Oil Revenues and Fiscal Policy World Bank

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					             Oil Revenues and Fiscal Policy
                             Philip Daniel
                      Fiscal Affairs Department
                     International Monetary Fund

         The PRMPS/COCPO Training Workshop
                  The World Bank
                     May 2007
   The views in this presentation are those of the authors and should not be attributed to
    the International Monetary Fund, its Executive Board, or its management.
Oil Revenues and Fiscal Policy

   Challenges posed by oil revenue
   Fiscal policy and macroeconomic stability
   The non-oil primary balance
   Fiscal policy and intergenerational issues
   Oil funds
   Expenditure management
   Some guidelines
Oil-Producing Countries Differ

   Importance of oil in the economy and fiscal accounts
       Development of the non-oil economy
   Maturity of the oil industry / oil production horizon
   Ownership of oil industry
   Fiscal regime for the oil sector
   Macroeconomic situation
   Financial position of the government and the public sector
    (gross and net debt, liquidity)
   Quality of institutions
Petroleum Revenues and
Uncertainty and Instability            Stabilization
   Uncertainty about value of            Stabilize by total expenditure
    resource and timing of                 and revenue management,
    revenues                               not by reliance on ―stable‖
   Instability caused by volatility       taxes
    of oil prices                         General economic stability
   Taxes must respond robustly               Reduces investors’ risk premia
    to realised outcomes                      Avoids disruption of projects
                                              Strengthens negotiating &
                                               trading position
                                              Vital to poverty reduction
                                                                      Crude Oil Spot Prices, 1970-2006 1/
                                                                            A Rollercoaster Ride

                                                                  Real oil prices



U.S. dollars per barrel





                          20                                    Nominal oil prices


                           1970              1975              1980              1985              1990               1995              2000             2005

                           Sources: IMF, World Economic Outlook (Washington, various issues); and IMF staff estimates.
                           1/ Average of U.K. Brent, Dubai, and West Texas Intermediate. Real oil prices deflated by the US CPI (December 2005 = 100.)
Guidelines for Stability

Keep public sector demand in line with sustainable rate of capacity growth
 Save excess petroleum revenues abroad

 Use conservative price forecasts

 Save foreign assets in boom periods, use in downturns

 No need to “fine tune” the economy

 Rely on automatic stabilizers

 Oil funds are no substitute for sound fiscal management.
The Non-oil Primary Balance
   Key fiscal indicator in petroleum exporters.
   Derived from the overall fiscal balance, excluding oil-
    related revenues & expenditures and net interest.
   Ideally, should include explicit or imputed expenditure on
    petroleum product subsidies if applicable.
   Analytical importance of the non-oil primary balance:
       Reasonable indicator of domestic government demand
       Measure of injection of oil revenue into the economy
       Measure of fiscal effort and underlying fiscal policy stance
       Key input into fiscal sustainability and intertemporal analysis
Size of the Non-oil Primary Deficit

   Some factors to take into account:
       macroeconomic objectives
       short-run vulnerability
       government wealth, including oil in the ground and net
        accumulated financial assets—sustainability
   In some petroleum exporters, large non-oil primary deficits
    are sustainable and do not pose vulnerability concerns.
   In others there may be a need to reduce the non-oil primary
    deficit due to vulnerability and sustainability considerations.
   In all cases, the non-oil primary deficit should be consistent
    with macroeconomic stability objectives.
Smoothing Fiscal Policy:
Fiscal Considerations (1)
   Costly and inefficient to adjust spending rapidly and
   The level of spending should be determined in light of its
    likely quality and the capacity to execute it efficiently.
   The sudden creation or enlargement of spending programs
    is risky.
       Increases in spending may exceed the government’s planning,
        implementation, and management capacity  waste.
       Spending should not rise faster than transparent and careful
        procurement practices will allow.
Smoothing Fiscal Policy:
Fiscal Considerations (2)

   Spending typically proves difficult to contain or
    streamline following expansions. Expenditure
    becomes entrenched and takes a life of its own.

   Drastic spending cuts may lead to social instability,
    discouraging investment and reducing future
The Non-oil Primary Balance
and Transparency

   Focus on the non-oil primary balance helps develop constituencies in support
    of prudent policies, thereby contributing to a less procyclical and more long
    term-oriented fiscal policy.
   This balance should be highlighted in budget documents used in
    parliamentary and public discussion.
   A clear presentation of the non-oil primary balance helps:
       Make the use of oil revenue more transparent
       Delineate policy choices more clearly

   Example: Norway’s budget.
Long-Run Oil and Fiscal Dynamics:
Trajectory of Net Government Wealth
                                  Total net wealth per capita
                                    (In 1997 U.S. dollars)








      1998   2003   2008         2013      2018        2023      2028       2033     2038

                    Oil wealth      Residual oil in the ground    Financial assets
A Path for Use of Oil Revenues:
Permanent Income
The Concept                        The Calculation
 Current consumption limited       Petroleum reserve data &

  to maintain wealth for future      production profiles
  generations                       Production cost or state take

                                    Output price forecasts
 Sustainable use – resources
  converted to other income-        Real interest rate

  producing financial assets        Population growth rate

 A guideline with uncertainties    Subtract discounted present value
                                     (adjusted for population growth)
 Advantage of making
                                     from total real revenues
  intergenerational equity an
  explicit goal
Oil Funds

Purposes                            Links with Fiscal Policy
 Stabilization– shield economy         Oil funds are no substitute for good
   from revenue instability              fiscal management; important
                                         producers operate without oil funds
 Savings – wealth for future
                                         (UK, Saudi Arabia, Indonesia,
   generations                           Australia, Russia)
 Precautionary – if projects are       Important features
   uncertain or absorptive              1.   Consolidated budget framework
   capacity is in doubt                 2.   Liquidity constraint on the budget
                                        3.   Limits on domestic investment by the
                                             oil fund
Types of Oil Funds, by Objective
  Stabilization Funds               Savings Funds           Precautionary Funds

Receive all revenues & inject   Fixed percentage of         Assign all or part of
regular amounts to budget       petroleum revenues          revenues to fund in early
[Papua New Guinea –             [Alberta, Alaska]           stages of petroleum
wound up 2000]                                              development
Petroleum revenues in           Percentage of total         Goal to ensure financial
excess of forecast budget       government revenue          viability if revenues are
amount [Oman]                   [Kuwait]                    lower than expected

Finance deficit or receive      Net government revenues     Guards against poor
surplus [Norway]                (budget surplus) [Norway]   absorptive capacity

Receive deposits above a                                    Recent examples in
reference price; can                                        Azerbaijan and Timor-Leste
withdraw when below floor                                   [now a Norway-type fund]
price [Chile, Venezuela until
Types of Oil Fund,
by Operational Rules
   Contingent funds
       Mainly stabilization objectives
       Deposit and withdrawal depend on rigid exogenous triggers, usually oil prices or fiscal
        oil revenues.
       Triggers: multiyear (fixed/moving average) or intra-annual (relative to budget oil price)
       Examples: Venezuela Macroeconomic Stabilization Fund (1998 rules), Iran
   Revenue-share funds
       Mainly savings objectives
       A fixed share of revenues or oil revenues is deposited in the oil fund. Various rules (or
        discretion) for withdrawals
       Example: Kuwait Reserve Fund for Future Generations
   Financing funds
       Both stabilization and savings objectives
       Net oil revenue is deposited in the fund. The fund automatically finances the budget’s
        non-oil deficit through a reverse transfer.
       Example: Norway Government Pension Fund
Fund Management

Potential for poor management with or without oil fund: Key
    elements for efficiency of oil fund –
   Regular public disclosure
   Accountability to elected representatives
   Independent audit of activities
   Clear investment strategy – majority foreign assets
   ―Benchmarking‖ of desired investment returns
   Competition in appointment of investment managers
Oil Funds, PFM, and Transparency

   Oil funds should not have the authority to spend
       avoid dual budgets: all spending should be transparently on budget.
   Oil revenues should not be earmarked for specific
       there should be genuine competition for fiscal resources.
   Avoid separate oil fund institutional frameworks
   Stringent mechanisms to ensure good governance,
    transparency, and accountability are critical
       clarity of rules, disclosure, audit, and performance evaluation
The Need to Distinguish
Oil Funds from Fiscal Rules

   Oil funds are sometimes confused with fiscal rules.

   Oil funds do not constrain fiscal policy—unless the
    government is liquidity-constrained.
Fiscal Rules in Oil-Producing Countries
   Attempt to insulate fiscal policy from political pressures.
     By placing restrictions or limits on fiscal variables (such as deficits,
       expenditure, debt), rules seek to constrain fiscal policy.
   Design of fiscal rules in oil producers must take into account their specific
    fiscal characteristics (oil volatility; expanded concept of sustainability).
   Rules should aim at decoupling expenditure and the non-oil deficit from
    the short-term volatility of oil revenues. But many oil producers are
    liquidity-constrained—can these countries afford to decouple spending in
    the downswing?
   A sound fiscal management framework is a necessary (not sufficient)
    condition for the success of a fiscal rule.
   Fiscal rules are no stronger than the will of the political class to abide by
Expenditure Frameworks

   MTEFs can help limit the extent of short-run spending responses to
    rapidly-changing oil revenues.

   They can allow a better appreciation of future spending implications of
    current policy decisions—including future recurrent costs of capital

Public Expenditure                     Extra-budgetary funds
  Management                              Better mobilization of public support?
   No special rules for expenditure      Simulate market conditions?
    from petroleum revenues               Disadvantages
                                              Loss of central control and budget
     Consistent base data
     Budget preparation procedures           Resource allocation distortion
                                               Entrenching old priorities
     Budget execution system

                                              Barrier to reallocation at the margin
     Cash planning and management
                                              Potential transparency concerns
                                          Attempts in special circumstances proved
                                           difficult (Chad example)
Final Remarks

   Target smooth responses of expenditure to oil revenues and prudent non-
    oil primary balances.
   Fiscal consolidation may be needed to reduce vulnerability and strengthen
    fiscal sustainability.
   Pay attention to the non-oil primary balance and scaling factors.
   Establish sound budgetary systems.
   Have a long-term horizon.
   Enhance fiscal transparency, so that everybody can see how oil revenue is
    used—or misused.

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