Designing a Sovereign Wealth Fund for Botswana: Issues and Policy Options1
This chapter discusses the rationale for and design of a new Sovereign Wealth Fund (SWF) in Botswana. It reviews the causes of declining financial reserves and calculates fiscal targets that would be needed to achieve insurance and intergenerational equity objectives. Staff conclude that a SWF could provide a useful institutional framework to support rebuilding buffers, but achieving significant savings to meaningfully fund an SWF would require much tighter fiscal policy than has been observed in recent years (e.g., achieving a 1 percent of GDP fiscal surplus on a persistent basis, versus deficits of almost 4 percent of GDP over the past decade). The institutional framework would need to be reformed by adopting (1) a new fiscal rule (e.g., an expenditure ceiling) that would enshrine the government’s commitment to generate fiscal surpluses in the medium term, and (2) a new SWF, where the savings would be invested and managed. Importantly, international experience shows that proper design is essential to ensure that the new framework supports fiscal discipline and does not undermine FX reserves. For instance, a fiscal rule targeting a fiscal surplus is superior to a rule saving a share of mineral revenues. And a “financing fund” model, where inflows and outflows are directly related to the budget position, is superior to more ad hoc models.
A. Introduction: Current Setup and Authorities’ Reform Plans
1. Established in 1994, Botswana’s Pula Fund, owned and managed by the Bank of Botswana (BoB), aims to save mineral revenues for future generations. FX reserves—above those needed for international transactions—are transferred to the Pula Fund and invested in stocks and bonds. At end-2023, total Pula Fund assets stood at 20 percent of GDP. The Pula Fund is sometimes described as a SWF, but there are critical differences: unlike typical SWFs, the government does not have direct access to these resources and there are no high-level operational rules for deposits and withdrawals. Government has an indirect claim on the SWF through its Government Investment Account (GIA)—a savings account in Pula at the BoB.2 The value of the Pula Fund is driven by the overall balance of payments and returns on investment (including valuation gains). The GIA is primarily driven by the fiscal balance (see Box 1).
2. Over time, the government has implemented several fiscal rules to preserve fiscal discipline and generate public savings out of mining revenues.3 The existing rule is a debt ceiling at 40 percent of GDP, with foreign debt at no more than half of this amount. This rule has not been tested because the government has run a disciplined fiscal policy and could draw down on cash reserves to fill the financing gap when needed. More recently, the impact of the pandemic— and an ambitious planned fiscal expansion for FY2023–2024—is bringing the fiscal account closer to these limits.
3. Despite the Pula Fund and fiscal rules, public financial wealth has declined over the past two decades, prompting the government to consider significant reforms of their resource management framework. FX reserves, which stood at 121 percent of GDP in 2001, had fallen to 24 percent by 2023, while government’s cash balances declined from 43 to 4 percent of GDP between 2008 and 2023. These trends mainly reflect a structural reduction in domestic diamond production and elevated public spending to GDP ratio. To reverse this decline, the authorities are considering the introduction of a fiscal rule that would automatically save a share of mineral revenues in a new SWF.4 The new SWF would be owned by the government, with its own deposit and withdrawal rules. Seed funding may come from transferring a portion of existing central bank FX reserves.
4. To contribute to the policy discussion, this SIP considers international experiences with SWFs. The chapter is organized in line with the analytical steps to be followed in designing a SWF (Figure 1): Section B puts the long-term decline in fiscal and external reserves into historical perspective. Section C outlines expected benefits from introducing a new SWF, while section D estimates the fiscal targets that will be needed to generate sufficient buffers for the ‘insurance’ or ‘intergenerational equity’ objectives. Section E makes the case for a ‘financing fund’ model for Botswana and explains the link between the fiscal rule and the SWF. Section F explains the risks to fiscal and external sustainability from more ad hoc models. Section G concludes with a summary of other institutional design considerations, including governance and investment strategy.
Sequential Steps for Designing a SWF
Citation: IMF Staff Country Reports 2024, 287; 10.5089/9798400288258.002.A001
Source: IMF StaffBotswana’s Pula Fund and the Government Investment Account
The Bank of Botswana’s FX reserves are divided between two main accounts: the Liquidity Portfolio and the Pula Fund. The Liquidity Portfolio is a money market and fixed income fund that provides a buffer for short- and medium-term trade and capital account requirements and is typically less than a fifth the size of the Pula Fund. The Pula Fund is a long-term investment portfolio in foreign assets. Assets in excess of what is needed for reserves adequacy (i.e., the Liquidity Portfolio) are invested long-term in the Pula Fund, with investment decisions made in consultation with the Ministry of Finance. The Pula Fund and Liquidity Portfolio appear on the asset side of the BoB’s balance sheet (see the complete balance sheet in Annex II).
The Government Investment Account (GIA) is one of the two government deposit accounts in Pula at the central bank (on the liability side). The government has a remittance account (like a current account for dayto-day transactions) which receives zero interest, while the GIA receives an estimated long-term SDR rate, plus revaluation gains/losses reflecting the revaluations arising from movements in the market value of the Pula fund assets (including from currency fluctuations). Through the GIA, the government has a notional claim on the Pula Fund, with the government’s share of the capital of the Pula Fund roughly equal to the GIA balance. When the GIA increases, it affects the government’s claim on the Pula Fund, but not the size of the Pula Fund. In general, the Pula Fund and GIA typically move in tandem because diamond exports drive both fiscal and BoP balances, but there is no mechanical relationship.
Financial Flows – Pula Fund & GIA
Citation: IMF Staff Country Reports 2024, 287; 10.5089/9798400288258.002.A001
B. Context: Long-Term Depletion of Fiscal and External Buffers
5. Botswana’s external and fiscal buffers have persistently declined over the past two decades. The fiscal and BoP accounts exhibit similar trends, with revenues (inflows) declining and expenditures (outflows) remaining relatively stable (Figure 2). Botswana is very exposed to the international environment, and tends to draw down on its buffers when hit by global shocks. This was particularly noticeable during the 2008 Global Financial Crisis (GFC), the diamond market downturn in 2014 and the 2020 Covid-19 pandemic.
External and Fiscal Buffers 2000–23
(Percent of GDP)
Citation: IMF Staff Country Reports 2024, 287; 10.5089/9798400288258.002.A001
Note: For the top panel, the denominator of the ratios is the imputed fiscal year GDP. Diamond imports to Botswana began in 2005.Fiscal Buffers
6. Falling fiscal buffers reflect a declining revenue-to-GDP ratio and sustained expenditure. The budget balance has shifted from a surplus of more than 12 percent of GDP in FY2006/07 to deficits averaging 5 percent of GDP over the past five years. Indeed, total revenues have fallen from more than 40 percent of GDP in 2007 to 28 percent of GDP in 2023. Half of this decline reflects falling mineral revenues, but both non-mineral and South African Customs Union (SACU) revenues have also fallen. Government spending, however, has kept pace with GDP, averaging 34 percent of GDP over the past 10 years. The public sector wage bill is high by international standards, at 13 percent of GDP.
7. While debt ratios have been steady, the government has financed these deficits by drawing down its assets. The government’s net financial assets (NFA) have fallen by more than 40 percentage points of GDP, from 32 percent of GDP in FY2008 to minus 16 percent of GDP by FY2023. Government deposits at the BoB—which is a proxy for the GIA5—fell from 40 percent of GDP in FY2008 to 4 percent of GDP in FY2023. The GIA would have declined more rapidly, were it not for returns on the Pula Fund and large exchange rate changes (i.e., accumulated revaluation gains).
External Buffers
8. From 2000 to the present, Botswana’s FX reserves have declined sharply. There have been persistent BoP deficits since 2009. The current account, which had exhibited large surpluses prior to the GFC, moved into deficit, mainly due to a weakening of the trade balance. Reserves have also declined due to net portfolio outflows (averaging 3.7 percent of GDP between 2000 and 2023) and net outflows from the income balance of the current account (averaging 5.8 percent of GDP). Portfolio outflows mostly reflect external investments by pension funds, while negative income balances reflect dividends and reinvested earnings paid to foreign investors (e.g., dividends paid by Debswana to De Beers). Over the past decade, additions to FX reserves have come almost exclusively from SACU transfers and valuation gains.
9. Over time, the trade balance has become a major contributor to the weaker external position. From an average surplus of 13 percent of GDP between 2000 and 2007, the trade balance has typically been in deficit since 2008. The deterioration is mostly due to the decline in the diamond balance, which, itself, reflects falling exports of domestically-sourced diamonds, while net re-exports have remained small and broadly stable.6 Non-diamond exports have also shrunk as a share of GDP, mainly reflecting a decline in textile exports.
C. Main Benefits Expected from a New Sovereign Wealth Fund
10. Accumulating government savings would be particularly beneficial for Botswana:
Financial savings is a powerful way of achieving intergenerational equity. A new SWF could support the authorities’ desire to preserve wealth for future generations and prepare for the depletion of diamonds by reining in spending pressures and ensuring that not all the mineral revenues are spent today. In fact, this was the original intent of the Pula fund, which was created in 1994 to preserve part of the income from diamond exports for future generations.
Intergenerational equity may be better served by creating financial assets, rather than through investment spending, although the two are not mutually exclusive. Botswana has tended to allocate resource revenues primarily to physical and human investment (Jefferis 2016). Like many other resource-rich countries, however, Botswana struggles to spend its mineral revenues efficiently. The 2023 IMF PIMA report noted a large gap in infrastructure spending efficiency between Botswana and the most efficient countries with comparable income levels and public capital stock. Similarly, despite generous public spending, the quality of education and the ability of social protection to reduce inequality remain low (World Bank 2023 and second Selected Issues Paper). This paper focuses mostly on intergenerational transfers achieved though the accumulation of financial assets, but recognizes the importance of finding the right balance between different forms of investment.
Creating buffers against shocks would strengthen the country’s resilience. Botswana is very vulnerable to shocks, given its dependence on one luxury good faced with erratic global demand and an artificial substitute. Thus, a SWF could be very helpful to build up an insurance cushion for the budget, helping smooth out public expenditure when diamond prices fluctuate.
11. Given low public debt in Botswana, government savings should be primarily allocated to building financial assets. Many countries in Africa struggle with elevated debt vulnerabilities and any fiscal surplus should primarily be directed to debt reduction rather than creating a buffer of assets. But Botswana has a much stronger fiscal position and does not need to deleverage.7 Thus, any fiscal surplus should primarily go to a SWF.
12. The reform would also be an opportunity to separate government’s savings across various functions. Both the Pula fund and the GIA are primarily stabilization funds used to respond to cyclical shocks (respectively, for Balance of Payments and the budget). Neither seems to prioritize the accumulation of longer-term savings. In fact, there is no pure saving fund owned by the government.
13. Nonetheless, a SWF cannot, in itself, rebuild buffers. The function of a SWF is to manage balance of payment or fiscal surpluses, not to generate them. A SWF alone does not affect the fundamental causes of the accumulation of buffers (e.g., competitiveness, diamond prices, and fiscal prudence). Rigid accumulation rules can give the (false) impression that the country is building up savings in a fund, but if the government continues to borrow in parallel, this may not have much impact on government net wealth from a balance sheet perspective. In the end, accumulating buffers requires surpluses. We will discuss these issues further in the next sections.
D. Calibrating Botswana’s Medium-Term Fiscal Targets
14. Before discussing SWF design, it is important to consider the level of savings that the government requires to achieve its policy objectives. There are many reasons why a government may want to generate savings and manage them in a SWF. In this section, we calibrate the mediumterm fiscal targets based on two alternative objectives. The “insurance” objective is to build sufficient financial buffers to absorb revenue shortfalls and prevent large cuts to public expenditure when faced with a shock. The “intergenerational equity” objective is to transfer wealth across generations. In the Permanent Income Hypothesis (PIH) framework, this is operationalized by estimating total net wealth (defined as net financial wealth plus resource wealth8) and computing the fiscal balance that would stabilize net wealth going forward—total wealth would remain constant, with growing financial assets offsetting falling resource wealth.
15. This section updates the 2023 Article IV report’s calculation of fiscal targets, considering the specific context of a SWF. Two changes are made to tailor the calibration to the proposed SWF reform. First, given that the aim is to accumulate savings, the net debt stabilization scenario is not considered. Second, we assume that asset returns differ from the interest rate on debt (these were equal in the 2023 Article IV report calculations). This seems a more reasonable assumption in the context of a SWF, where savings tend to be invested in a wide range of assets to achieve higher yield.
16. The main conclusion of this exercise, summarized in Box 2, is that the authorities will need to generate fiscal surpluses in the medium term. The calibration of the fiscal targets varies significantly depending on the policy objective and the interest-growth differential. Achieving the insurance objective would require a surplus of 1 percent of GDP. The intergenerational equity objective is much more demanding, requiring a surplus of 2–4 percent of GDP to stabilize wealth in real terms, and even larger to stabilize wealth in percent of GDP. Although achieving a fiscal surplus is in line with the authorities’ medium-term budget plans, this represents a significant tightening in the fiscal position relative to the past. Over the past five years (FY2020-FY2024), the fiscal deficit averaged 4.6 percent of GDP. In the five years before the pandemic (FY2015-FY2019), the deficit averaged 3.8 percent of GDP.
Estimating Fiscal Balance Benchmarks to Build Up a SWF
Assumptions:
Gross debt is 20 percent of GDP and assets represent 5 percent of GDP, with net debt equal to 15 percent of GDP at end FY2023. Gross interest bill is 1 percent of GDP. Mineral revenues are estimated at 10 percent of GDP. We assume that the debt ratio is constant in the future.
Nominal GDP growth is 8.5 percent (equal to 4 percent real growth plus 4.5 percent midpoint inflation target). The ratio of non-resource GDP to total GDP is assumed to be 80 percent.
A 5 percent effective interest rate on debt (1 percent of GDP of interest bill divided by 20 percent of GDP gross debt ratio) is a used as proxy for average debt costs.
The return on financial assets depends on the investment strategy of the SWF. Under a “risky strategy,” we assume for illustrative purposes that all investments are in rand (as an example of higher-risk and higher-return investment), with a return of long-term bonds of 10 percent, and no currency depreciation (since central bank inflation targets are identical in Botswana and South Africa); thus, the return in pula terms is 10 percent. Under a “prudent strategy”, we assume that half of the investment is in South Africa and half in US/euro. For US/euro, we assume a neutral real rate of 1.5 percent plus inflation target of 2 percent plus a depreciation against the pula of 2.5 percent (reflecting the gap between the inflation targets of the central banks), meaning a 6 percent nominal return in pula. Under the prudent strategy, the weighted average South Arica-US/euro is therefore a return of 8 percent in pula terms.
Option 1. Maintaining an overall surplus of about 1 percent of GDP over the medium term would be sufficient to create a credible insurance buffer against shocks. The 2022 IMF TA report on “Strengthening the Fiscal Rule Framework” estimates that a buffer of 20 percent of non-resource GDP (equivalent to 16 percent of GDP) would be sufficient to protect the budget against major economic shocks over a full National Development Plan. To achieve this objective over 10 years, the authorities should maintain, on average, a fiscal surplus of 1.1 percent of GDP, which would improve the net debt ratio by 16 percent of GDP.1
Option 2. Transferring wealth to future generations requires much higher fiscal surpluses. The 2022 TA report estimates resource wealth at 225 percent of non-mining GDP at end-FY2021 (equivalent to 180 percent of GDP) using an 8 percent discount rate. Combined with net debt of 15 percent of GDP, this yields a total wealth estimate of 165 percent of GDP. The Permanent Income Hypothesis (PIH) model’s formulas can be used to estimate the fiscal balance needed to stabilize total wealth either in real terms or in percent of GDP. Results are very sensitive to the underlying assumptions and the policy objective:
Stabilizing wealth in percent of GDP in future years is the most demanding option, and probably an unrealistic policy objective (requiring very tight fiscal policy, possibly to the detriment of development spending—a traditional criticism against models based on the PIH, see Eyraud and others 2023). Under the prudent strategy, iA = 8% and iD = 5%, stabilizing the wealth ratio would require a non-resource primary balance (very similar to the Norway model, assuming no return on the fund transferred to the budget since the fund is very small).Using today’s interest bill and resource revenue ratios (1 percent of GDP and 10 percent of GDP), this would correspond to a fiscal surplus of 9 percent of GDP. Under the risky strategy, iA = 10% and iD = 5%, resource wealth is now discounted at 10 percent and revised down to 190 percent of non-resource GDP, or 150 percent of GDP. Combined with financial wealth, this gives 155 percent of GDP for total net wealth, which, to be stabilized, requires a non-resource primary deficit of 3 percent of GDP. At today’s interest bill and resource revenue ratios, this would correspond to a fiscal surplus of 6 percent of GDP.
Stabilizing wealth in real terms (rather than in percent of GDP) requires less fiscal effort (although still significant). This scenario relies on the excel template of the TA report. Using a discount rate of 8 percent9, the TA report shows that, although the non-resource primary deficit is constant in real terms, its GDP ratio would improve over time and remain around 7–9 percent of non-resource GDP in the medium term. In terms of overall balance, the target would translate into a fiscal surplus of 2–4 percent of GDP in the medium term.
17. The fiscal surplus target could be supported by a fiscal rule. Fiscal rules can be used to enshrine the authorities’ commitment to fiscal prudence, although their ability to constrain fiscal policy should not be overstated. This paper does not discuss the pros and cons of various rules, and there are many possibilities. A 1 percent of GDP surplus target, for example, could be achieved using an expenditure rule, a structural balance rule, or a non-resource balance rule (assuming that mineral revenues are around 10 percent of GDP, even targeting a non-resource deficit would be sufficient to generate an overall surplus). All these rules have countercyclical properties because they allow the nominal balance to fluctuate around the 1 percent surplus target over time. The key is to have a stable expenditure path.
18. The fiscal surplus target should be re-estimated periodically. As shown in Box 2, the calibration exercise is very sensitive to the assumptions and policy objectives. Best practice is to recalibrate fiscal rules every 3–5 years, accounting for changes in the economic environment, including export prices, external demand, and the frequency of severe shocks. For instance, a fiscal target could be enshrined in a fiscal rule for the duration of the next NDP.
E. Proposing a “Financing Fund” for Botswana
19. When designing a SWF, the first step is to establish a policy and legal framework for transferring monies into and out of the fund. While the current Pula Fund has a legal basis in the Bank of Botswana Act, it is not legally separated from the foreign exchange reserves, and there are no legal provisions requiring monies to be paid into the Fund, nor legal restrictions on drawdowns from it. An Act of Parliament (either a new one, or an amendment to the BoB Act) may be needed to set out the rules for inflows and outflows. There are multiple ways of designing them: one is the financing fund approach (described in the section below); other ad hoc models are discussed in section F.
20. Staff propose a type of design for inflows and outflows, described in the literature as a “financing fund” model (see, for instance, Villafuerte 2015, Ossowski 2016, and Delechat and others 2017). This model, followed in Chile and Norway, is generally considered best practice (see Annex I). In this design, the SWF is the mirror image of the budget and is usually accompanied by a fiscal rule constraining directly or indirectly the budget expenditure envelope.
Funding and Withdrawal Mechanisms under a “Financing Fund”
21. Under the “financing fund” model, the inflows and outflows are dictated by the budget position rather than by ad hoc transfer rules. The SWF is fully integrated into the budget, and, in its purest design, is simply the mirror image of the budget: the fund receives any budget surplus, and any budget deficit is financed by withdrawing from the SWF.9 For instance, a 10 pula fiscal surplus in the budget, would lead to 10 pula of inflows to the SWF; conversely, a 10 pula deficit would require 10 pula of outflows from the fund. There is no ad hoc funding/withdrawal rule that is disconnected from the budget position (as in other models described in Section F).
22. In practice, there is not always an exact identity between net inflows to the financing fund and the fiscal balance. For instance, fiscal surpluses could sometimes be used to reduce government debt, especially when a country faces high borrowing costs. Even when running a budget deficit, a government may choose to continue funding the SWF, provided that the deficit could be cheaply financed (e.g., through long-term, multilateral project financing) or because the country issues large amounts of debt to build a yield curve and develop their domestic financial markets. For all these reasons, the fiscal balance is not always equal to the change in financial assets at the SWF.
Link to the New Fiscal Rule
23. To be effective, a financing fund must be accompanied by a fiscal rule applying to the budget. Without a binding budget rule and a clear political commitment to fiscal prudence, it is unlikely that the budget will generate sufficient savings to fund the SWF. And if there is no fiscal surplus, there will be no transfer to the SWF, at least under the financing fund model.10 A budget’s fiscal rule is therefore essential to constrain the government to accumulate savings (and, in the case of stabilization funds, allow dissaving in bad times).
24. Except in the case of a stabilization fund, the fiscal rule should generate persistent fiscal surpluses to build up assets in the SWF. For instance, Chile used to target a structural fiscal surplus of 1 percent of GDP in the 2000s. A non-oil balance rule like Norway would also typically generate a surplus for the overall balance, since oil revenues (excluded from the rule) tend to be large in oil producers. By comparison, a stabilization fund does not require a structural budget surplus; in this case, the fiscal rule could achieve a nominal surplus in good times, offset by nominal deficit in bad times (with a balanced budget on average).
25. In a setup with multiple funds, an additional rule is needed to allocate the budget savings across funds depending on their function. A single SWF can play multiple roles simultaneously: both stabilization and longer-term saving (like in the Norwegian model). But a country may prefer to separate these functions across various funds (e.g., Chilean model). In this case, an additional rule should dictate the split of the budget surplus between them, as discussed in Annex I. In general, the saving fund would be served first, up to a threshold (cap or target), and the residual would go to the stabilization fund, which would then fluctuate over the cycle.
26. If the authorities wish to achieve very high savings through a tight fiscal rule, it is possible that there is no need for withdrawals, except in exceptional circumstances allowed under an escape clause. To illustrate this point, let’s assume that the authorities wish to pursue a structural fiscal surplus of 1 percent of GDP like in the original version of the Chilean rule. Assuming an expenditure ratio of 30 percent of GDP, and an output gap oscillating between -4 to 4 percent, the (nominal) overall balance would likely fluctuate in the range of 0–2 percent of GDP. Thus, during a normal business cycle, the budget would remain balanced at a minimum, and there would not be any financing need (unless some debt needs to be repaid from the SWF, which is an unlikely scenario in Botswana). During more severe downturns, a deficit may, of course, materialize under the rule, but the advice would be that the government resorts to debt to finance it, rather than by drawing from the SWF—given the low level of debt in Botswana. Only in exceptional circumstances (very large or persistent drop in diamond prices) would withdrawals from the fund be allowed, possibly under well-defined escape clauses.
One or Several Funds?
27. Given that the funding and withdrawal flows mirror the budget position, a financing fund can achieve both stabilization and long-term saving objectives simultaneously (as in Norway, for instance). As long as the fiscal rule has counter-cyclical properties, meaning that it allows the expenditure envelope to be stable across the business cycle, the SWF would stabilize the budget, even if its main function is to accumulate savings for future generations.
28. Allocating savings across two separate funds is also possible. In the above proposal, the budget surpluses are transferred to a single fund and any deficit is financed from the fund (and possibly debt). There would be nothing left going to the GIA. An alternative setup is to separate the policy objectives across two SWFs—e.g., one for long-term saving (new SWF) and the other one for stabilization (GIA), like in Chile. To do so, it is necessary to fix or cap the value of transfers going to the new SWF, with any residual savings going to the GIA. The ceiling/target should be calibrated to ensure that the new SWF can achieve its long-term intergenerational saving objective. Following the Chilean example: transfers to the saving fund are capped at 0.5 percent of GDP, whereas the structural surplus target is 1 percent of GDP. This means that, on average over the cycle, the stabilization fund receives 0.5 percent of GDP (when the output gap is closed, the budget records a nominal surplus of 0.5 percent of GDP, pays 0.5 percent of GDP to the saving fund, leaving 0.5 percent of GDP to the stabilization fund). All this would need to be simulated, depending on the specific calibration of the rules.
F. Risks Associated with More Ad Hoc Inflow-Outflow Models
29. Although “financing funds,” as described in the previous section, seem preferable and have been successfully implemented in several countries, many governments opt for more ad hoc models. In these ad hoc models, the SWF operational rules (for accumulation and withdrawal) are set independently from the budget position, and there is often no fiscal rule applying to the budget. “The SWF is conceived as an independent instrument of fiscal policy rather than simply as a medium to manage part of the government’s net worth” (Shields and Villafuerte 2010). Transfers from and to the SWF are achieved through rigid and often arbitrary operational rules, such as:
Funding rules: Deposit rules can be price- or revenue-contingent. For instance, many oil stabilization funds specify a threshold price for oil revenue (e.g., $80 per barrel), with any excess (shortfall) above (below) the threshold being transferred to (from) the fund. Revenueshare rules are formulated as a predetermined share of revenue going to the fund (e.g., 10 percent of oil revenue).
Withdrawal rules: Similarly, withdrawals can be dictated by ad hoc rules with strict conditions that are disconnected from the budget position—for instance, price or revenue contingent rules.
30. A first problem with ad hoc operational rules is that they do not tend to discipline the budget. The introduction of SWFs with ad hoc rules is often motivated by the expectation that removing “high” commodity revenues from the budget would help moderate or stabilize expenditure and reduce policy discretion. In practice, the opposite tends to happen, because ad hoc rules do not directly constrain government spending or borrowing. Limiting the ability of the government to use its deposits, through seemingly tight withdrawal rules, is not an effective disciplining device if the government is allowed to borrow without restriction as a substitute. In fact, this may eventually contribute to deteriorating the fiscal position, since borrowing is generally more expensive than depleting deposits (i.e., the forgone return on assets is lower than the interest paid on debt).
31. As a result, a situation of “leveraged deposits” may emerge, reflecting poor assetliability management. Since the SWF can receive funds even when the budget is in deficit, the deposits accumulated in the SWF can be generated from government borrowing. This is a common problem in many resource-rich countries:11
This tends to generate large budgetary costs, since government borrowing is generally more expensive than the SWF asset returns. For example, in the early 2010s, inflows into Ghana’s petroleum-based SWF (the Ghana Stabilization Fund) increased substantially due to high oil prices. At the same time, however, the government ran large deficits, resulting in a rising debt-to-GDP ratio. Between 2014 and 2018, withdrawals from the GSF were mainly used for debt repayments, rather than the primary object of sustaining public expenditure capacity during periods of unanticipated petroleum revenue shortfalls (Gyeyir 2019).
This is a risky strategy (Villafuerte 2015). Since access to financing is procyclical for commodity producers, debt rollover becomes very costly or even impossible in bad times (reflecting partial of full loss of market access). Then, either the SWF assets are sold (possibly at discount if they must be liquidated quickly) to offset sharp fiscal revenue drops and are not available anymore to offset rising borrowing costs; or the SWF assets are sold to cover debt costs and are not available to support spending in bad times. This illustrates the fundamental problem that borrowed deposits are not “true” savings, since there is no accumulation of financial assets in net terms.
Transparency problems may also arise, since the SWF wealth does not represent the outcome of fiscal policy and the overall wealth of the government (e.g., when the SWF is accumulating assets, but the central government has large debt).
32. Another problem is that poorly calibrated rules may be too ambitious and lead to systematic underfunding of the budget, which would undermine the credibility of the SWF. If funding/withdrawal rules are inconsistent with the budget (for instance, by creating funding shortages, cash management problems, or additional budget costs), then they are likely to be bypassed. The SWF itself could eventually be closed, as illustrated by numerous country examples (see Ossowski and others 2008). In the context of Botswana, a funding rule transferring 40 percent of mineral revenues to the SWF every year, as initially considered by the authorities, would represent 4–5 percent of GDP of forgone revenues for the budget, which seems too high. By comparison, our previous analysis finds that targeting a surplus of 1 percent of GDP—meaning transferring 1 percent of GDP every year to the SWF—would be sufficient to create an adequate safety buffer against shocks.
33. Finally, ad hoc rules could reduce the central bank’s FX reserves and threaten the sustainability of the exchange rate regime. While a SWF is sometimes presented as a way of ringfencing reserves, some rigid designs may achieve the exact opposite and contribute to depleting reserves. This is because ad hoc rules allocate a share of FX to the government (rather than to the central bank), but do not force the government to generate savings in the budget. Therefore, the central bank’s reserves’ accumulation is reduced by the annual transfers to the fund; but there is no offsetting factor reducing the drain on reserves (e.g., lower government imports or lower external debt service) since the budget position does not improve. Box 3 discusses this issue.
Impact of the SWF on FX Reserves
While a new SWF should strengthen the government’s financial position, it may paradoxically lead to a decline in FX reserves. If government deposits (in pula) are initially transferred to the SWF and then converted into forex to be invested abroad, this will reduce the level of FX reserves available for the central bank to support the peg. Indeed, government’s foreign assets in a SWF are not treated as central bank reserves by international statistics standards, which only consider as reserves the assets meeting the following criteria: (a) invested in external assets in foreign financial markets and in high-quality financial instruments traded in highly liquid and deep global markets; (b) controlled by monetary authority (in the books of the central bank); and (c) can be used toward balance-of-payments purposes (IMF 2009).
Not only the level but also the pace of reserve accumulation could be affected. If some reserves are initially re-allocated to the new SWF when it is created, there will be a one-off downward shift in the level of reserves of the BoB. But the new setup may also affect future reserve growth. This is because FX inflows come mostly from the public sector in Botswana—SACU and mineral revenues. Thus, if these FX are partly retained by the government rather than remitted to the central bank, this could entail a much slower pace of reserve accumulation. Given that reserves have already declined sharply in the past decade, this may be problematic for the sustainability of the exchange rate regime.1
This effect could be mitigated if the government exerts greater fiscal prudence, supported by a fiscal rule. Indeed, a higher fiscal balance would translate into lower public imports and lower external debt service, hence less pressures on reserves.
The impact on reserves will ultimately depend on the design of the SWF operational rules and the existence of a fiscal rule applying to the budget. Although detailed simulations would be necessary to estimate the precise impact of a particular design proposal, simple examples illustrate the critical effect of the fiscal framework on FX reserve dynamics. To simplify, we assume that the SWF’s assets are entirely invested abroad, so that any transfer to the SWF (owned by the government) entails a loss of reserves for the central bank, all else being equal.
Scenario 1—"ad hoc model” with 40% funding rule and no fiscal rule. Every year, the government transfers 40 percent of mineral revenues to the Fund, which translates into 5 percent of GDP of forgone reserves for the central bank. Assuming that the government is not subject to a fiscal rule and does not change the fiscal deficit path, it continues to tap reserves at the same pace (for imports and debt service). Given that FX reserves account today for about 25 percent of GDP, this could be an unsustainable reform from the perspective of the sustainability of the peg.
Scenario 2—"financing fund model” with 1 percent of GDP fiscal surplus rule. The government transfers to the fund 1 percent of GDP every year, which reduces the central bank’s reserves by the same amount, all else equal. On the other hand, the budget’s position would now be much stronger, with an improvement of 5 percent of GDP compared to the average deficit ratio of 4 percent of GDP observed over the past decade. Assuming an import content of 50 percent, this means that the import drain on reserves would be reduced by 2.5 percent of GDP every year (without even considering the possible reduction in external debt service). Thus, the net effect on reserves would be positive for the central bank.
G. Other Design Considerations
34. Beyond the financing mechanisms discussed in the previous sections, there are other important design features that should be considered for the SWF. These relate to the institutional setup, investment management, governance safeguards, and the impact of the SWF on budget procedures—all key elements of the legal framework for the SWF (see also IWG 2008; Hammer and others 2008; Das and others 2009).
Institutional Setup
35. The structure and ownership of the SWF will have to be carefully considered. One option would be to create an arrangement like the existing GIA. The BoB could host the SWF, but with government having ultimate ownership of the fund (similar to Norway’s SWF). In this instance, the fund would be a pool of assets, rather than having its own legal personality. Assets would be managed by the BoB, given its accumulated expertise and institutional relationships in the field of asset management. Hosting the SWF at the BoB would also limit administrative costs.
36. Another option would be to have a legally independent SWF, either as a statutory or corporate entity. A legally separate SWF owned by government and with its own investment management structure is the model followed by the main Singapore SWF (the Government Investment Corporation, or GIC, which is an SOE). Another example is the Nigeria Sovereign Investment Authority, which manages three different funds and is not subject to any company law. A distinct variation model is also possible, such as that recently proposed by Namibia for its new SWF to assist in the management of projected oil revenues. The Namibian SWF will be an independent statutory entity but managed by the Bank of Namibia.
37. Regarding the process of creating the SWF, it is advisable to start early given that establishing the institutional and financing infrastructure will take time. The authorities could consider ‘starting small’ and taking initial steps to set up the fund. This would entail selecting an overall design, establishing inflow/outflow rules, defining legal and institutional requirements, identifying a team, and setting aside a small amount of seed funding. This would help quick start the SWF activities on a small scale to test the functioning of the fund. It would then be ready to be scaled up when the budget generates persistent fiscal surpluses. The initial seed capital should not substitute for regular transfers from the budget and the SWF should only become fully operational after significant fiscal effort has been made to return to fiscal surpluses from the current deficit position.
SWF Investment Strategy
38. The new SWF will require clear and transparent investment policy and guidelines in the legal framework. These guidelines determine the parameters against which the activities of external managers of funds are monitored. Investment policies, and associated risk management, depend on the economic objectives established for a SWF. For instance, short-term stabilization implies a focus on liquid and low-risk investments that can be sold relatively quickly, whereas intertemporal equity calls for longer-term assets and more risk-taking, which requires expertise to properly oversee transactions and protect the SWF integrity.
39. Proper risk management calls for diversification of assets. SWFs may hold assets with negative correlation of the country’s major exports (e.g., diamonds) or offset the price risk of future imports. SWFs without identified liabilities allow for a more exclusive focus on a return objective and acceptable level of risk (IMF 2007).12
40. Domestic investments are generally ruled out by SWFs, which tend to focus on external financial investments. Investing domestically can run counter to the objective of isolating the whole economy from the volatility and uncertainty of those revenue sources. Furthermore, large domestic investments (e.g., loans or equity participations in companies) by SWFs could be seen as hidden quasi-fiscal or extrabudgetary operations that should instead take place within the budget (if these operations are not conducted on a commercial basis); or could overlap with the remit of developments banks (in the case of promotion of commercial domestic investments) (Ossowski 2016, Villafuerte 2016). In the case of Botswana, institutions, such as Botswana Development Corporation, are better suited to undertake domestic projects. Finally, domestic investments have important macroeconomic implications. To invest domestically, SWFs would typically need to convert part of their accumulated assets back into domestic currency, which creates pressures on the domestic currency. Investing domestically could also stimulate domestic demand with inflationary consequences.
Governance: Transparency, Independence, and Accountability
41. A good internal governance structure is essential to ensure that resource revenues are managed in a sound and transparent manner. Some of the safeguards include:
The legal basis and institutional set-up and structure of a SWF should be based on clear roles and responsibilities for the owner of the resources (the government) and the fund managers to enhance its legitimacy, performance, and accountability.
SWF managers should have the capacity to administer its financial assets at arm’s length from the government on the basis of strategic asset allocations and accountability principles provided by the government.
Proper oversight and transparent operations are essential in setting SWFs. This includes oversight carried by several agencies and operational units (internal auditors, private independent auditing firms, external custodians), production and publication of annual reports and accompanying financial statements on the SWF operations and performance as well as of annual audits in line with international standards or equivalent national auditing standards.
Risk to Public Financial Management (PFM)
42. International experiences show that SWFs should respect the integrity of the budget process. Good PFM requires that the budget process constitutes the central mechanism to allocate resources. This has important implications for SWFs – in particular, they should not have authority to spend, and their outflows should go through the budget. Furthermore, designs where the SWF is set up as an extrabudgetary entity should be avoided.
43. The lack of integration between the SWF operations and the budget process tends to create a range of expenditure management problems (Ossowski and others 2008):
Spending pressures in the budget lead to liquidity problems that can translate into government arrears (if the government loses part of the revenues going to the SWF and is short on cash).
When the SWF is allowed to do extra budgetary spending (that is, the SWF has legal authority to spend) or SWF outflows are earmarked for specific purposes, this leads to a fragmentation of policymaking, which results in a loss of control over expenditure and reduces the efficiency of resource allocation (e.g., duplication of budget activities, spending pressures re-channeled to the SWF etc.). This fragmentation undermines the budget process as the main vehicle to allocate resources.
Allowing SWFs to pursue domestic investment makes them the target for rent-seeking capture, a latent risk in many resource-rich countries.
Scarce resources are diverted away from developing national PFM systems—a common problem associated with the “islands of excellence” argument.13
Annex I. Consistency of the SWF and the Budget in the Chilean and Norwegian Frameworks
Norway’s Fiscal Rule
1. Under the fiscal rule, the annual nominal expenditure envelope is capped by the sum of non-resource revenues (cyclically adjusted) plus the return coming from the SWF. In more technical terms, the fiscal rule states that the non-oil structural deficit of the central government should not exceed the expected real return of the SWF—the Government Pension Fund (GPF). Initially estimated at 4 percent, the long-run rate of return on GPF assets was lowered to 3 percent in 2017.
2. By isolating spending from volatile commodity revenues, a non-resource budget balance rule has stabilizing properties similar to those of a structural balance rule (even in the absence of any cyclical correction for non-resource revenues). For instance, if the non-resource deficit NRD = α (where α is the deficit target), then the overall deficit is D = NRD – RR (where RR = resource revenues) = α – RR. This means that when RR < α, the budget can record a deficit in compliance with the rule. When RR > α, compliance with the rule results in an overall surplus. In practice, given the size of oil revenues, the overall balance has recorded a surplus in most years, but the size of the surplus varies greatly over the cycle.
Norway’s SWF
3. In Norway, the GPF receives every year the full amount of oil revenues (transferred from the budget) and the GPF transfers an amount covering the budget’s non-oil deficit. In other words, the funding rule of the GPF is simply to transfer annual oil revenues. And the withdrawal rule is automatic, consisting in financing the non-oil deficit of the budget, which is, by virtue of the fiscal rule, capped at 3 percent of the GPF assets. Sometimes, the setup is described (improperly) as the GPF sending its returns to the budget, which is not the case (the returns are kept in the GPF); the GPF covers the budget non-oil deficit, which happens to be constrained by the fiscal rule.
4. Although the design may look different at first glance, the GFP functions like a “financing fund.” The overall budget balance = oil revenues + NOB = oil revenues – r.SWF, since NOD = r.SWF under the rule. Thus, the mechanism described in the previous paragraph is equivalent to a standard “financing fund” model, where the fiscal rule generates a budget overall surplus (amounting to oil revenues net of SWF returns), which is sent to the SWF. Sending oil revenues net of returns is equivalent to sending the oil revenues and receiving the financing of the non-oil deficit, which corresponds to the return.
5. An additional complexity comes from the fact that the rule is expressed in structural terms. Using the same equation as above, overall balance = oil revenues + NOB, with NOB = - NOD = - NOSD + (nonoil revenues – structural nonoil revenues) and NOSD = r.SWF. Thus, what is transferred to the fund in net terms is the sum of three components: NOB = oil revenues – r.SWF + (actual nonoil revenues – structural nonoil revenues). The third component can be interpreted as follows: if there is a nonoil revenue cyclical shortfall, the budget would receive a compensation from the fund, whereas if there is a nonoil revenue windfall, it would go to the fund (but on average, over the cycle, these symmetric transfers cancel out, and the last component is zero).
6. The fact that the government transfers all oil revenues to the fund may not be reproducible in other countries. This is possible in Norway because the government has large non-oil revenues (in fact, larger than oil revenues) and the budget also receives the returns of the GPF (with assets above 300 percent of GDP in 2023). Thus, removing all oil revenues from the budget does not lead to severe resource shortfalls. For instance, the loose fiscal stance in 2020–21 was consistent with the fiscal rule.
7. The GPF only finances the non-oil deficit; it does not finance the amortization of debt. Given that debt in Norway is relatively small by international standards and can easily be rolled over, the GPF’s withdrawal rules do not provide for possible debt redemptions. Thus, the accounting identity between overall budget balance and net accumulation of assets in the GPF still holds.
Chile’s Fiscal Rule
8. The Chilean fiscal rule sets a limit on the structural budget balance, with an independent body providing key inputs. Government expenditures are budgeted ex ante in line with structural revenues, i.e., revenues that would be achieved if: (i) the economy were operating at full potential; and (ii) the prices of copper and molybdenum were at their long-term levels.
9. The fiscal surplus target has been revised over time. The target is set by the incoming administration at a level consistent with its objective of fiscal sustainability (Fuentes and others 2021). From 2001-07, the constant target for the structural balance was a 1 percent of GDP surplus. In 2008-09, a new constant target was specified (surplus of 0.5 percent of GDP). The downward drift of the CAB target continued in 2010 and 2011. From 2011 to 2019, the CAB target has remained in the range between -1.0 and -1.8 percent of GDP.
Chile’s SWFs
10. Chile maintains two separate SWFs: a stabilization fund to insulate the budget from volatile commodity prices (ESSF) and a saving fund to accumulate resources over a longer time horizon (PRF). Any fiscal surpluses generated by the fiscal rule are transferred first to the PRF (with a minimum of 0.2 percent of GDP per year but could go up to 0.5 percent of GDP if there are large fiscal surpluses), then the residual surplus (if any) goes to the stabilization fund.
11. In contrast with the Norwegian model, withdrawals from the ESSF are not automatic and decided annually by the minister of finance. This allows the authorities to have a more flexible approach that incorporates some asset-liability management considerations. For instance, the ESSF can be used to finance fiscal deficits (or part of them) but can also be used to repay debt. This is a desirable feature: if debt is considered too expensive, it is possible to repay it by selling some assets of the SWF. In this case, the ESSF could potentially cover up to the gross financing needs (rather than just the deficit, as in the vanilla financing fund model). In other cases, the minister may decide that the ESSF will not be used to cover the deficit in a particular year (in which case, the deficit would be financed solely through additional borrowing).
12. If the fiscal surplus target is sufficiently high, there may be no need to withdraw from the stabilization SWF, even during a downturn. A few simple examples illustrate this point:
Let’s start with a 1 percent of GDP surplus target, which was the target set over 2001–07. Then, during the business cycle, the nominal balance oscillates around this structural surplus target of 1 percent of GDP. The balance would fluctuate between 0 and 2 percent of GDP assuming an expenditure ratio of 25 percent of GDP and an OG between -4 percent and +4 percent (as estimated by Medina and Magud 2011).1 This means that, under the 1 percent surplus rule, the budget is unlikely to require transfers from the ESSF. Indeed, even in severe downturns, the fiscal balance is likely to record a small surplus; thus, even after transferring the minimum amount of 0.2 percent of GDP to the PRF, the budget is unlikely to be in deficit.2 In other words, in bad times, the budget would simply reduce its transfers to the two funds, but these transfers would not turn negative. This is a feature of countries targeting a significant surplus (rather than a balance): on average, they tend to always send money to the SWF, reducing them in bad times and raising them in good times. This still achieve stabilization, although not by withdrawing from the fund.
If the structural target is smaller (like in the revised version of the Chilean rule: 0.5 percent of GDP in 2008-09), then the nominal balance would oscillate between -0.5 percent and +1.5 percent of GDP, under the same assumptions. Given the mandatory transfer to the PRF, the budget would draw 0.7% of GDP from the ESSF at the trough of the business cycle, and it would transfer 1 percent of GDP at its peak (given that the transfer to PRF is capped at 0.5 percent of GDP). This means that, over the cycle, the budget transfers to the ESSF a maximum of 1 percent of GDP, which declines gradually when the economy slows down until becoming a withdrawal of 0.7 percent of GDP; when the output gap is closed, the nominal balance is 0.5 percent of GDP and there is no transfer/withdrawal to the ESSF.
Annex II. Bank of Botswana’s Balance Sheet
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References
Das, U., Y. Lu, C. Mulder, and A. Sy. 2009. “Setting Up a Sovereign Wealth Fund: Some Policy and Operational Considerations,” IMF Working Paper WP/09/179.
Delechat, C., M. Villafuerte, S. Yang. 2017. “SWFs in the Context of Macro-fiscal Frameworks for Resource-rich Developing Countries”, Chapter 9, The New Frontiers of Sovereign Investment.
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Medina, L. and N. Magud. 2011. “The Chilean Output Gap,” IMF Working Paper WP/11/2.
Ossowski, R., H. Halland. 2016. “Resource Funds”, Chapter 8, Fiscal Management in Resource Rich Countries. World Bank Group.
Ossowski, R., M. Villafuerte, P. Medas, and T. Thomas. 2008. “Managing the Oil Revenue Boom: The Role of Fiscal Institutions,” IMF Occasional Paper 260.
Shields, J. and M. Villafuerte. 2010. “SWFs and Economic Policy at Home”, Chapter 4, Economics of Sovereign Wealth Funds: Issues for Policymakers.
Villafuerte, M. 2015. “Fiscal Policy Management and Sovereign Wealth Funds.” In Sovereign Funds: Fiscal Framework, Governance, and Investment, edited by Ana Maria Jul and Donghyun Park. London: Central Banking Publications.
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Prepared by Ian Stuart and Luc Eyraud (both AFR). The authors want to thank Bidisha Das, Rolando Ossowski, Andrea Richter Hume, Peter Dohlman, Lusine Lusinyan, Malika Pant, Emmanuel Ramathuba, Mauricio Villafuerte, Bedri Zymeri, Deputy Governor Kealeboga Masalila, Director Innocent Molalapata, and the participants of the workshop at the Bank of Botswana for their very helpful comments.
Although the government is the ultimate owner of the Pula Fund as shareholder of the BoB, it does not own the Fund in an economic sense (e.g., right to manage or dispose of assets to finance the deficit).
Botswana’s rules have typically been non-binding political commitments. In the mid–1990s, the government aimed to keep the ratio of recurrent spending (excluding development spending) to non-diamond revenue below 1. Adhering to this rule would leave diamond revenue to finance the accumulation of financial assets and development spending. Another indicative target was on the composition of spending: development spending ought to make up at least 30 percent of total spending. In 2003, the government set as an indicative target a non-negative fiscal balance. In 2005, a formal cap on debt (to be kept below 40 percent of GDP) was introduced.
The National Development Plan 11 (2017) outlined a rule requiring the government to save 40 percent of mineral revenues in financial assets for future generations.
At end-2023, government deposits held at the BoB amounted to P10bn, while the GIA held P8bn. This difference mainly reflects the resources set aside for development funds and day-to-day government operations.
Botswana is a global diamond hub. In addition to its own domestic production, the country imports diamonds for sales events, known as “sights,” in which buyers from all around the world come to see the new diamond batches. Diamonds are later re-exported. In Figure 2, net re-exports are computed as diamond re-exports minus imports.
In fact, there may be a case for issuing more debt in Botswana for the purpose of financial sector development.
Resource wealth is the net present value of future resource revenues until full depletion of resources.
This statement assumes that there is no change in net financial liabilities (in percent of GDP). Then, overall balance = change in net financial assets – change in net financial liabilities = change in net financial assets. The underlying assumption is that debt is rolled over to maintain the debt ratio constant. The next paragraph explains how this model can be tailored to more complicated cases.
As discussed below, there are alternative (“ad hoc”) models for SWF inflows and outflows. Under such models, recurrent budget deficits may lead to a situation where the SWF is funded from borrowing, but this is not optimal from an asset-liability perspective. See section F.
In general, the IMF has cautioned against borrowing to accumulate deposits both for cost and risk management reasons. That said, in Botswana, there is perhaps a stronger case for accumulating both debt and financial assets, since debt costs are relatively moderate (an effective interest of around 4.5 percent at the time of writing this paper) and rollover risks are limited (no Eurobond).
For instance, pension funds, which are sometimes treated as a type of SWF, have identified pension liabilities.
When PFM systems are perceived to be weak in some countries, it is sometimes argued that the creation of a SWF with separate procedures and controls might yield better results than the budget (e.g., enhanced selection, evaluation, and procurement for investment projects). There is little tangible evidence, however, to support the creation of such “islands of excellence” (Ossowski 2016). Moreover, this can negatively impact the development of national PFM systems, as scarce resources may be diverted to the fund’s management and there also might be less scrutiny of core budget systems as the focus shifts to a single large resource.
Indeed, SB ≈ OB – α.OG with α being the expenditure ratio.
The budget does not draw from a fund when it records a balance or surplus.
