Fiscal Policy Frameworks for Resource-Rich Economies: Considerations for Liberia

Todd Mattina Fiscal Affairs Department

International Monetary Fund March 18, 2013

Presentation plan:

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I. Motivation: Challenges for resource-rich developing countries (RRDCs)

II. Fiscal policy frameworks for RRDCs: key considerations

III. Summary

Motivation: Macroeconomic and Fiscal Policy

Challenges for RRDCs

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Resource revenues are increasingly important for many developing countries

4

0

10

20

30

40

50

60

70

80

90

100

Equatorial Guinea

Libya Kuw

ait Tim

or-Leste Iraq Angola C

ongo Republic

Nigeria

Algeria Iran Yem

en Sudan Kazakhstan C

had Venezuela Botsw

ana M

alaysia M

exico Bolivia Ecuador R

ussia Ivory C

oast D

RC

M

auritania Papua N

ew G

uinea G

uinea Zam

bia

1 27 LICs and MICs have mineral & oil revenue above 25 percent, in 2011.

Receipts from Natural Resources in 2011

(Selected countries, percent of government revenues)1

Petroleum Revenue

Mining and Petroleum Revenue Mining Revenue

0

2

4

6

8

10

12

14

16

2000 2011

LICs MICs

1/ Latest data for five countries are as of 2010 and earliest data for five other countries are as of 2001-2004.

Number of LICs and MICs with mineral and oil revenue above 25 percent of government revenue 1/

Macroeconomic and Policy Challenges in RRDCs

5

0.0

0.4

0.8

1.2

1.6

Oil Producers Mineral Producers Non-Resource Rich*

Sources: World Economic Outlook; and IMF staff estimates. *Real total revenue.

Volatility of Real Resource Revenue and Expenditure

(Coefficient of variation, average: 1992–2011)

Resource Revenue Expenditure

AGO

BGD

BOL

BWA

CMR

COG

CIV GAB

GHA

GIN GUY

IDN

KAZ LBR

MLI

MNG

MOZ

NAM

NER PER

ZAF

SDN SYR

TZA

TGO

TTO

VNM

ZMB

-35

-25

-15

-5

5

15

25

35

0 20 40 60 80

Resource Rent

Adj

uste

d N

et S

avin

gs

Adjusted Net Savings and Exhaustible Resource Rent1,2

(Average:2000–09, in percent of GDP)

Sources: World Development Indicators, World Bank; and IMF staff estimates. 1Adjusted net savings are net national savings plus education expenditure minus energy, mineral and net forest depletion, and emissions damage. 2Resource rents are unit price minus unit cost of oil, mineral and forest sectors.

Boom-Bust Cycles Low Saving Rates

Building assets with resource revenues

6

Low Public Investment in RRDCs

0

2

4

6

8

10

12

Public Investment in RRDCs and Non-RRDCs (Average: 1980–2011, median and interquartile range,

in percent of GDP)

1980–89 1990–99 2000–11

RRDCs Non-RRDCs

Sources: World Economic Outlook; and IMF staff estimates.

Public investment in RRDCs has been relatively low compared to non-RRDCs.

For a lasting impact on development, part of the natural resource revenues needs to be saved or invested.

Consumption and investment benchmarks

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0 T0 T1 Time

Resource Windfall

Optimal Consumption

Bird-in-hand Rule

Permanent Income (PIH) Rule

1Stylized example based on Collier et al. (2010), p. 93.

Incremental Consumption from a Resource Windfall1

Optimal Savings

The permanent income hypothesis (PIH) implies that the government should consume the real return on accumulated financial assets and the net present value of future resource revenues.

When living standards are expected to rise over time, it is optimal to tilt incremental consumption forward to benefit relatively poorer current generations (blue line).

Fiscal Policy Frameworks for RRDCs

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Objectives of fiscal policy frameworks

Demand management • How does fiscal policy

contribute to domestic demand, growth, inflation and the balance of payments?

Solvency • Can fiscal policy be

sustained once resources have been exhausted?

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As in other countries, the fiscal framework for resource rich countries needs to address two key issues:

These issues are complicated by resource revenue volatility and resource exhaustibility

Fiscal framework design is linked to the “resource horizon”

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Resource Horizon: Duration Until Resources are Exhausted

Long Horizon Focus is on managing volatility

Short Horizon Focus is on sustainability

25-35 years

Managing resource revenue volatility in countries with short resource horizons

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• Fiscal targets based on the non-resource primary balance (NRPB) are appropriate – The NRPB is defined as the primary balance less resource

revenues (or non-resource revenues less primary spending).

• Since resource revenues largely accrue from abroad, an increase in the non-resource primary deficit generally implies an expansionary fiscal stance.

• Setting fiscal policy based on an NRPB target can de-link expenditures from volatile resource revenues and avoid abrupt adjustments when resources are exhausted.

Managing resource revenue volatility in countries with long resource horizons

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• Resource revenues are often a large share of overall revenues in countries with long resource horizons. – Excluding resource revenues from fiscal targets may not be intuitive,

easy to communicate and could be misinterpreted.

• A rule based on the “structural primary balance”, defined as the primary balance excluding cyclical resource revenues can help to de-link spending from volatile revenue swings.

• Spending will be a function of “structural” or “normal”

resource revenues and the primary balance target. – Price-based rules can be used to estimate structural revenues

Managing resource revenue volatility: Tradeoffs in price-based smoothing rules

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1/ This chart simulates real primary expenditure growth for an oil-producing country following alternative price rules. The rules are a function of an M-year trailing average of historical prices; the current spot price, C; and an N-year average for market-based forward prices (e.g., M/C/N).

-5

0

5

10

15

20

1974 1979 1984 1989 1994 1999 2004 2009

Price Rule (5/1/5)

Price Rule (5/1/5) + Expenditure Growth Limit

Real Primary Expenditure Growth

(Percent change, year-on-year)

-5

0

5

10

15

20

1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Price Rule (5/0/0)

Price Rule (5/1/5)

Price Rule (12/1/3)

Real Primary Expenditure Growth

(Percent change, year-on-year)

Managing resource revenue volatility: Tradeoffs in price-based smoothing rules

14

0

10

20

30

40

50

60

70

80

90

100

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

Price rule (5/0/0)

Price rule (5/1/5)

Price rule (12/1/3)

Cumulative financial savings (Percent non-resource GDP)

0

10

20

30

40

50

60

70

80

90

1973

19

76

1979

19

82

1985

19

88

1991

19

94

1997

20

00

2003

20

06

2009

Price rule (5/1/5)

Price rule (5/1/5) + expenditure growth limit

Cumulative financial savings (Percent non-resource GDP)

Assessing fiscal sustainability

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• While many fiscal policy paths are sustainable in principle, three “sustainability benchmarks” are of particular interest:

Permanent Income Hypothesis (PIH) • Government consumption

and wealth are held constant over time. The present value of non-resource deficits should equal the present value of resource revenues.

Modified PIH (M-PIH) • Allows for a temporary

drawdown of financial assets to scale up public investment. The initial drawdown is offset by a future fiscal adjustment to rebuild financial assets.

Fiscal Sustainability Framework (FSF) • Allows for a sustained

drawdown of financial assets to build human and physical capital to deliver an expected permanent gain in non-resource revenues.

Assessing Fiscal Sustainability

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Fiscal Sustainability Frameworks for Resource-Rich Developing Countries

0

10

20

30

40

50

60

Primary expenditure Non-resource revenue

PIH framework (Percent non-resource GDP)

0

10

20

30

40

50

60

Modified PIH framework (Percent non-resource GDP)

Front- loading Period

Long-run Period

MPIH Adjust. Period

0

10

20

30

40

50

60

Fiscal sustainability framework (Percent non-resource GDP)

Front- loading Period

Long-run Period

MPIH Adjust. Period

Assessing Fiscal Sustainability

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Fiscal Sustainability Frameworks for Resource-Rich Developing Countries

-35

-30

-25

-20

-15

-10

-5

0

2012 2017 2022 2027 2032 2037 2042 2047

PIH perpetuity

MPIH perpetuity

FSF perpetuity

Non-resource balance (Percent non-resource GDP)

Front- loading Invest. Period

Adjustment Period

Long-run Period

620

630

640

650

660

670

680

690

700

2011 2015 2019 2023 2027 2031 2035 2039 2043 2047

PIH perpetuity

MPIH perpetuity

FSF perpetuity

Financial wealth (Percent non-resource GDP)

Front- loading Invest. Period

Adjustment Period

Long-run Period

Transparency and Public Financial Management Considerations

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The type of investment with the greatest impact on growth will be country specific

Many countries are focusing on infrastructure investment Investments in education and health could be key for some

Investments in social capital such as schools and hospitals also require higher recurrent spending to be made productive

The effectiveness of scaling up depends on capacity to appraise, select, implement and evaluate projects.

Resource Funds

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Resource funds help deal with resource revenue volatility and save for future generations

Funding should come from fiscal surpluses and remain linked to the government’s overall cash management strategy

Fund flows should be integrated into the budget and should

not have independent spending authority With weak institutional capacity, it is advisable to have just

one resource fund (sometimes with separate portfolios for stabilization and saving).

Summary

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Summary

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Resource revenues are an opportunity to progress on key development goals, such as poverty reduction, infrastructure and growth.

Fiscal frameworks should be designed to avoid the resource curse of slow growth, pro-cyclical fiscal policies and inadequate savings and investment.

Fiscal rules can help resource-rich countries mitigate externally driven volatility from commodity prices by building saving cushions.

Public investment should only be front-loaded once implementation capacity and fiscal transparency have been strengthened to avoid misuse.

THANK YOU

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Presentation is based on:

Macroeconomic policy frameworks for resources-rich developing countries. Available at: http://www.imf.org/external/np/pp/eng/2012/082412.pdf

Fiscal Regimes for Extractive Industries: Design and Implementation,

Fiscal Affairs Department, IMF, August 15, 2012. Available at:

http://www.imf.org/external/np/pp/eng/2012/081512.pdf

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Other useful references from the IMF’s Fiscal Affairs Department

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Resource-rich developing countries (RRDCs) have a mixed growth record

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-2

-1

0

1

2

3

4

5

1980–89 1990–99 2000–11

RRDCs

Non-RRDCs

Growth in Real GDP Per Capita for RRDCs and Non-RRDCs (Averages for 1980-2011, median and interquartile range, in percent)

Sources: World Economic Outlook; and IMF staff estimates.

Median

Managing resource revenue volatility: Tradeoffs in price-based smoothing rules

26

0

20

40

60

80

100

120

1973 1978 1983 1988 1993 1998 2003 2008

1 percent NR-GDP PB target 0 percent NR-GDP PB target -1 percent NR-GDP PB target

Cumulative financial savings under 5/0/0 price rule with different overall primary

balance targets (Percent non-resource GDP)

• Price-smoothing rule can also help to address sustainability concerns.

• This can be achieved by targeting different structural primary balances (e.g., Chile targets a surplus of 1 percent of GDP)

• Adding a “prudence factor” in the forecast (e.g., Mexico multiplies smoothed oil prices by a factor of 0.84).