with parliament approval, are repaid along with accrued interests. | |
| Libya Oil Reserve Fund (ORF), 1995. | Stabilization and saving | Oil revenues exceeding those corresponding to the reference oil price in budget law is deposited to the ORF. Discretionary transfers are made both to the budget and to finance extrabudgetary spending. | The Libyan Investment Authority was established in 2006 (started operations in June 2007) to manage the government’s financial assets, including the ORF. |
| Russian Federation Reserve Fund (RF) and National Wealth Fund (NWF), 2008 | RF; Stabilization NWF; Saving to finance the deficits of the Pension Fund | Oil and gas revenues in excess of budget allocation are deposited in the RF until the RF’s balance reaches 10 percent of GDP. Excess resources will then be transferred to the NWF. RF assets can be withdrawn to cover financing needs in case the amount of oil and gas revenues is not sufficient for the budget purposes. The RF assets could also be withdrawn for early debt repayment. Until 2013, withdrawals from the RF should be approved by the federal budget law for the corresponding fiscal year and planning period. From 2013, the current Budget Code imposes a limit on the non-oil/gas deficit of the federal government equivalent to 4.7 percent of GDP. (However, the government is discussing shifting the deadline for imposing this limit to 2015) | The former oil stabilization fund (established in 2004 as a stabilization fund) was redesigned into the Reserve Fund (RF) and the National Welfare Fund (NWF) in January 2008. The fund rules have been temporarily suspended until 2013, to directly finance fiscal deficits using oil revenue after the global crisis. |
| Tuvalu Tuvalu Trust Fund, 1987, and later the Consolidated Investment Fund (CIF) and the Tuvalu Trust Fund (TTF). | CIF; Stabilization TTF; Saving Government accounts | Windfall revenue and ad-hoc donor assistance are deposited in the TTF, from which transfers are made to the CIF when the market value of the fund exceeds the maintained value, being the real value as measured by the Australian CPI. Withdrawals from the CIF are at discretion of the Ministry of Finance, although there is a target minimum balance (by a guideline) of 16 percent of the TTF’s maintained value. | The fund was initially designed for long-term fiscal sustainability. As stabilization needs also became more pressing, in 1993, a stabilization account (later transformed into the Consolidated Investment Fund) was added to the saving account (later called Tuvalu Trust Fund). |
References
Davis, J., Ossowski, R., Daniel, J., and Barnett, S., 2001, “Stabilization and Savings Funds for Nonrenewable Resources,” Occasional Paper 205 (International Monetary Fund).
International Monetary Fund, 2007a, “Code of Good Practices on Fiscal Transparency”, http://www.imf.org/external/np/fad/trans/.
International Monetary Fund, 2007b, “Manual on Fiscal Transparency,” Fiscal Affairs Department.
International Working Group of Sovereign Wealth Funds (2008), “Sovereign Wealth Funds—Generally Accepted Principles and Practices—Santiago Principles.”
Le Borgne, E. and Medas, P., 2007, “Sovereign Wealth Funds in the Pacific Island Countries: Marco-Fiscal Linkages,” IMF Working Paper (International Monetary Fund).
OECD, 2002, “Best Practices for Budget Transparency,” http://www.oecd.org/LongAbstract/0,3425, en_2649_34119_1905251_1_1_1_1,00.html
Ossowski, R., Villafuerte, M., Medas, P., and Thomas, T. (2008), “Managing the Oil Revenue Boom: the Role of Fiscal Institutions,” Occasional Paper 260, (International Monetary Fund).
Shields, J. and Villafuerte, M., “Sovereign Wealth Funds and Economic Policy at Home,” (forthcoming).
Prepared by Keiko Takahashi (Fiscal Affairs Department).
Compared to other natural resources, revenue from natural gas production is not as uncertain, because sales agreements with buyers are decided in advance.
For example, Kazakhstan, Russia, and Trinidad and Tobago changed the threshold values for accumulating deposits several times and even the definitions of oil revenue affected by those rules in an effort to accommodate higher spending while maintaining the relevance of their funds.
Algeria borrowed domestically to finance increased spending and passed on the liabilities to its oil fund, which was only allowed to repay debt.
Venezuela stopped the simultaneous accumulation of deposits and domestic debt.
The initial provision restricting the amount transferred to the budget in any one year to no more than 20 percent higher than the previous year was found to be unduly restrictive and relaxed in 1986. The fund does not appear to have been well integrated with overall fiscal policy or to have helped stabilize budget expenditure, which had been partly financed with debt operations outside of the MRSF (Davis and others, 2001).
See for details on the IMF Code of Good Practices on Fiscal Transparency and the explanatory Manual on Fiscal Transparency; and for information on the OECD’s Best Practices for Budget Transparency.
For example, the Kuwaiti Reserve Fund for Future Generation is prohibited by law from disclosing its assets and investment strategy, although the parliament receives some periodic information which is subsequently reported in the media.
“Sovereign Wealth Funds—Generally Accepted Principles and Practices—Santiago Principles,” International Working Group of Sovereign Wealth Funds, October 2008.
Those principles fall short of internationally accepted principles of transparency and financial disclosure that should apply to public sector entities, but are nonetheless a reference point for some SWFs.