Eric LE BORGNE The World Bank Beirut office May 10 2013 OUTLINE Challenges and policy i nstruments available for natural r esource rich countries SWFs objectives and associated design ID: 600005
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Slide1
Experiences with Sovereign Wealth Fund ManagementEric LE BORGNE The World Bank (Beirut office)May 10, 2013Slide2
OUTLINEChallenges and policy instruments available for natural resource rich countriesSWFs objectives and associated designSWFs’ best practices and challengesRecent trends in SWF designSlide3
CREATING A LEBANESE SWF MAY, UNDER CERTAIN CONDITIONS, HELP ADDRESS CHALLENGES RESULTING FROM NATURAL RESOURCES ABUNDANCE (Resource curse/paradox of plenty)
Resource
Revenue
Characteristics
Policymaking Incentives
Volatile:
as a result of natural resource price volatility
Excessive spending today:
of resource revenues, at the expense of future generations, due to excessive discounting of the future, the assumption that future generations will be richer, and/or to gain political support
Rent-seeking, corruption
Uncertain:
due to uncertainty of reserve volume and production potential ex ante
Exhaustible:
due to the nature of the resource
Sizable:
as a share of GDP and government revenues (which translates into the high magnitude of potential impact of volatility on the economy, and the incentives for rent-seeking)
Key Challenges
Spend
commodity revenues
efficiently
within a
sound macroeconomic frameworkEnsure revenue stabilization to avoid boom and bust cyclesGuarantee revenue sustainability for future generations and/or generate alternative sources of income different from non renewable resources
Policy Objectives
Resource Sovereign Wealth Funds
Fiscal Rules Fiscal Responsibility Laws Budgetary oil pricesExtractive Industries Transparency InitiativeEtc.
Examples of Potential Policy InstrumentsSlide4
To ensure counter-cyclical fiscal policy that can mitigate the impact of highly volatile commodity prices on fiscal revenues
Stabilization
Description
Potential Policy Objective
To set aside revenue for future generations or future needs of current generations (e.g. future pension
liabilities)
To ensure intergenerational equity
Inter-generational Saving
To develop long-term fiscal sustainability (generate alternative non-resource revenues)
To support local or national economic development
For
lack sufficient current opportunities for domestic investment or consumption expenditure that provide the same current benefits as financial
investment
Investment
To hedge against extraordinary shifts in the fiscal situation of a country (e.g. natural disasters, blow-outs, war, etc.)
Precautionary
KEY DESIGN ELEMENTS OF A SWF FOR
LEBANON
WILL DEPEND ON THE POLICY OBJECTIVE(S) THE FUND IS MANDATED TO ACHIEVESlide5
Examples of Sovereign Wealth FundsSlide6
Examples of Sovereign Wealth FundsSlide7
Alaska Permanent Fund Corporation
Norwegian Government
Petroleum Fund
Consists of the Alaska Permanent Fund (APF) and the Earnings Reserve Account (ERA)
50% of resource revenues are deposited in the APF and cannot be withdrawn, while the rest remains with Treasury
Income from APF investments is deposited in ERA and used for (1) inflation proofing of APF funds, (2) cash transfers to households, and (3) other uses as per Legislature’s discretion (e.g. budget support)
Consists of one fund which is managed by the Central Bank on behalf of the government
Oil revenues are deposited in the fund and are used for making financial investments overseas with a long term horizon
Oil revenues and income from their investment is used as necessary to finance deficits in the state budget as per Parliament decisions
Deposits and withdrawals adhere to fiscal policy guidelines
Institutional Setup
Safeguarding
against pressures to spend
revenue
Automatic stabilization
Insulation of investment
policy from
political arena
Contribution
to increase
in average
income of the poorest familiesSterilization of oil revenues through overseas investmentAccumulation of liquidity buffer that can stabilize potential future fluctuations in oil revenue and fund investment income
Achievements
Income Redistribution
through direct cash transfers to households to improve the quality of life of all, and of the poorest families particularly
Fiscal Management
through transfers to the state budget to cover non-oil budget deficits, through conservative s
aving
and
investment to (1) generate
revenue when oil runs out,
(2) manage
oil revenue volatility,
(3) reduce
public debt,
(4) reduce
taxes, etc
.
Objectives
SUCCESSFUL
SWFs
SUCH AS THE ALASKAN AND NORWEGIAN FUNDS HAVE ACHIEVED DISPARATE OBJECTIVES USING VARIED INSTITUTIONAL SETUPSSlide8
* This led to the closure of the SWF and the depletion of almost all SWF assets, respectivelySource: Le Borgne and Medas, 2007, “Sovereign Wealth Funds in the Pacific Island Countries: Macro-Fiscal Linkages”, Working Paper 07/297, International Monetary Fund, Washington, DC
Fiscal Challenges Facing Many Asia Pacific Economies
Volatile government spending and fiscal deficits
Significant or complete depletion of SWF funds
Accumulation of expensive debts
and/or
payment arrears
Causes of Fiscal Challenges
Weak spending controls
Poor cash management
Rigid SWF operational rules
Use of SWF funds as collateral to finance fiscal deficits (e.g. Papua New Guinea, Nauru*)
Risky and/or undiversified
investment,
mismanagement and poor governance (e.g. Nauru
)
Poor / fragmented cash management combined with rigid
SWF withdrawal
rules (e.g. Marshall Islands and Tuvalu)
Depletion of cash reserves due to required contribution to SWF’s (e.g. Marshall Islands
)
Without consistent overall fiscal framework (incl. strong spending controls and cash management), a SWF is unlikely to achieve its objectives of limiting size and volatility of spending. Rigid operational rules limit ability to use funds for stabilization, ability to adjust to changing circumstances, and may result in need for costly borrowing
Asset mgt
strategy (incl. chosen level of risk-return tradeoff) must be consistent with SWF policy objectives (e.g. stabilization vs. income generation)
Lessons Learned
OTHER SWFs, SUCH AS THOSE IN THE ASIA PACIFIC ISLANDS, HAVE NOT BEEN AS SUCCESSFUL IN ACHIEVING FISCAL GOALSSlide9
Source: Le Borgne and Medas, 2007, “Sovereign Wealth Funds in the Pacific Island Countries: Macro-Fiscal Linkages”, Working Paper 07/297, International Monetary Fund, Washington, DCGLOBAL TRENDS IN SWF DESIGN ARE SHIFTING TOWARDS FUNDS THAT ARE FELXIBLE, TRANSPARENT, AND INTEGRATED WITH FISCAL SYSTEMS AND COUNTRY INVESTMENT STRATEGIES
Description
Design
F
eature
Flexible rules (for deposit and withdrawal) facilitate use of funds for stabilization, avoid need for costly borrowing or arrears
in asset accumulation
period, and permit adjustment to changing circumstances (e.g. Norway)
Flexible
Operational Rules
Limited earmarking and/or extra-budgetary spending using SWF funds ensures
Flexibility to adjust to changing conditions and priorities,
Efficiency of spending through competition for resources between priority areas
Simpler liquidity
management
Limited Earmarking and/or Extra-budgetary Spending
Integration of SWF investment policy in country’s broader fiscal and asset management strategy avoids simultaneous accumulation of public debt and SWF financial assets
Choice
of portfolio
geared towards maximizing (
risk-adjusted) financial return, conditional on
underlying fiscal objectives
(e.g., stabilization, long-term fiscal sustainability
)
Investment Coherence with Country Investment Strategy
Integration of resource revenue expenditure with the budget system ensures spending
decisions are aligned with
fiscal policy and addresses
fungibility
challenges (e.g.
Financing Funds in Norway
, Timor
Leste
)
This, however, eliminates SWF role in enforcing fiscal discipline in resource revenue expenditure
Integration with Budget Systems
Fund oversight (including performance reports, external audits, standards for disclosure of information) can promote better performance, limit corruption, and build public confidence in the management of resource revenues and in turn foster public support for the fund
Transparency & AccountabilitySlide10
Thank Youhttp://worldbank.org/LebanonSlide11
Extra SlidesSlide12
Prior information campaignEstablishment Accumulation and Withdrawal Management and InvestmentGovernance
Constitutional amendment, parliamentary act, presidential decree
Rigid rules, budget support, mixed
Special fund strategy body, investment advisers, external managers, target returns and benchmarks, permitted investments
Autonomous body, multilevel oversight, published audits and performance reports,
Special dissemination programs, limited public debate
COMMON FEATURES OF OIL FUNDSSlide13
OVERVIEW OF ACCUMULATION AND WITHDRAWAL RULES AMONG SWF’S AROUND THE WORLDEach method has pros and cons. Whatever the methodology, operational rules need to be consistent with actual fiscal policy. Oil fund gross assets should not detract attention from the government’s overall net financial position.
Description
Withdrawal Rules
Fully specified mechanisms:
Price or revenue contingent withdrawal rules
Earmarking
for specific uses (Alaska, Azerbaijan, Chad, Ecuador, ..)
Financing funds:
Budget needs (e.g. Norway, Timor
Leste
)
Accumulation Rules
Direct Transfers:
Price
or revenue contingent deposit rules (Algeria, Iran, Mexico, Russia, Trinidad and Tobago, Venezuela,
etc.)
Pre-determined share of oil revenue is deposited into the fund (Equatorial Guinea, Gabon, Kazakhstan, Kuwait,
etc.)
All
government oil revenue (Chad, Sao Tome et Principe, Timor
Leste
, etc.)
Indirect Transfers:
Oil revenues are first paid to the treasury, then a part is transferred to the fund (Norway, etc.) Slide14
CB Core Reserves & Stabilization FundsFuture & Endowment FundsPension LiabilitiesObjectiveCover unexpected Balance of Payments outflows or budget shortfallsPreserve capital in real terms for future generations or to generate alternative source of revenueCover contractual and measurable long term obligationsInvestment HorizonShort TermLong termMaturity of contractual obligations: 20 to 40 yearsReturn TargetPrevailing nominal returnsLong term real return targetDiscount rate on future benefit payoutsRisk Tolerance
No
negative nominal returns over the investment horizon
Not meeting the real return target over time
Not meeting expected benefit payouts
Increasing tolerance for short term risk and decreasing need for liquidity
OVERVIEW OF SWF
INVESTMENT
POLICIESSlide15
SANTIAGO PRINCIPLES FOR MANAGING INSTITUTIONAL RISKS FACED BY SWF’SThe main problem that SWF’s face over time is the potential conflict between their strategic objectives and short term political objectives. This conflict may result in Direct raiding: funds are used for purposes other than originally intended, or ex-ante contributions are not paidIndirect raiding: unsustainable fiscal behavior e.g. excessive debt accumulation on the back of fund’s resourcesInefficient management of funds: constraints on investments that are inconsistent with the fund’s long-term objectives because of reputational risk concernsKey Institutional Risks facing SWF’s…Sound legal framework to enable SWF to accomplish its stated objectivesClearly defined and publicly disclosed SWF strategic objectives (in particular for the procedure that governs accumulation and withdrawals)Institutional arrangements for fund management shielded from political interference and supportive of efficient management of funds to achieve SWF objectives…can be managed using Santiago PrinciplesSlide16
The Case of AlaskaAlaska Constitution Article IX, Section 15Alaska Permanent Fund.At least twenty-five percent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral revenue sharing payments and bonuses received by the State shall be placed in a permanent fund, the principal of which shall be used only for those income-producing investments specifically designated by law as eligible for permanent fund investments. All income from the permanent fund shall be deposited in the general fund unless otherwise provided by law [Effective February 21, 1977].Slide17
What are the key features of this fund? Established by constitutional amendment Managed by autonomous body with clear mandate and objectives The capital (inflation proofed) cannot be withdrawn. Rule to determine the cash transfers to households.
Most Alaskans thought the Fund should be considered a public trust and that the paramount concern should be protection of the principalSlide18
Flows in and out of the APFEligible Revenues
Treasury
General Fund
Alaska Permanent Fund
APF Corporation
Earnings Reserve Account
Dividend Fund
50% of Income available for distribution
Inflation proofing
1
1
2
4
5
50% of Eligible Revenues
3
Income
Note:
The
Legislature decides the use of the balance remaining in the Earnings Reserve Accounts (budget support, back to the Fund, keep it on ERA to stabilize future low income.Slide19
What has the Alaska Permanent Fund achieved?
Description
Achievements
Safeguard against pressures to spend the oil revenue;
Insulate the investment policy from the political arena;
Equal sharing of the revenue from publicly owned resources
Build a strong constituency in support of the fund
Macroeconomic effects
No evidence of impact on current labor force supply
Contributed to increase the average income of the poorest families
Served as automatic stabilizerSlide20
What is the future of the Alaska Permanent Fund? The earnings of the fund could help to address the fiscal problem of Alaska but so far no consensus has been reached on the issue…..
In practice, the dividends have come to be seen as entitlements, making changes in rules a challenging proposition.Slide21
The Case of Norway The Petroleum Fund was established in 1990 after a decision by the legislature to counter the effects of the expected decline in income and to smooth out the disrupting effects of highly fluctuating oil prices. The broad objectives of the fund were to: safeguard the long-term use of oil revenues, manage the government’s net cash flow from oil, and transfer money to the fiscal budget to cover the non-oil deficit.
In 2006 the government established the Government Pension Fund consisting of two parts: "The Government Pension Fund - Global", which is a continuation of the Petroleum Fund, and "The Government Pension Fund - Norway", which invests in domestic companies quoted on the stock market. Slide22
What are the key features of this fund? The fund can be used only for transfers to the central government budget following an annual resolution by the Storting.The minister of finance controls the management policies of the fund: limitation of the investment universe. The fund cannot be used to provide credit to the central government or private sector entities, or to raise loans Norges Bank invests the capital in its own name (directly/external managers) in financial instruments and cash deposits denominated in foreign currency. Annual audit reports, and performance reports are published.Slide23
Flows in and out of the GPFGSource: Vidar Ovesen (2013), Presentation at the International Conference on Effective Sovereign Wealth Fund Management, titled “How to agree on why, when and how much to save – Norway’s experience”Slide24
Was the fund successful in shielding the economy from fluctuations in prices and extraction rates in the petroleum sector? By investing abroad the fund has effectively sterilized oil revenues … but the effects of the new investment strategy are untested Given the size of the fund, future governments should be able to cope with fluctuations in revenue (and returns). The true long term benchmark is the pension liabilities Given diversified portfolio, all limits on expected volatility of the returns impose costs.
The Fund allows petroleum revenues to be gradually phased into the economy, and provides resources to face future pension liabilities of an aging population. Given its large size, it becomes more and more difficult to reduce volatility of the returns through investing in uncorrelated assets. Slide25
Conclusion
Oil funds with best management practice are subject to certain common principles:
Strong governance
Clearly defined goals and transparency
Integration with the state budget
Sound asset management strategy
Broad political support for the pursued objective is an important ingredient for the efficient use of oil revenue.