1. The Algerian economy is heavily reliant on hydrocarbons, which account for about 30 percent of GDP, 95 percent of export earnings and 60 percent of budget revenues. Thanks to high oil prices and prudent macroeconomic policies in recent years, Algeria has built comfortable external and fiscal buffers. These have enabled the economy to weather the global financial crisis and regional uncertainties well. Fiscal policy is not on a sustainable trajectory while—with hydrocarbon resources expected to be depleted within the next 50 years—it should be geared toward the preservation of wealth for future generations. The present study examines options and strategies for designing a fiscal framework for Algeria to achieve this objective, building on the recent IMF guidance papers on fiscal frameworks for resource-rich countries.2 The note is organized as follows. Section II takes stock of Algeria’s current fiscal framework. Section III discusses options and strategies for a revised fiscal framework. Section IV discusses the proposed framework. Section V summarizes key principles for managing natural resource funds, and Section VI concludes.

Abstract

1. The Algerian economy is heavily reliant on hydrocarbons, which account for about 30 percent of GDP, 95 percent of export earnings and 60 percent of budget revenues. Thanks to high oil prices and prudent macroeconomic policies in recent years, Algeria has built comfortable external and fiscal buffers. These have enabled the economy to weather the global financial crisis and regional uncertainties well. Fiscal policy is not on a sustainable trajectory while—with hydrocarbon resources expected to be depleted within the next 50 years—it should be geared toward the preservation of wealth for future generations. The present study examines options and strategies for designing a fiscal framework for Algeria to achieve this objective, building on the recent IMF guidance papers on fiscal frameworks for resource-rich countries.2 The note is organized as follows. Section II takes stock of Algeria’s current fiscal framework. Section III discusses options and strategies for a revised fiscal framework. Section IV discusses the proposed framework. Section V summarizes key principles for managing natural resource funds, and Section VI concludes.

A. Introduction

1. The Algerian economy is heavily reliant on hydrocarbons, which account for about 30 percent of GDP, 95 percent of export earnings and 60 percent of budget revenues. Thanks to high oil prices and prudent macroeconomic policies in recent years, Algeria has built comfortable external and fiscal buffers. These have enabled the economy to weather the global financial crisis and regional uncertainties well. Fiscal policy is not on a sustainable trajectory while—with hydrocarbon resources expected to be depleted within the next 50 years—it should be geared toward the preservation of wealth for future generations. The present study examines options and strategies for designing a fiscal framework for Algeria to achieve this objective, building on the recent IMF guidance papers on fiscal frameworks for resource-rich countries.2 The note is organized as follows. Section II takes stock of Algeria’s current fiscal framework. Section III discusses options and strategies for a revised fiscal framework. Section IV discusses the proposed framework. Section V summarizes key principles for managing natural resource funds, and Section VI concludes.

B. Background

2. Algeria’s fiscal framework is based on a saving rule based on the current oil price: above the threshold of US$37 per barrel, oil revenue is saved into the oil stabilization fund (Fonds de Regulation des Recettes, or FRR). The FRR can be freely drawn upon for budget support, so that expenditure is disconnected from the saving rule.

3. The framework lacks credibility in many respects. The effective price is more than twice the reference saving price; this, however, is not binding because of the uncapped annual drawdown from the FRR (Figure 1). Moreover, the FRR—which is housed at the central bank—yields low effective returns by international standards.

Figure 1.
Figure 1.

Algeria: Price Rules in the Actual Fiscal Framework, 2008–18

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Sources: IMF World Economic Outlook; and IMF staff’s estimates.

4. The long-term trajectory of fiscal accounts is unsustainable. The medium-term nonhydrocarbon deficits, though narrowing, cannot maintain real wealth in the long run (see 2012 Article IV report). In addition, Algeria’s fiscal stance has been heavily influenced by hydrocarbon prices (Figure 2). The nonhydrocarbon primary deficit (NHPD) and spending have been highly correlated with oil price during the past 15 years, widening during good times and contracting in bad times. Finally, a long-lasting period of low hydrocarbon prices could set the country on an unsustainable fiscal trajectory even in the short term.1 With such challenges, revamping the fiscal framework and setting fiscal policy on a more sustainable foundation are essential.

Figure 2.
Figure 2.

Algeria: Procyclicality of Fiscal Policy, 1997–2013

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Sources: IMF World Economic Outlook; and IMF staff’s estimates.

C. Fiscal Framework Considerations

5. A fiscal framework for resource-rich countries should provide a set of tools to achieve two interrelated objectives: (i) ensure long-term sustainability and intergenerational equity, and (ii) manage revenue volatility and uncertainty.

Assumptions

6. Before examining options for a revamped fiscal framework in Algeria, it is necessary to discuss key macroeconomic assumptions. The analysis is conducted through 2050.

  • The resource horizon for crude oil and gas follows the projections in British Petroleum.1 Accordingly, crude oil reserves would be depleted by 2032, gas reserves by 2068. This assumption is conservative; proven reserves have been revised upward over the two past decades (Figure 3).2

  • The oil price path is projected with a similar level of volatility to that experienced over the past 10 years. The natural gas price is held constant at 10½ percent of the oil price. This is based on the average, for the past five years, of the ratio of natural gas price to oil price, which has been hovering at about 10 percent during 2000–12 (Figure 4).

  • For nonhydrocarbon activities, long-term real growth is assumed to be around 4.3 percent.3 This reflects the average long-term growth projected for non-OECD countries for the period 2011–60 (3.7 percent). There is an additional 0.6 percent for long-term growth of the population as estimated by the United Nations.

  • The real rate of return on financial assets in dollar terms is assumed to be around 6.6 percent. This is based on the typical breakdown of a savings fund, as follows: 91 percent is invested in fixed-income assets, 5 percent in cash holdings, and 4 percent in global equities.4 The rate of return of each class of assets is as follows: 5.2 percent for fixed-income assets, 1.8 percent for cash-based assets, 7½ percent for global equity, and 7 percent for other assets (see J.P. Morgan 2013).5

  • On the fiscal sector, the following specific assumptions are postulated. Based on the medium–term projections of the Algerian economy (2013–18), it is assumed that till 2032 the share of hydrocarbons in government revenues in the hydrocarbon sector is constant, at about 55 percent.6 Afterward, only gas extraction will continue and corresponding remittances in the budget will represent approximately 26 percent of total fiscal revenues. Based on staff estimates, the steady-state multiplier of public investment in Algeria is estimated to be around 1.3. The tax revenue multiplier is set to ½.7 Because of the lack of a longer time series for Algeria, the elasticity of investment with respect to the real nonhydrocarbon output for Algeria is calibrated to around 0.19, in line with the work done on Central African oil-wealthy states.8

Figure 3.
Figure 3.

Hydrocarbon Proven Reserves, 1980–2012

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: British Petroleum Statistical Review of World Energy (2013).
Figure 4.
Figure 4.

Ratio of Gas Price over Oil Price, 2000–12

(Percent)

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: IMF staff estimates.

7. In the medium term (2013–18), the baseline assumes that real GDP is driven by a recovery in the hydrocarbon sector following higher investment, and by stronger external demand as Europe’s outlook improves. Nonhydrocarbon growth is projected to stabilize at 4.3 percent, reflecting a slowdown in construction and government services. Inflation is projected to fall to 4 percent in the medium term as the government withdraws fiscal stimulus, food prices soften, and monetary policy remains prudent. Algeria is projected to run a small current account deficit by 2016, on the assumption of lower oil prices and continued growth in domestic hydrocarbon consumption. The baseline also assumes that fiscal consolidation is on track over the medium term. The nonhydrocarbon overall deficit is expected to slowly improve, from about 34 percent of nonhydrocarbon GDP (NHGDP) in 2013 to about 27 percent of NHGDP by 2018.

Sustainability Analysis

8. With the expected depletion of hydrocarbon resources over the next 50 years, preserving this wealth for future generations should be the top priority in Algeria’s fiscal framework. The IMF has developed a new toolkit for designing fiscal rules that aim to smooth revenue volatility and ensure long-term fiscal sustainability in resource-rich countries. The toolkit includes intergenerational equity and price-based rule models.9

9. The starting point of the long-term sustainability analysis is the permanent income hypothesis (PIH).10 The PIH assumes that a country maintains a constant ratio of the nonhydrocarbon primary balance (NHPB) to NHGDP, equal to the implicit return on the present value of future natural resource revenue plus accumulated net financial savings. The computation basically transforms resource wealth on the ground into “virtual” financial wealth and uses an implicit rate of return. Total resource wealth is then computed as the sum of existing financial wealth and future resource revenues, measured in net present value. A shortcoming of the PIH, however, is that it is strictly a consumption-smoothing theory that does not address the need for investment.

10. Alternative approaches have been proposed in the literature to account for temporary investment needs—and thus lower accumulation of fiscal savings than the PIH, in at least some periods. In such cases, the PIH is combined with temporary escape clauses to accommodate temporary modifications of public spending. These are the Modified PIH (MPIH) and the Fiscal Sustainability Framework (FSF).11 First, the MPIH accommodates front-loaded investment by allowing financial assets to be drawn down during the scaling-up period; the drawdown would then be offset by fiscal adjustment in the future to rebuild financial assets to the same level as under the traditional PIH. This approach does not explicitly account for the potential impact of the scaling up on growth and nonresource revenues. Over time, if the scaling up of investment is yielding “fiscal returns” (i.e., increasing nonresource revenues), the need for fiscal adjustment to compensate for the initial scaling up would be lower, and could be eliminated. Unlike the MPIH, the FSF explicitly accounts for the impact of investment on growth and non-resource revenues. The FSF is consistent with an NHPD that allows a drawdown of resource wealth to build human and physical capital. In this context, it stabilizes resource wealth at a lower level than the PIH models. Lower financial wealth will generate a lower stream of income to the budget than in the PIH-based frameworks, which will result in a lower NHPD consistent with fiscal sustainability; however, fiscal spending can still be stabilized at a higher level because higher growth will have “fiscal returns” in the form of larger nonresource revenues.

11. In line with the Algeria’s need to build its capital stock to overcome infrastructure gaps and help support the diversification of the economy and the growth of a robust private sector (see 2012 Article IV), public investment is assumed to increase at the recently observed pace for the next Algerian development plan (2015–19).12 For Algeria, public investment has been strong over the past decade, averaging about 15.5 percent of GDP between 2007 and 2013.

12. Simulations indicate that the NHPD consistent with the PIH rule would be 11 percent of NHGDP (Figure 5).13, 14 This benchmark is derived by accounting for the actual saving in the FRR. In fact, unless a country starts with a high level of debt, the PIH exercise will deliver a deficit. Cumulative savings would stand at around 458 percent of NHGDP by 2050. Under the MPIH, the target for the NHPD-to-NHGDP ratio would temporarily be 15 percent, to accommodate an investment increase. This should be compensated by a long period of lower deficits until around 2040, and thereafter should stabilize at the PIH benchmark. In this case, cumulative savings would converge to the PIH level after 2040. Under the FSF, the NHPD-to-NHGDP ratio closely tracks with the MPIH outcome, though it would stabilize at 8 percent in the long term. Lower deficits reflect the positive impact of higher investment.15

Figure 5.
Figure 5.

Algeria: Sustainability Assessment Indicators, 2013–50

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: IMF staff’s estimates.

13. Below we discuss some macroeconomic implications of scaling up public investment in Algeria:

  • In 2013, the NHPD-to-NHGDP ratio is estimated to be about 34 percent higher than the PIH benchmark (Figure 6, Panel 1). The gap narrows to about 15½ percent by 2018. Significant fiscal consolidation, 20 percent of NHGDP, would therefore be necessary to bring fiscal policy onto a sustainable footing.

  • The PIH implied reference saving price rule could be between US$25 and US$21½ more stringent levels than the current one (Figure 6, Panel 2).

  • Scaling up investment will have a macroeconomic impact through several channels. Scaling up investment domestically could raise potential non-resource growth and create a virtuous cycle of increased fiscal space; however, the increase of investment could crowd out private investment or lead to a “Dutch disease” phenomenon. For Algeria, these risks are somewhat limited in the near term (Figure 6, Panel 3). Indeed, recent trends suggest that private and public investments are mostly complementary rather than substitutable. In the same vein, the real effective exchange rate proved marginally sensitive to the recent scaling up of public investment (Figure 6, Panel 4).

  • The application of the PIH-type rule would strengthen Algeria’s financial position. As a result of a saving rule preserving resource wealth for future generations, the reserves coverage will increase significantly in the medium term and would surpass the current projections by almost 18 months of imports coverage (Figure 6, Panel 5).

Figure 6.
Figure 6.

Algeria: Macroeconomic Implications of the PIH Rule

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Sources: IMF World Economic Outlook; and IMF staff’s estimates.

Volatility Analysis

14. As shown previously, the medium-term deficit remains far from the PIH benchmark, which would imply fiscal consolidation of an unrealistic magnitude; however, a price-based rule could provide a transitional anchor toward the PIH benchmark. Price-based rules are a good approach for managing price volatility. Under the price based-rules, the expenditure envelope is based on a smoothed price of the resource, protecting the budget from volatility. The smoothing formula may use backward-looking and/or forward-looking prices. In practice, international experiences suggest the choice of price-smoothing formula depends on countries’ characteristics (Table 1). With price-based rules, windfall revenues are saved and drawn upon during difficult times.

Table 1.

Price Rules in Selected Countries

article image
Source: IMF (2012). “Macroeconomic Policy Frameworks for Resource Rich Developing Countries—Analytic Frameworks and Applications,” IMF Policy Paper. Washington, DC: IMF.

15. For Algeria, three smoothing rules are simulated: the price rule 5/0/0, the price rule 5/1/5, and the price rule 12/1/3.16 Figure 7 shows a simulation of the realized oil price that Algeria would receive as well as reference prices implied by the three price rules. All three rules smooth prices. The price rule 5/0/0 tracks closely with the effective price. The rule 12/1/3, with its reliance on a long historical price series, provides for the most smoothing of prices.

Figure 7.
Figure 7.

Algeria: Oil Price, 2008–18

(US$ per barrel)

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Sources: IMF World Economic Outlook; and IMF staff’s estimates.

16. Under all scenarios, the realized NHPD-to-NHGDP ratio converges to the PIH benchmark by 2022 (Figure 8). This contrasts with the current observed trend of Algeria’s fiscal policy. Price-based rules lead to higher saving than the current projected FRR level. The price rule 12/1/3, with a longer backward-smoothing rule and the future price, performs well and generates the highest savings. The price rule 5/1/5, with short smoothing windows for both past and future prices, leads to higher volatility with lower but still sizeable financial savings. The price rule 5/0/0 yields somewhat similar volatility to that of the 5/1/5 formula but is consistent with financial savings.

Figure 8.
Figure 8.

Algeria: Managing Volatility Indicators, 2013–50

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: IMF staff calculations.

17. Backward-looking price rules tend to be adequate for Algeria from a practical standpoint. The price rule 5/0/0 presents the advantage of not requiring any forecasting exercise, contrary to the price rule 5/1/5, and incorporates changes in price trends with shorter lags than in the price rule 12/1/3. In particular, the price rule 5/0/0 scores well by reining in volatility and by leading to a strong financial position. These rules are indicative and ultimately depend on the policy objective. Budget prices relying on a shorter past horizon will better track changes in realized prices but may be associated with more volatile and procyclical expenditure. In contrast, budget prices with longer backward-looking horizons would have smoother expenditure paths, but might systematically under- or over-shoot actual revenues if price trends change. Forward-looking formulas anchor spending to oil markets’ expectations but remain challenging in countries with limited forecasting capacity or lacking well-established independent fiscal agencies.

18. The price-based rule could be further supplemented with a structural balance (SB) rule. For Algeria, two different structural primary balance rules are simulated using the price rule 5/0/0, with the constraint of preserving the size of the FRR. Accordingly, we simulate a structural balance rule that preserves real wealth until 2033. This requires a structural surplus of 5 percent. In addition, we also display in Figure 9 the previous 5/0/0 rule that corresponds to a structural equilibrium of the budget (strictly structural surplus). The realized NHPD-to-NHGDP ratio varies across different structural balance targets. The 5 percent SB rule would anchor fiscal policy to the PIH benchmark by 2026. With the end of oil, the target has to be adjusted to -1 percent to ensure smoothed spending profile. Cumulated financial saving will stand at comfortable levels at about 112 percent of NHGDP by 2050, with real wealth increasing after 2033. At the other extreme, a rule that targets a structurally balanced budget would delay the convergence toward the long-term anchor and lead to negative financial saving (about -52 percent of NHGDP by 2050). Real wealth tapers off will be rapidly in a negative territory. Likewise, under the current policy course, the return to the long-term sustainability level is further delayed and leads to financial dissaving and negative real wealth. This will lead Algeria to accumulate debt of about 88 percent of NHGDP by 2050.

Figure 9.
Figure 9.

Algeria: Proposed Fiscal Rule, 2013–50

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: IMF staff calculations.

D. Fiscal Rule for Algeria

19. Because Algeria is faced with the depletion of its crude oil reserves in two decades, the Algerian fiscal framework should be mostly geared toward the preservation of financial wealth for future generations. Hence the PIH benchmark should remain the anchor of fiscal policy; it gives a stable and clear anchor for policymakers.17 However, it requires substantial fiscal consolidation that is difficult to implement (20 percent of NHGDP per annum on average in the medium term). Therefore, while the PIH would be the first-best rule to ensure intergenerational equity, a more practical approach is needed.

20. As previously shown, backward-looking price rules tend to be appropriate for Algeria. In particular, the price rule 5/0/0 scores well by tempering spending volatility, mitigating fiscal profligacy, and, importantly, by securing comfortable fiscal savings.18 In particular, such a rule helps preserving real wealth over time when combined with a 5 percent structural balance (that will be adjusted to -1 percent at the end of oil production, supposedly in 2032). Such an approach would help Algeria manage revenue volatility stemming from fluctuating commodity prices, secure comfortable financial savings for the long term, and preserve real wealth per capita. Compared to the current macroeconomic framework, the proposed rule would require an additional consolidation of 3 percent per year over the medium term and continued fiscal consolidation in compliance with the fiscal rule over the long term.

21. Compared with the actual situation, the proposed rule implies a more credible and flexible saving rule that includes a clear replenishment and drawdown principles. The FRR will increase in good times (realized price above the reference level) and be drawn upon in bad times (realized price below the reference level).

22. The fiscal framework also needs to be supported by an adequate institutional arrangement. Fiscal responsibility laws or independent fiscal agencies, as implemented in other countries, enforce the rule-based framework, strengthening the credibility, transparency, and accountability of fiscal policy decisions. Algeria could follow a similar approach.

  • Fiscal Responsibility Law (FRL). Most countries opt to codify the rules and institutional arrangements for natural resource management in some form of legislation, generally an FRL.19 The scope of the FRL could cover activities related to determining and presenting the saving price according to the rule, and submission and approval of a medium-term fiscal framework. The FRL could include details regarding the calculation of resource revenues; and could specify permissible and temporarily deviations, and the eventual corrections.

  • Organic Budget Law (OBL). A transitional approach would be the inclusion of clear rules along the lines developed above in the OBL. The budget law needs to incorporate the new fiscal rule and define the way to enforce it.

  • Extractive Industries Transparency Initiative (EITI). By ensuring disclosure of the financial transactions surrounding natural resources extraction, the EITI principles could help increase transparency and accountability in revenue collection (see Appendix I).

E. Managing Resource Funds

23. The management of financial wealth should be overhauled in Algeria.20 As shown in previous sections, revamping Algeria’s fiscal framework is necessary to achieve sizeable financial saving since its current framework is incomplete.

24. In the context of the revamped fiscal framework proposed, the FRR should be transformed into a full-fledged sovereign wealth fund (SWF) with a clear investment strategy able to yield market-based return. The goals, the deposits, and the drawdown rules should be clearly defined, consistent with the proposed rule (see section IV). Furthermore, the goals of the FRR could be broadened to include the saving motive and secure financial wealth for future generations.

25. Moreover, the creation of a SWF could help ground the management of fiscal reserves on a market footing. In the current arrangement, the effective return on the FRR is low by international standards. During the 2008–11 period, the implicit return, based on dividend payments from the central bank to the government, was less than 2 percent—well below the returns for most resource-rich countries (Figure 10).

Figure 10.
Figure 10.

Nominal Return of Sovereign Wealth Funds (SWFs), Selected Resource-Rich Countries, 2008–11

(Average, Percent)

Citation: IMF Staff Country Reports 2014, 034; 10.5089/9781475525984.002.A002

Source: SWFs’ annual reports and reviews. * Implicit return based on central bank’s transfer to the government.

26. In addition, adhering to international best practices may help the governance structure of SWFs. Recently, the Santiago Principles were established: these are a voluntary code of conduct governing investment policies, disclosure rules, and other parameters of SWF activity (see Appendix II).

27. Overall, the reserves management capacity should be strengthened. For the sake of smooth transition, the management of the SWF should be the responsibility of the central bank, which already has the capacity and experience in reserves management.

F. Conclusion

28. Revisiting Algeria’s fiscal framework is of the essence: fiscal policy needs to be set on a sustainable course and the current fiscal framework in Algeria is incomplete in many respects: the reference saving price is not binding because drawdown from the oil fund is uncapped; and the oil fund yields low returns by international standards, and remains vulnerable to sizeable oil shocks.

29. This study has explored options and strategies for a revamped fiscal framework. It concludes that given the expected lifetime of hydrocarbon reserves, ensuring long-term sustainability and saving for future generations should be the priorities of fiscal policy. Simulations indicate that the PIH would provide a stable anchor and clear guidance for policymakers but would require an unrealistic adjustment of 20 percent of NHGDP on average. Under these circumstances, backward-looking price rules would be appropriate for Algeria. In particular, the price rule 5/0/0, combined with a structural surplus target of 5 percent NHGDP (that will be adjusted to -1 percent at the end of oil production, supposedly in 2032), scores well by tempering spending volatility, mitigating fiscal profligacy, and, importantly, securing comfortable fiscal savings and preserving real wealth over time. With the current macroeconomic framework, the necessary fiscal consolidation under the proposed rule is about 3 percent per annum in the medium term, which is more realistic.

30. In addition, the oil fund should be managed on a market basis. A SWF scheme could be explored and the reserve management capacity of the central bank should be strengthened. Finally, the fiscal framework needs to be supported by suitable institutions, including those affecting the capacity to produce long-term forecasts, establish a medium-term orientation of the budget, implement efficient public investment projects, and manage resource funds. A first step may be incorporating the proposed rule in the organic budget law.

31. Finally, extending the time horizon for hydrocarbon production, and increasing exports, will improve the prospects for Algeria’s oil wealth. This will require more foreign investment in the oil and gas industry, together with steps to curb domestic hydrocarbon consumption.

Appendix I. The Extractive Industries Transparency Initiative

1. The Extractive Industries Transparency Initiative (EITI) is a global standard established in 2003 to promote and support improved governance in resource-rich countries. The EITI brings together various parties with a stake in improving the economic outcome of the utilization of extractive industries (EI) revenues—governments of resource-rich countries who opt to participate; governments of other countries who decided to support, politically, financially, and with technical assistance; EI companies and industry groups; financial investors; civil society; and international institutions which share the EITI objective. Adhering to the EITI involves the full publication and verification of payments by companies and revenues to government from the oil, gas, and mining sectors.1

2. The key task of the EITI is to publish independent reports on resource revenues.2 Their wide dissemination and discussion create opportunities for public accountability. EITI reports compare company information on payments related to the exploitation of oil, gas, and mining with government information on revenues. If the two reconcile, the public will be assured of the integrity of official data, and confidence in the government will benefit.

3. The EITI requires governments to strengthen transparency of their EI revenues. First, the regular provision of quality information enables checks-and-balances institutions—within and outside government—to hold the agencies that collect EI revenues accountable. Moreover, governments also have to engage directly with civil society, broadening the public debate on EI revenues. Finally, once an EITI country report is out, there will be questions on how its data compare to budget execution data the government has submitted to parliament. The anticipation that EI revenues shown in budget execution reports will be scrutinized by the next EITI report should impose discipline. Once the public is confident that it knows the full size of EI revenues, it is likely to direct more of its attention to how they are spent. That falls outside the EITI framework but is critical to full accountability for EI revenues.

4. The EITI is not a silver bullet for achieving good governance in resource revenue management. There are serious potential weaknesses it does not address. Notably, the EITI report will not detect whether companies—aided by weak auditing by the government or perhaps even collusive government officials—do not pay what they are supposed to under the contracts. Nor will the EITI uncover whether EI contracts and fiscal regime were poorly designed—perhaps fraudulently so—and as a result do not produce optimal revenue flow for the country. More generally, the EITI does not address the transparency of a broader set of arrangements relevant to the prudent management of resource revenues such as depletion rates, policies that ensure fiscal sustainability, the design of taxes and contracts that are efficient, competitive licensing procedures, and optimal asset management.

Appendix II. Santiago Principles

1. The Santiago Principles are a set of 24 codes for Sovereign Wealth Fund (SWF) operations. Proposed in 2008 through a joint effort between the IMF and the international working group of SWFs, the principles are voluntary and aim to promote global financial stability and free cross-border capital and investment flows; to ensure adequate operational controls and risk management; to ensure compliance with applicable regulatory and disclosure requirements in host countries, and to guarantee economic and financial risk and return-related investments. So far 19 nations have signed on to the principles.1

2. The principles are divided into three distinct blocks:

  • The first block requests SWFs to disclose their legal framework and define and disclose their policy purpose. SWFs also are asked to publicly disclose their funding and withdrawal arrangements.

  • The second block covers SWFs’ institutional frameworks and governance structures. Specifically, they stipulate that each SWF should have a sound governance framework that clearly and effectively divides roles and responsibilities among its constituents. The SWF owner’s influence should be limited to setting the fund’s objectives, appointing the members of the governing bodies, and overseeing the SWF’s operations. The governing bodies should have a clear mandate to set the strategy and policies aimed at achieving the SWF’s objectives and should carry ultimate responsibility for the fund’s performance. The operational management should be tasked with implementing the strategies set by the owner and the governing bodies independently and in accordance with clearly defined responsibilities.

  • The third block requests that SWFs employ appropriate investment and risk management frameworks. It asks funds to disclose their investment policies, including information about investment themes, investment objectives and horizons, and strategic asset allocation. They should disclose investment decisions that are subject to non-economic and non-financial considerations and whether they execute ownership rights to protect the financial value of investments. The SWF should have a framework that identifies, assesses, and manages the risks of its operation and measures to track investment performance employing relative and/or absolute benchmarks.

Appendix III. Elements of Fiscal Frameworks in Selected Resource-Intensive Countries

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Note: Resource funds can be an account or a statutory legal entity. R = contingent (i.e., linked to threshold values) or revenue-share (i.e., flows in proportion to total revenue) funds. F = flexible (i.e., financing, linked to the overall fiscal position) funds.Source: Baunsgaard, Villafuerte, Poplawski-Ribeiro, and Richmond (2012). “Fiscal Frameworks for ResourceRich Developing Countries“s, IMF Staff Discussion Note 12/04.

References

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  • British Petroleum (2013). Statistical Review of World Energy.

  • IMF (2012), “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries—Background Paper 1—Supplement 1,” IMF Policy Paper, p. 61, (Washington: International Monetary Fund).

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  • IMF (2012) Macroeconomic Policy Frameworks for Resource-Rich Developing Countries,” IMF Policy Paper, (Washington: International Monetary Fund).

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  • J.P. Morgan Asset Management (2013). “Long-term Capital Market Return Assumptions”.

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  • Tabova and Baker (2012). “Non-oil Growth in the CFA Oil-Producing Countries: How Is It different?” In Akitoby and Coorey (Eds.), Oil Wealth in Central Africa: Policy for Inclusive Growth (Washington: International Monetary Fund).

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1

Prepared by S. A.-J. Tapsoba (FAD).

2

IMF (2012). “Macroeconomic Policy Frameworks for Resource Rich Developing Countries,” IMF Policy Paper. Washington, DC: IMF.

1

In the 2012 report, staff estimate that a drop in oil prices of one standard deviation (over 1998–2012) from 2013 onwards would push the current account balance into negative territory, and the FRR reserves as a percentage of GDP would shrink rapidly.

1

See the 2013 British Petroleum Statistical Review of World Energy.

2

In October 2013, an important shale oil field was discovered that could potentially lift Algeria’s oil reserve base by an additional 10 percent which corresponds to two additional years of production (based on the current extraction rhythm). Such an upside scenario does not change the results presented below.

3

OECD (2012), “Looking to 2060: A Global Vision of Long-Term Growth”, OECD Economics Department Policy Notes, No. 15 November 2012.

4

IMF (2012), “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries—Background Paper 1— Supplement 1,” IMF Policy Paper, p. 61, Washington, DC: IMF.

5

See the 2013 edition of J.P. Morgan Asset Management’s long-term Capital Market Return Assumptions.

6

This assumption is conservative and requires a constant cost-to-profit ratio in the hydrocarbon industry as well as streamlined domestic consumption.

7

MCD staff estimates.

8

Based on Tabova and Baker (2012). “Non-oil Growth in the CFA Oil-Producing Countries: How Is It different?” In Akitoby and Coorey (Eds.), Oil Wealth in Central Africa: Policy for Inclusive Growth.

9

IMF (2012). “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries,” IMF Policy Paper.

10

This approach has several variants (e.g., infinite or finite horizon; spending constant in real, per capita, or as share of nonresource GDP; and using the perpetuity or annuity value of the financial wealth of the resource revenue windfall) which can determine the sustainable path for the nonresource primary deficit.

11

These tools can be used either for investment scaling-up or scaling-down scenarios.

12

These approaches could include social spending, which might impact growth as public investment does.

13

For long-term sustainability analysis in resource-rich countries, the nonresource primary balance (NRPB) is a good measure of the macro-fiscal stance. The NRPB identifies the impact of government operations on domestic demand, because resource revenues typically originate abroad.

14

A more stringent PIH benchmark could be derived by using the stabilization funds strategy. The breakdown of such a fund is as follows: 25 percent is invested in fixed-income assets, 4 percent in cash holdings, 56 percent in global equities, and the rest is investment in other types of asset. The aggregated interest rate is estimated at about 5.1 percent. In this case, the NHPD-to-NHGDP benchmark is estimated at 4 percent.

15

The fiscal target could be a higher deficit if investment turns out to be less efficient than postulated here (that is, an elasticity of investment with respect to the real nonhydrocarbon output of 0.19). Testing for lower efficiency does not dramatically change our findings.

16

The numbers in the price rule refer, in order, to the number of years in the past, present, and future used to calculate the expenditure path. Thus, the 5/0/0 price rule uses oil prices for the past five years only to calculate the smoothed resource revenue. A 12/1/3 price rule uses prices for the past 12 years, the current price, and prices forecast for the following three years.

17

Several countries apply a non-PIH rule to anchor fiscal policy (see Appendix III).

18

As capacity develops, a combination of past and future prices in the smoothing rule could be envisaged. With uncertainty surrounding oil prices and limited institutional capacity, high reliance on forward-looking prices may be risky.

19

However, this depends mostly on the circumstances and the legal and administrative traditions of the country.

20

This section draws heavily on IMF (2012). “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries—Analytic Frameworks and Applications,” IMF Policy Paper.

1

The EITI preserves the confidentiality of company payments and contracts.

2

Since the EITI’s launch in 2002, 35 countries have produced EITI reports.

1

Australia, Azerbaijan, Bahrain, Botswana, Canada, Chile, China, Equatorial Guinea, Iran, Ireland, Korea, Kuwait, Libya, Mexico, New Zealand, Norway, Qatar, Russia, Singapore, Timor-Leste, Trinidad and Tobago, United Arab Emirates, and the United States.

Algeria: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.