Posted by Andrew Bauer1
A sovereign wealth fund (SWF) should serve a purpose; this seems obvious. Yet time and time again, as discussed in my previous blog, funds are established with no clear purpose or do not achieve their stated objectives.
Posted by Andrew Bauer1
A sovereign wealth fund (SWF) should serve a purpose; this seems obvious. Yet time and time again, as discussed in my previous blog, funds are established with no clear purpose or do not achieve their stated objectives.
The Alberta Heritage Savings Trust Fund in Canada, for instance, was designed in part to save oil revenues for future generations, yet failed to save in all but two years between 1987 and 2012. And, despite Trinidad and Tobago’s Heritage and Stabilization Fund’s mandate to mitigate the negative effects of oil revenue volatility on the budget, government expenditure consistently oscillates in line with swings in oil prices. This spending volatility has led to worse public investment decisions and slower growth than would have been the case if the Fund had worked as planned.
Equally bad, SWFs can become channels for corruption and patronage, diverting billions of dollars away from social service and infrastructure spending (see Kuwait and Libya).
In short, SWFs by themselves do not guarantee sound macroeconomic management. In fact, they may complicate budget processes and make public spending less accountable. Still, many international advisors and development partners continue to press for establishment of SWFs in oil-, gas- or mineral rich countries as a solution to the ‘resource curse’, often without a full appreciation of the risks involved.
SWFs can be useful, but only if they help fulfill at least one macroeconomic objective, such as mitigating the impact of oil or mineral revenue volatility on government spending or ‘parking’ oil windfalls until they can be spent more efficiently. Based on the Natural Resource Governance Institute (NRGI) and Columbia Center for Sustainable Investment’s (CCSI) global study of natural resource funds, for this to happen, two pre-conditions must be met: Appropriate rules must be enacted and there must be adequate oversight and enough broad-based consensus to ensure compliance with those rules.
What are ‘appropriate’ rules? While there is no one-size-fits-all, the NRGI and CCSI study offers guidance on formulating appropriate rules, described below.
Deposit and withdrawal rules: These determine the timing, amount and conditions for the fund’s inflows and outflows, either to or from the Consolidated or General Fund (the government’s main bank account). In some cases, these rules are the operational form of a macroeconomic framework. For instance, Norway’s rule (based on political consensus, not legislation) that the non-oil structural deficit cannot exceed four percent of GDP determines how much flows from their SWF to the central government account. In other cases, these rules are more ad hoc, such as Kazakhstan’s presidential decree that annual transfers from the National Fund to the budget be fixed at $8 billion per year, plus or minus 15 percent.
Withdrawal and deposit rules must be tight enough to constrain government spending but loose and flexible enough to withstand political pressures to spend more. For instance, Timor-Leste enacted a rule that only allowed it to spend 3 percent of petroleum wealth in any given year. This rule was too restrictive given the country’s capital scarcity, high poverty levels and the high social rate of return on domestic investment. As a result, the rule has consistently been broken. Further guidance on deposit and withdrawal rules can be found here.
Investment risk limitations: SWFs hold public assets to improve macroeconomic management or for safekeeping. As such, governments should not be allowed to gamble with these funds and their asset portfolios should reflect their purpose. For example, a petroleum fund designed for stabilizing budget expenditures would require more liquid assets than a savings fund designed to benefit future generations since the government might need to draw on these assets if oil revenues collapse unexpectedly. Guidance on investment strategies for SWFs can be found here.
Regardless of the asset allocation used, SWFs should be explicitly prohibited from investing in certain high risk assets, such as junk bonds. Governments also need to monitor conflicts of interest and set clear investment guidelines. Where there is inadequate oversight and rules are unclear, it is often too easy for the investment managers to invest with political allies, family or friends.
Equally, following the precedent set by Abu Dhabi (UAE), Botswana, Chile, Kazakhstan and Norway among others, SWFs should be strictly prohibited from investing domestically. Spending directly out of the SWF could bypass the normal budget process, including parliamentary, auditor, media or citizen oversight. This could result in inconsistencies with the budget and circumvention of controls and safeguards such as project appraisal, public tendering and project monitoring. In Angola, Azerbaijan, Iran and Russia, SWFs have been used as secondary budgets, becoming easy sources of patronage or financing for investments that support the political goals of fund managers.
Institutional structure: There needs to be a clear division of responsibilities between the legislature, president or prime minister, the fund manager, the operational manager and external managers to help funds meet their objectives and prevent corruption. Again, there is no one-size-fits-all solution, but guidance can be found here.
Transparency: Disclosure requirements need to be legislated. Oversight bodies like parliaments, fiscal councils, and the media cannot do their jobs unless there is adequate and verifiable information. The Alaska Permanent Fund (USA) is a model of transparency, which has helped to reduce conflict over the distribution and management of Alaska’s petroleum resources. A checklist of recommended disclosures can be found here.
As mentioned, even the best rules will not be followed unless there is effective and independent oversight of SWFs, and a broad-based consensus on these rules. Compliance is ultimately a political problem, and as such deserves a political response. The Government of Ghana took the initiative when, prior to the enactment of the Petroleum Revenue Management Act, it carried out extensive public consultations, ranging from a national survey on how Ghana should manage its petroleum revenues, to regional town-hall discussions, to soliciting technical advice from experts, civil society and the diplomatic community. These consultations provided Ghanaians and internationals with a feeling of ownership over the Act. A similar exercise is currently underway in the Northwest Territories, Canada, which has just established a Heritage Fund to invest mineral revenues. Such initiatives, in addition to formal oversight by the external auditor, the parliament, the media and formal bodies like Norway’s Supervisory Council or Ghana’s Public Interest and Accountability Committee, are not useful-to-have additions but essential components of successful fund governance. After all, rules established between the government, international financial institutions and expert advisors alone will likely not survive a political transition or even minor pressure to break the rules.
1 Economic Analyst, Natural Resource Governance Institute (formerly Revenue Watch Institute)
Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.
