Headlines about resource-rich economies faltering under crashing commodity price pressures fill the news. "Venezuela in a bind as Nicolas Maduro faces default dilemma" warns the Financial Times. "Alberta premier considers sales tax to fix ailing, oil-based economy" says the Canadian Press. "Iran says it can no longer afford Ahmadinejad's cash handouts" reports the Guardian.
Yet for every crisis, there is a story of a government having planned in advance for exactly this circumstance. Some governments spent years paying down public debt so they could borrow when needed. Others saved money in a sovereign wealth fund upon which they might draw during a downturn. Still others invested to diversify their economies, making them less vulnerable to commodity price cycles or unexpected declines in production in the first place.
|Some well prepared and poorly prepared governments of resource-rich countries|
|Well prepared||Poorly prepared|
|Brunei Darussalam||Congo, Rep. of|
|Saudi Arabia||South Sudan|
|United Arab Emirates||Zambia|
|We use the label "well prepared government" here to mean one that meets two conditions: (1) the government is in a sustainable fiscal position in absolute terms, meaning that it has low public debt levels and/or relatively large holdings of foreign assets to withstand a prolonged commodity price slump; and (2) the government acted in a fiscally responsible manner relative to its degree of capital scarcity in the decade(s) prior to the commodity crash, meaning that, if it was capital-rich a significant portion of resource revenues were saved, whereas if it was capital-scarce it was investing well in human and physical infrastructure.|
Neither geography nor level of economic development nor degree of democracy explains why one government would be well prepared for a price downturn while another would not. Successes and failures can be found on every continent, in developed and emerging economies, and across authoritarian and democratic countries.
Stability for some…
Most successes have emerged from a consensus—often codified in law—that fiscal stability and sustainability principles ought to drive public finance decisions. Peru, for instance, passed the Fiscal Responsibility and Transparency Law in 1999, following decades of economic crises. The law established Peru's fiscal rules—a deficit limit and an expenditure growth rule—which were then reviewed in 2013. The result was a reduction in public debt from 44 percent of GDP in 2004 to 20 percent of GDP in 2012, one of the lowest rates in Latin America. At the same time, the government established the Fiscal Stabilization Fund (FSF) to accumulate fiscal surpluses. Today the FSF holds approximately $9 billion, equal to 4.6 percent of GDP.
In another example, Norway's political parties jointly committed to its fiscal rule in 1990. The rule set the non-oil budget deficit at 4 percent, which is the expected long-term return on savings in the country's sovereign wealth fund. Similar to the Peruvian case, Norway established its rule after decades of financial mismanagement, including two banking crises. Norway's sovereign wealth fund has accumulated $884 billion, making every Norwegian a krone millionaire ($173,000 per capita) on paper.
Timor-Leste has also taken a long-term view to managing its natural resource wealth. In 2005, the Petroleum Fund Act was passed establishing a fiscal rule that limits annual spending to 3 percent of petroleum wealth, unless justified to parliament. Any excess is saved in the Petroleum Fund. In recent years, Timor-Leste has spent beyond this limit to invest in electricity, housing, and education, among other items. Still, since the law was passed, the government has never run a fiscal deficit and built up $15.7 billion in savings ($13,000 USD per capita) as of July 2014. Even as oil prices collapsed, the Timor-Leste 2015 budget only called for $70 million in borrowing (4.5 percent of the budget)—a smaller percentage than in Chile or Saudi Arabia.
… and crises for others
Not all countries have done so well. Some resource-rich states have faced major financial and economic crises, and even violent conflict. These countries have little in common other than the absence (or abandonment) of a long-term macroeconomic framework during or even prior to their respective commodity booms. For example, Venezuela witnessed an enormous increase in government spending and widening budget deficits starting with the rise of oil prices in 2005. The government has run a fiscal deficit in every year since 2005, even during oil boom periods. The IMF estimates that in 2015 the Venezuelan budget deficit could reach nearly 20 percent of GDP.
The government's response has been to extend price and exchange rate controls, first introduced in 2003, and nationalize a number of companies that provide basic goods and services. These have led to shortages of imports, a growing foreign currency black market, hyperinflation, and demonstrations on the streets, rather than generating the type of growth and stability the government expected. Prices of credit default swaps on Venezuelan public debt suggest a 60 percent chance of default in the next year and a 90 percent probability of default in the next five years.
In mineral-rich Mongolia, exuberance around mining prospects contributed to a huge public and private sector spending boom starting in 2006 and that accelerated in 2010. The crash in mineral prices, including a 38 percent drop in copper prices—and consequent decline in fiscal revenues—has underscored the government's structural deficit (a budget deficit adjusted to strip out the effects of economic cycles). Mongolia has been left exceedingly vulnerable to further shocks. In the IMF's words, "Mongolia is […] at high risk of debt distress." The government and its state-owned companies are currently paying some of the world's highest interest rates on international sovereign debt markets due to perceived financial risk. The Trade and Development Bank of Mongolia, a government-guaranteed, state-owned institution, is now borrowing at over 8 percent annually in real terms on international financial markets. The government itself is borrowing at 4-6 percent more annually than Vietnam, another fast-growing Asian emerging market.
In both of these cases problems started before the 2012-14 commodity slump. In each, and in others (e.g., Equatorial Guinea, Mexico, Malaysia, Iran, South Sudan, Trinidad and Tobago, Yemen), the government was in structural deficit before the crash. This means that, prior to the crash, in each, public spending was not generating the growth (and non-resource tax revenue) necessary to meet public sector obligations over the long-term without relying on revenues generated from oil, gas or mining.
Unrealistic expectations drove overspending
Unrealistic expectations around resource revenues have also played a role in overspending and debt crises. In Ghana and Mongolia, for instance, claims of vast national wealth dominated the political discourse in the years preceding the start of major resource production. These assertions directly contributed to consumption-driven booms in both countries. Recently, Ghana has been forced into signing an IMF bailout agreement. While it saved slightly less than $500 million in oil revenues in two sovereign wealth funds from 2012 to 2014, the government borrowed approximately $7 billion on international financial markets, at interest rates approximately 5 percent higher than the rate of return on sovereign wealth fund assets. The Ghanaian experience highlights the dangers of over-exuberance when new discoveries are made.
A lack of transparency in public finances can exacerbate overspending. In the Republic of Congo, opaque reporting practices led external observers to believe that the country was well prepared for the current crisis, when in reality national savings were smaller than expected.
Beyond the immediate fiscal crises, budget cuts (e.g., Iran cutting cash transfers), asset sales (e.g., Russia raiding the National Wealth Fund, earmarked for public pensions), and tax increases (e.g., Alberta's plans to raise corporate and income taxes), the commodity price crash is impacting longer-term macro-fiscal plans. For instance, Papua New Guinea has delayed implementation of its sovereign wealth fund. There is also less interest in creating new funds in regions where large oil or mining projects have been delayed (e.g., Afghanistan, Liberia, Sierra Leone).
At the same time, some governments are adapting the lessons of the past into draft laws on managing natural resource wealth. For example, Mongolia has tabled a Future Heritage Fund bill which calls for a portion of windfall revenues to be saved in a new fund. And oil-rich Bojonegoro regency in Indonesia is planning to establish a fiscal rule and a fund to save a portion of its subnational government share of oil revenues.
Common success factors
We can point to a few commonalities among the resource-rich governments that have successfully countered fiscal revenue volatility and maintained fiscal responsibility despite having or expecting vast oil, gas or mineral wealth. First, each country has a history of sticking to a macroeconomic framework, whether or not the framework is rooted in the constitution, in a law, or in a policy document. In most cases, this is reflected in a formalized fiscal rule which generates a fiscal surplus. The fiscal surplus is then saved in a sovereign wealth fund or used to pay down public debt.
According to IMF staff estimates, national governments comply with fiscal rules approximately 60 percent of the time. Balanced budget rules are broken most often since they are complex and therefore difficult to enforce. Expenditure rules and debt rules are easier to enforce, particularly in emerging economies—since the data required for their determination is easily available and the calculations are fairly simple to carry out—which helps explain the higher rates of compliance. Expenditure rules (and revenue rules) generally have the added benefit of being counter-cyclical, making them particularly appropriate for emerging resource-rich economies.
Second, most countries have competent and powerful ministries of finance as well as strong oversight of their public finances, either through parliament or independent fiscal watchdogs.
Third, in many cases, leaders committed to long-term fiscal sustainability, resisting temptations to over-spend on projects that curry popular favor—especially on expensive but low-return status projects like stadiums. Political resoluteness by powerful individuals has often been key to sticking to a fiscal framework.
Finally, in most democratic countries, political consensus has played an important role in compliance with fiscal rules or fiscal sustainability and stability principles. Both Norway and Timor-Leste, for instance, have generally controlled spending, even in good times, by virtue of a cross-party political commitment to fiscal responsibility. While we don't have all the answers, recent experiences may help us better manage future commodity price booms—and busts.
NRGI revenue management data tools
NRGI is building visual tools and a database of indicators to help policymakers, media and researchers better understand macroeconomic preparedness for commodity revenue shocks. Below we present a sample of this work. We welcome comments on how to improve our approach.
Visual tool 1: Government revenues and expenditures over time in resource-rich countries, which shows budget balances.
Visual tool 2: Change in government revenue and expenditure over time in resource-rich countries, which illustrates government fiscal policy responses to volatility.
Measures of commodity price crash preparedness for selected countries
|Measures of preparedness|
|Fiscal rules||Fund||History of volatility management and fiscal sustainability||Net debt (percentage of GDP, 2014 est.)||Gross debt (percentage of GDP, 2014 est.)||Expenditure volatility||CDS spread (Jan 2015)||Expected budget balance (2015)|
|Chile||Yes (structural balance)||Yes (Pension Reserve Fund and Economic and Social Stabilization Fund)||Strong||-5.10%||13.90%||Low||60 BPS||-8.9%|
|Saudi Arabia||No||Yes (SAMA Foreign Holdings)||Strong||-97.10%||1.60%||Low||60 BPS||-20%|
|Peru||Yes (structural deficit; expenditure rule; subnational debt ceiling)||Yes (Fiscal Stabilization Fund)||Moderate-Strong||3.40%||20.70%||Low||120 BPS||-8.8%|
|Russia||Yes (expenditure rule; suspended in 2010)||Yes (Reserve Fund and National Wealth Fund)||Moderate||N/A||17.90%||Moderate||190 BPS||-19%|
|Mongolia||Yes (balanced budget, expenditure, revenue and debt rules; some operational in the future)||Yes (Fiscal Stability Fund)||Moderate||N/A||76.50%||High||550 BPS||-38%|
|Venezuela||No||Yes (Macroeconomic Stabilization Fund)||Poor||N/A||45.60%||High||750 BPS||-88%|
Table sources and methodology:
Andrew Bauer is a senior economic analyst at the Natural Resource Governance Institute (NRGI). David Mihalyi is an NRGI economic analyst.