Is This Your Rainy Day?—Cash Management in Small Resource Dependent Economies
Posted by Tej Prakash
Small economies where resource revenues are a significant part of the budget often face volatile inflows due to fluctuations in production, demand, and price. Hence, if the budget is based on a particular reference price for the resource, actual revenues will often over- or under-perform based on the actual resource price. In case of underperformance, the country then faces, the choice of continuing the smooth implementation of the budget, if price movements are only seen as temporary, or adjusting expenditure downward. The question is, are there approaches to insulating the budget from such unpredictable cash flows?
On the policy side, one option stands out: the creation of a "rainy day fund" from revenues from the resource. The rainy day fund helps to facilitate revenue flows. Other options include of course direct borrowing, possibly against future revenue flows. This is usually expensive in countries with poorly developed capital markets, or can lead countries down a debt spiral. Many indebted resource economies have actually had worse economic growth than countries without resource wealth. Yet another option is decreasing the portion of non-discretionary spending (for example, entitlements), so that expenditure can more easily be postponed.
The size of rainy day funds and annual in- and outflows in it, should be determined in accordance with the importance of the resource revenue for the medium-term budget needs, and the volatility of resource price. Ideally such a Fund must be managed on a hands-off basis from the ministry of finance or the political level (except in national emergencies), with access being rule-based. Temptations to poach from the fund for political expediency should be resisted. In practice this is difficult; one of the reasons for the poor track-record of rainy day funds,
There are a number of options to set up a rainy day fund. In times of revenue over-performance, the surplus revenue could be saved. Another option is to negotiate an advance against future supply of such a resource and to use that money to create the fund. Some low-income countries have also negotiated concessionary loans from multilateral institutions as initial capital. The investment income of the fund and any revenue over-performance in good times can feed the use of the fund in bad times. If the fund grows excessively or, as often witnessed, needs replenishing often, this obviously is a serious indication that the reference price for the budget needs to be adjusted. Instead of a rainy day fund, the country could in theory also hedge against the volatility of resource prices in the options markets. However, this would require a degree of sophisticated financial market expertise which many such countries may not have, and may prove more expensive than the financing costs of the fund.
Managing rainy day funds requires a lot of discipline and well-designed governance framework. In the past countries have often disregarded these requirements. In addition, in support of the management of the fund, a number fundamental reforms in budgetary management in the country are often advisable. These are, for example: preparation of a medium-term budget scenario, including cash flow projections; managing all public sector cash in a unified manner (a Treasury Single Account with a very wide coverage); and introducing cash planning and management.
Developing cash planning and management which would involve: creating a cash planning unit in the ministry of finance; developing cash forecasting capacity both for cash inflows and outflows on an annual and rolling quarterly basis; establishing information flows and systems from budget entities to the cash planning unit. It would also involve other important steps including, establishing spending and cash allocation priorities in budgetary spending; establishing rules on borrowing requirements or support from the "rainy day fund"; and, developing investment strategies for short term cash surpluses.