In resource-rich developing countries (RRDC), the main goals of fiscal rules—numerical constraints on the budget balances, spending or debt—are to address the exhaustibility and volatility of resource related income, while prioritizing development spending. Yet many countries find it difficult to stick to these rules, particularly in bad times. A recent study by the Natural Resource Governance Institute shows that, of the 34 resource-rich countries with a least one fiscal rule in place in 2015-2016, only six adhered fully to their rules following the latest commodity price crash. Worse, some countries did not follow their rules in good times either.
The implementation of fiscal rules depends critically on the quality of PFM systems. A system where budget execution is weak, for instance, will not deliver the fiscal outcomes as planned.
While it can be argued that all PFM systems matter for the implementation of fiscal rules, the most fundamental elements are strong macroeconomic and fiscal forecasting, a robust system of preparing the annual budget, reliable medium-term expenditure ceilings, timely and accurate fiscal reporting, and—since infrastructure is often the lynchpin of the strategy of RRDC governments to use of resource wealth—good public investment management.
Ideally, countries should start improving their PFM systems well before the natural resource revenues start flowing. The following areas of PFM are especially important:
- Strengthening budgetary management. The effective implementation of fiscal rules requires a strong Medium-Term Expenditure Framework (MTEF) that sets credible and preferably binding aggregate expenditure ceilings over the medium term. A robust MTEF requires (i) strong political ownership of the top-down fiscal objectives, (ii) the ability to prepare reliable forward estimates of the cost of existing and new policies and projects, and (iii) the ability to set budgetary ceilings based on the above. At the execution stage, a strong MTEF requires effective commitment controls, the prevention of spending arrears, and limited recourse to supplementary budgets, all of which are critical to the credibility of fiscal rules.
- Improving fiscal reporting. To be effective, the coverage of fiscal rules should be broader than budgetary central governments, and ideally extend to the general government sector. Comprehensiveness matters: a fiscal rule with narrow coverage increases the temptation for governments to embark on extra-budgetary operations to bypass the rule. The definition of petroleum revenues should also be clearly spelt out, particularly when a non-resource balance is targeted.
- Enhancing the reporting of fiscal risks. In a rules-based framework, particularly with volatile resource revenue, governments should be transparent about the risks they face, and how they are being managed. In the face of resource revenue volatility, providing the public with a clear statement of fiscal vulnerabilities to resource price downturns, and the kind of fiscal adjustments that would be required can help build support for prudent and less pro-cyclical fiscal policies.
- Improving fiscal transparency. International experience points to the critical role of fiscal transparency in the sustainable management of resource revenues. Transparency should cover each stage of the revenue extraction cycle—the allocation of resource rights, resource revenue mobilization and management, and reporting on resource sector activity.[2] The special characteristics of the sector—volatile and uncertain future revenues, large potential rents, upfront costs and long production periods—underscore the need for transparent practices that can foster the more efficient use of public funds, reduce the risk of unstable macroeconomic policies, and improve public confidence in the budget process.
- Improving public investment management (PIM). The goal in resource-rich economies with limited resource horizons is to transform their underground wealth into durable wealth. In a capital-rich economy, this could translate into the accumulation of financial wealth. In a capital-scarce economy, the emphasis could be on developing public infrastructure and spending for development. Scarcity of capital does not mean that public investment will automatically translate into a larger and more efficient public capital stock, and evidence shows that “leakages” can be greater than 50 percent in many LICs. The benefits of RRDC improving their PIM institutions (by “investing in investing”) ahead of scaling up their infrastructure spending are potentially large. Evidence shows that, for the same dollar spent, countries with the most efficient institutions can get twice as much growth in the first four years as those with the least efficient institutions.
[1] Fazeer Sheik Rahim and Richard Allen are respectively Senior Economist and Visiting Scholar in the IMF’s Fiscal Affairs Department.
[2] See IMF Fiscal Transparency Code Pillar IV for the principles for good practice. Available at https://www.imf.org/external/np/fad/trans/.
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