Resource revenues fluctuate through time, varying with the development of new discoveries, with price changes and with fiscal provisions. Effective utilization of revenues requires that expenditure be smoothed and that investment and outlays be built up over time. A gradual build up may also be necessary to ensure the quality of public spending and to avoid adverse macroeconomic repercussions.
In budgeting it is critical to take account of volatility of commodity prices and revenue flows, something that recent experience has clearly demonstrated. Such a domestic expenditure pattern can be achieved by saving a portion of revenues during high price periods, holding the savings in a ”stabilization” fund, and then dissaving (drawing down) the saved revenues during low price periods. Smoothing can also be enhanced by limited foreign borrowing or adjustment of the rate of resource depletion.
The amounts paid into the stabilization fund should be held in international financial assets. If the government relies upon domestic savings it will cushion its own expenditure during a period of low prices only at the expense of passing all the contraction in resource revenue on to domestic households and firms as it liquidates its domestic savings. Hence, a better strategy is for the government to smooth public expenditure by means of foreign financial assets to avoid this adverse effect on domestic households and firms when the fund is drawn down. Such policies can be made more effective by transparency and by taking the response of private sector actors into account.
Since the purpose is to smooth public expenditures around fluctuations in revenue, this has implications both for the scale of foreign asset accumulation and its composition. Although the objective is not to build a long run fund, the savings may need to be a substantial part of the revenues during boom periods at least until a significant cushion is established. Any stabilization fund should hold investments that are reasonably liquid and less exposed to fluctuations in value: the investments will need to be sold during periods of low global commodity prices and this may, for example, coincide with global recessions and low asset prices. Effectiveness will be enhanced if there are transparent rules or guidelines for triggering asset accumulation and withdrawals, with any deviations subject to public debate and formal procedures.
Smoothing of expenditures may also require borrowing in international capital markets. This may be particularly valuable in the interval between resource discovery and significant revenue flow, during which period an initial ramping up of expenditure is appropriate. However, it is important to signal prudence, both internationally and domestically. Prudence requires defenses against an inability to repay new loans, against a drop in commodity prices, and against delays in getting new discoveries into production. Care must be taken to not drive up the cost of capital to the private sector. An international facility (such as IBRD lending) is preferable to private borrowing as a means to ensure this in part to avoid encumbering the resource itself and in part because the international entity will reinforce the government’s direction of sustainable spending. Over the longer term, resource wealth should be used to reduce government debt, not increase it.
The postponement and hence smoothing of spending can alternatively be achieved by limiting the rate of resource depletion. If the resources are left in the ground economic principles suggests that their expected return will be competitive with the returns of foreign financial assets. Leaving resources in the ground also reduces the risk from future economic populism since assets in the ground are harder to spend quickly. The costs of any deferred development strategy include current unpopularity, and delaying diversification of the total asset portfolio of the country’s economy that could be achieved by extraction and conversion of wealth into a broad portfolio of other assets.
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