Commodity prices, sovereign wealth funds, and fiscal policy: lessons from Chile and Norway

(1)

Commodity Prices, Sovereign Wealth Funds, and

Fiscal Policy: Lessons from Chile and Norway

Klaus Schmidt-Hebbel

Catholic University of Chile

[email protected]

Getúlio Vargas Foundation and VALE Conference on “The Economics and Econometrics of Commodity

(2)

Key Issues

• Resource-rich economies (RREs) at critical juncture:

• Decade of high commodity prices – resource boom • Most RREs lack appropriate fiscal institutions

• Fiscal stance: often weak and ineffective in promoting macro-financial stability, growth, and equity

• Fiscal position vulnerable to commodity price reversal

• Chile and Norway: two RREs with decade-long

experience of fiscal reform and good performance • They show the way forward in four key fiscal policy

(3)

Outline

1. Chile’s Fiscal Institutions and Policy

2. Norway’s Fiscal Institutions and Policy

3. International Evidence on Fiscal Policy and Macroeconomic Performance in RREs

4. Lessons on Fiscal Institutions for RREs 5. Conclusion

(4)

(5)

Chile’s Fiscal Policy Institutions in

International Comparison (1)

Institution Marks

Fiscal Responsibility Law √

Financial Management of Budget √

Budget Horizon X

Fiscal Rule √√

(6)

Chile’s Fiscal Policy Institutions in

International Comparison (2)

Institution Marks

Management of Gov. Balance Sheet X

Budget Accountability + Transparency √√

External Control and Auditing √

Fiscal Ad hoc Committees √√

(7)

Chile’s Fiscal Rule

• Cyclically adjusted government balance rule –

implies a-cyclical government spending (automatic tax stabilizers are still counter-cyclical)

• Unique: targets government spending to cyclically-adjusted revenue, adjusting for cyclical revenue due to cycles in GDP and mineral prices

• Has been in place since 2001

• Strong governance and political economy / support • Has generally worked well

• Except in 2009-10: rule was overruled because of insufficient counter-cyclicality; reestablished 2011 • Yet requires technical and institutional refinements

(8)

A Simple Rule (1)

Cyclical net saving (cyclically adjusted balance minus actual balance) is determined by cyclical revenue (c.a. revenue minus actual revenue):

Non-mining Tax Rev* = NMTR* = f (output gap) Mining Tax Rev* = MTR* = f (trend mineral prices) Mining Transfers* = CR*+MR* = f (trend min prices)

B

*_t

-

B

_t

=

(R

_t*

-

G

_t

)

-

(R

_t

-

G

_t

)

=

(9)

A Simple Rule (2)

• Actual overall government spending equals trend structural revenue net of structural balance:

G = R* - B*

• Hence government spending G is a-cyclical

• Government sets target for c.a. balance B* (net c.a. saving)

• Committees project trend GDP and mineral prices required for estimating c.a. revenue R* (strong political economy)

(10)

GDP Growth: Committee Forecasts and Actual Growth (%) -2% -1% 0% 1% 2% 3% 4% 5% 6% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

(11)

Copper Prices: Committee Forecasts and Actual Prices ($/lb) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 U S$ /C o p pe r p o u n d

(12)

Chile: Actual and cyclically-adjusted Gov. Balance (% of GDP) -5% -3% -1% 1% 3% 5% 7% 9% 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 R a o to G D P

(13)

Chile: Gov. Revenue and Expenditure Growth Rates (%) -25% -15% -5% 5% 15% 25% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 R e a l ra te o f g ro w th

(14)

Chile: Gross Assets, Gross Liabilities, and Net Assets of the Government, 1990-2010 (% of GDP) -40% -30% -20% -10% 0% 10% 20% 30% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 R a o to G D P

(15)

Chile: International Country Risk Guide Index (0-100) and EMBI Spread (in bp), 1990-2010

50 70 90 110 130 150 170 190 210 230 250 65 67 69 71 73 75 77 79 81 83 85 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

(16)

(17)

Rule’s Fiscal and Macroeconomic Effects

Reviews and research suggest Chile’s fiscal rule has: • Lowered pro-cyclical bias of fiscal policy

• Contributed to fiscal sustainability and credibility, lowering the sovereign risk premium

• Reduced macroeconomic uncertainty

• Lowered volatility of GDP, interest rates, and exchange rate

• Reduced dependence on foreign financing during downturns

• Improved protection of social programs during cyclical downturns

(18)

2. Norway’s Fiscal Institutions and

Policy

(19)

Norway’s Fiscal Policy Framework

• Oil production peaked in 2005 and is projected to decline significantly in coming years

• 2001: Norway adopted new fiscal framework

aiming at macro stability, fiscal sustainability, inter-generational equity, and resource use efficiency

• Three institutional pillars:

(i) Structural fiscal rule (ii) Sovereign wealth fund

(20)

(21)

Norway’s Fiscal Rule (1)

• Oil rents are transferred to SWF

• Cyclically-adjusted non-oil budget deficit financed by average transfer from the SWF at an (imputed) 4% real return on SWF investments

• Annual deviations of the latter transfer are allowed for further discretionary government spending

geared at counter-cyclical stabilization and expenditure smoothing

(22)

Norway’s Fiscal Rule (2)

• Therefore government spending is equal to:

• trend values of government tax revenue and excise duty

revenue and of Norges Bank transfers

• minus: trend values of unemployment benefit payments and of

net interest payments and transfers

• plus: 4% real return on SWF investments

• plus or minus: discretionary spending adjustment for cyclical

stabilization and to avoid excessive spending volatility

• Hence Norway’s fiscal rule:

1. is consistent with c.a. balance measure (like Chile)

2. is consistent with inter-generational rent sharing (not Chile) 3. allows for additional counter-cyclical spending (not Chile) 4. allows for additional spending smoothing (not Chile)

• Hence Norway has an outstanding rule in place with outstanding results since 2001

(23)

Norway’s Sovereign Wealth Fund

• Norway established Gov Petroleum Fund in 1990, renamed Gov Pension Fund Global (GPFG) in 2006 • GPFG is managed by Norges Bank Investment

Management, under investment guidelines issued by MoF

• GPFG investments are highly diversified internationally with 56% equity share of

outstanding total investments valued at 275% of mainland GDP in 2010

• Actual government surplus – the consolidated surplus of GPFG and the non-oil government

budget – are transferred to GPFG, at the tune of circa 20% since 2005

(24)

Norway: Government Budget and Pension Fund Performance

The National Budget 2 0 1 2

7

market value of the GPFG at the end of 2010, and thus the 4 pct. real return on the Fund in 2011, was somewhat higher than expected last autumn.

The proposed 2012 Budget implies an increase in spending of petroleum revenues in line with the average expected increase in the four percent path in the years ahead. M easured as a share of trend GDP for M ainland Norway, the structural

non-oil budget deficit will increase by about ¼

per centage point fr om 2011 to 2012.

M acroeconomic model simulations indicate that the overall impact of the Government's proposed budget on mainland GDP is broadly neutral.

These calculations take into account that different budget items may affect the activity level of the Norwegian economy differently.

The main features of the proposed Budget for 2012 are as follows:

- The spending of petroleum revenues, as measured by the structural, non-oil budget deficit, is estimated at NOK 122.2 billion, which is NOK 2.4 billion below the expected real return on the GPFG.

- An increase in the structural non-oil deficit

from 2011 to 2012 corresponding to ¼ pct. of

mainland trend GDP. The overall impact of Figure 3.1 Fiscal policy

B. Rea l underlying expenditure growth in the Fisca l Budget. Percent

A. Expected rea l return on the Government Pension Fund a nd structura l non-oil deficit. Bn. NOK (consta nt 2012 prices)

Fiscal policy

D. Consolida ted surplus in the fisca l budget a nd the Government Pension Fund. Percent of ma inla nd GDP -1 0 1 2 3 4 5 6 1985 1990 1995 2000 2005 -1 0 1 2 3 4 5 6 0 25 50 75 100 125 150 175 2001 2003 2005 2007 2009 0 25 50 75 100 125 150 175 Structural d eficit 4 p ct. real return 2015 2012 2012

C. Avera ge a nnua l cha nge in use of oil revenues a nd pension expenditures. Per cent of

ma inla nd trend GDP. 0,0 0,1 0,2 0,3 0,4 0,5 2001-2012 2012-2025 0,0 0,1 0,2 0,3 0,4 0,5 In creased use o f oil revenues

In creased expenditure on o ld-age an d d isability p ensions -20 -10 0 10 20 30 40 1986 1991 1996 2001 2006 -20 -10 0 10 20 30 40 2012 No n -oil bud get surplus

Co n solidated surplus in th e fiscal bud get an d th e Go vernment Pen sion Fund

(25)

Norway: Government Pension Fund Global (GPFG) Investment Portfolio, 1997-2011 (ratio to GDP, %)

0% 50% 100% 150% 200% 250% 300%

(26)

3. Fiscal Policy and Macroeconomic

Performance in RREs

(27)

Findings on Fiscal Policy and Outcomes in RREs

1. Natural resources: curse or blessing?

• curse where initial institutions are weak (Robinson et al.) • curse where taxes on non-resource sectors are low,

corrupting institutions (Salti; Bornhorst et al.)

2. Fiscal pro-cyclicality

• World evidence: fiscal policy is pro-cyclical (deepening cycles) when governance and institutions are weak, corruption is

widespread, fiscal credibility is low, financial markets are under-developed, and international financial integration is weak (Végh et al., Calderón and Schmidt-Hebbel, others) • Oil-producing countries: high fiscal pro-cyclicality in

2003-2009 (Villafuerte and Lopez-Murphy)

• GCC countries: spending follows resource rents, hence fiscal policy is pro-cyclical with a lag (Fasano and Wang)

(28)

Findings on Fiscal Policy and Outcomes in RREs

3. Weak fiscal sustainability

• Fiscal positions weakened in oil-producing countries duirng 2003-08 oil boom (V and L-M)

4. Fiscal vulnerability to commodity price reversals

• Fiscal positions are highly vulnerable to oil-price reversal in oil-producing countries (V and LM)

5. Macroeconomic volatility and Dutch Disease

• Fiscal policy pro-cyclicality has amplified business cycles in oil-producing countries (V and L-M, Abdih et al.)

• Pro-cyclical government spending leads to Dutch Disease during revenue booms -- hence RER misalignment, loss of competitiveness, and large non-resource curr. account deficits

(29)

Findings on Fiscal Policy and Outcomes in RREs

• Weak fiscal-policy institutions have adverse effects beyond policy pro-cyclicality and Dutch disease

• Opaque budgetary management and external control, lack of transparent fiscal policies and

budgets, and poor budgetary accountability lead to ineffective and inefficient government spending, misuse of government resources, and corruption • Adoption of modern institutional framework for fiscal policy makes major contribution to lessen adverse impact of commodity bubbles and

(30)

(31)

Lessons on Fiscal Institutions in RREs

• Frontier fiscal framework is key for the triple goal of fiscal policy:

• fiscal solvency (or budgetary sustainability) • macroeconomic stability

• inter-generational equity

• International experience in general and successful development of sound fiscal policy frameworks in Chile and Norway since 2001 suggest lessons in four key policy areas to strengthen fiscal policy

(32)

1. Strengthen Fiscal Institutions

• Adopt / reform Fiscal Responsibility Laws

• Strengthen government’s budget initiative and mgmt

• Extend budget horizon from 1 year to multi-year planning • Maximize fiscal policy transparency and accountability

• Strengthen external control and auditing of budget

execution and government accounts

• Strengthen fiscal analysis and monitoring by relying on

(33)

Government Budget Transparency in

International Comparison, 2010

92 90 87 87 83 83 82 72 71 71 68 65 63 61 58 56 52 South Africa New Zealand UK France Norway Sweden US Chile Brazil South Korea Germany Peru Spain Colombia Portugal Argen ne Mexico

(34)

2. Adopt a Fiscal Rule

• Adopt a fiscal rule based on cyclically-adjusted balance of the government

• Adjust for both domestic GDP cycles and

commodity price cycles – key budget variables

• Make rule consistent with a-cyclical or, preferably, counter-cyclical spending and spending smoothing • Preferably based on assumptions and forecasts of

key variables provided by independent committees • Possibly anchored in Fiscal Responsibility Law

(35)

3. Start/develop a Sovereign Wealth Fund

• Key complement of cyclically-adjusted balance rule • Effective and transparent corporate governance

• Transparent information of transfers between budget and SWF

• Investment portfolio composition set by maturity preference (length of commodity-price and GDP

cycles, inter-generational sharing), and risk aversion • Investment management bound by transparent

(36)

Transparency of Sovereign Wealth Funds in

International Comparison, 2011

(37)

4. Adopt Committees and Fiscal Council

• Special Independent Committees: focus on narrow tasks, like key budget forecasts or fiscal reforms

• Independent Fiscal Councils: based on ad hoc law, Board members voted by Congress. Responsible for following tasks and recommendations:

• Budget assumptions, projections, monitoring, and recommendation of corrective actions

• Medium and long-term fiscal projections and assessment of fiscal sustainability and corrective actions

• Assessment of macro-financial effects of fiscal policy

• Assessment and recommendations on government asset and liability management

• Technical advice and public hearings (Congress) on budget management and fiscal reforms

(38)

(39)

Conclusion

• The world has made much progress in some areas of

macro-financial institutions and policies – e.g., independent central banks and the conduct of (conventional) monetary policy

• Yet fiscal institutions and fiscal policies face major

challenges to strengthen sustainability of fiscal policy, its counter-cyclicality, and its transparency – in industrial and emerging economies alike

• RREs face a particularly serious challenge to break out of

the vicious circle between fiscal policy weaknesses and commodity cycles

(40)