Transcript the role of fiscal rules and oil management funds in oil

THE ROLE OF FISCAL RULES IN OIL
REVENUE MANAGEMENT-NIGERIAN
EXPERIENCE
Dr. Bright E. Okogu, D. Phil (Oxon.)
Senior Special Advisor to the Honorable Minister of
Finance, Nigeria
Presentation to a Workshop organized by the Angolan Government
Luanda, 15-19 May, 2006
Order of Presentation
• Introduction
• Oil: How a potential blessing can become
a curse
• Some theory: strategies to ensure
effective management of oil revenue
• From theory to practice: Nigerian
experience of oil revenue management
• The Nigerian Fiscal Responsibility Bill/Law
• Summary and closing thoughts
Oil as a potential economic ‘curse’
• Conventional wisdom of resource endowment as
source of wealth (Adam Smith & David Ricardo)
• Resource ‘curse’ a direct contradiction
• Resource rich countries found to grow more
slowly (Gelb, 1988); higher corruption, greater
income inequality, poverty & conflict (Palley,
2003; Hoeffler, 1998, 2001), etc.
• Numerous country examples (Africa &
elsewhere)
• Transmission channels include:
– ‘Dutch Disease’ effects;
– macroeconomic volatility (discourages investment &
growth);
– rent-seeking behavior (Aizenman and Marion, 1993; Fátas
and Mihov, 2003 ); poor quality of capital spending; weak
public expenditure management, etc.
In the case of Nigeria…
• Most of the negative effects were
experienced:
– Macroeconomic volatility (see charts in next 2
slides)
– Corruption
– Uncoordinated budget implementation; so
aggregate demand unpredictable
– Low level conflict, etc.
Nigeria exhibited procyclical expenditure
behavior before reforms
Pro-cyclical public expenditure pattern, 1971-2001
90
80
CHART 3: TRENDS IN % CHANGES IN OIL REVENUE AND
TOTAL EXPENDITURE: 1971-2001
60
50
40
30
20
10
% CHANGE IN REV
& EXP
70
300
250
East
West
North
200
150
100
50
0
1971
-50
1976
1981
1986
1991
0
1996
2001
Oil revenue
1st Qtr
2nd Qtr
3rd Qtr
YEARS
4th Qtr
Total Expenditure
De-linking expenditure from oil revenue
since reforms
Figure 2. Procyclical Expenditure Pattern: % Change in Oil Revenue Vs. Expenditure
150
100
50
0
2000
2001
2002
2003
-50
Oil Revenue
Total Expenditure
2004
2005
2006
OVERVIEW OF OIL PRICE TREND
Major Events and World Oil Prices (1970-2004)
45
Venezuela
Refiner Acquisition Cost of Imported Crude Oil (Saudi Light Official Price for
1970-73)
Unrest
40
Iran-Iraq War
Saudis abandon
"swing producer" role Operation Desert
Storm
35
Nominal Dollars per Barrel
30
OPEC cutbacks
25
20
15
10
Arab Oil
Embarg
o
9/11 attacks
Iranian Revolution
Iraq Invades Kuwait
Asian economic crisis; Iraq
oil-for-food
5
0
1970
Source:
EIA
1975
1980
1985
1990
1995
Major World Events impact on Oil Prices
2000
2004
Strategies for Managing Oil Revenue
• Key issues
– Protection of the budget process (stabilize level of expenditure)
– Exhaustibility of oil resources (planning for the future; fiscal
sustainability)
– Intergenerational equity considerations
• Suggested approaches
– Choice of, & adherence to, a rule fiscal (to de-link expenditure from
oil revenue)
– Rule must be explicit and publicized to protect implementers
– Build consensus around it & must have strong political support
– Pay attention to the choice of benchmark oil price: moving average
(3, 5, 10-year average?)
– Danger is if moving average is used, and actual price deviates
significantly from this, the fund could be jeopardized due to large
withdrawals
– Integrate adaptive expectations into system, e.g., automatic cuts
after a certain level of deviation plus some withdrawal
– IMF had suggested 3-5 year average for Nigeria (Katz et al, 2005)
– Target a level of international financial reserves, but how much?
Types of Funds…I
• Stabilization fund (to protect the budgeting process;
guarantee minimum expenditure levels)
– Build up fund in boom times
– draw down in weak market periods
– Weakness relates to behavior of the oil price: random
walk; weak mean reversion feature
– Fund can quickly become exhausted if actual price is
below benchmark price for longer than envisaged
• Stabilization fund has disadvantage that it looks
after the interest of present generation only; no
guarantee of savings for future generations
– But…if well run, will leave strong economy for future
generations (physical & social capital)
Types of Funds…II
• Savings fund (mostly to protect future consumption;
intergenerational equity)
– Require given percentage of revenue or expenditure to be saved
in fund (example of Kuwait)
– Idea is to build up fund to a comfortable level; convert oil assets
into financial assets
– Limit consumption to income flows from stock of assets, thus
keeping value of wealth constant
– More stringent version is keeping per capita wealth constant
– An even more stringent version is the so-called “bird-in-hand”
approach (obsolescence argument)
• For these issues, see, e.g., Davies et al (2001); Barnett and
Ossowski (2002); Davies et al (2003).
• Problems include
– Complexity of operation (capacity issues; political support)
– Assets can grow indefinitely; problematic for developing country
with huge needs
– Always a tempting target for succeeding governments, which may
then waste it; this fear could discourage governments building it
– Examples of Kuwait, State of Alaska, Venezuela (mixed results)
Types of Funds…III
• Financing Fund (Norwegian model)
• Fiscal policy operated as though there was no
oil revenue
• Oil revenue used to finance non-oil deficit; it’s a
below-the-line item
• Stock of funds used to pay for long-term
obligations, e.g. pensions
• Problem is that it is not easily adaptable for
Developing Countries where non-oil revenue is
small (Nigeria non-oil primary balance now
about 40% even under the PSI)
Practical steps for improving oil
revenue management
•
•
•
•
•
Diversify the economy
Broaden the tax base
Discourage ‘white elephant’ projects
Watch quality of capital spending
Reform public procurement procedures.
Due Process has saved Nigeria about
$3bn in last 4 years
• Get into a transparency pact, e.g. the EITI
OIL REVENUE MANAGEMENT IN NIGERIA
• Public expenditure management at the core of the
reforms for better oil revenue mgt
• Price-based fiscal rule introduced since 2004 ($25/b
in 2004; $30/b in 2005; $35/b in 2006)
• Any revenue above this price is saved in an Excess
Crude Oil Account
• It is a mixture of stabilization & savings fund
• Savings provided resources for clearing Paris Club
debt; part of it being used for power projects
• Medium-term expenditure framework (to force hard
choices & minimize abandoned projects syndrome)
• Cash management committee
Some Results of Reforms/Oil Fund
• Strong fiscal performance
– Surplus of 10% of GDP in 2004; 10.6% in 2005
(consolidated)
– $5.9bn in oil fund account in 2004; another $13.4bn in
2005
– Foreign reserves rose from $7bn at end 2003 to
$17bn at end 2004; & $28.3bn at end 2005
– No resort to borrowing from CBN/comm. banks
– Broad money targets met for first time in decades
– Inflation down from 23% in December 2003 to 10% at
end 2004, and 11.6% at end 2005
– Strong performance set backdrop for Paris Club debt
deal & sovereign ratings (BB-) by Fitch and S & P.
Institutionalizing the Process: The
Fiscal Responsibility Bill
• Sets of rules to be embodied in legislation
committing all tiers of government to:
– Fiscal prudence and sound financial
management
– Withdrawal from the fund only when commodity
price falls below predetermined level for 3
consecutive months
– Greater transparency and accountability in public
finance.
– Improve inter-governmental fiscal coordination to
secure greater macroeconomic stability
Institutionalizing the Process: EITI
• For confidence building among population,
Nigeria was first country to sign up for EITI
• Sector generally seen by Nigerians as corrupt &
non-transparent
• Carried out financial, physical & process audit
of oil & gas sector, 1999-2004; results shared
widely with public
• Standard templates now being designed for
regular reporting; will help to institutionalize
process.
Some Features of the Bill
•
•
•
Section 2.- of the FRB empowers Fiscal Responsibility
Council to:
(a) compel any person or government institution to disclose
information relating to public revenues and expenditure;
Section 39. sets the basis for the savings fund: (1) Where
the Reference Commodity Price rises above the
predetermined level, each Government in the Federation shall
save its share of the resulting excess proceeds in accordance
with subsection (2) of this section.
(2) The savings of each Government in the Federation in
pursuance of subsection (1) of this section shall be deposited
in a separate account, which shall form part of the respective
Governments Consolidated Revenue Fund to be maintained at
the Central Bank of Nigeria by each Government.
(3) 5-year moving average; but due to recent high oil price, a 10year average will be used initially plus spread </= $5/b
Why the Law ?
 The Law is a key ingredient of NEEDS. Without it,
our economic reforms won’t work.
• Need to secure greater macroeconomic stability
 Nigeria’s 3 tiers of government have
constitutional autonomy. But together they make
up ONE NIGERIAN ECONOMY.
• FG controls less than 50% of revenue but has
responsibility for macroeconomic stability.
• Bad fiscal decisions taken by some tiers of
government have had drastic effects on inflation,
exchange rates, interest rates, etc.
• Need to instill and institutionalize transparency
and accountability in economic management
The Medium Term Economic
Framework
• Conceives budgeting as multi year exercise
• Efficiently reconciles needs with available
resources
• Allocates money to strategic priorities among
and within sectors
• Commences with the preparation of a
macroeconomic framework and guidelines
• Forms basis for preparing projects and
programmes in the annual budgets
More from the FRB
• Under Section 2C, the Council shall cause to be
prepared:
• An Expenditure and Revenue Framework setting
out –
• (i) estimates of aggregate revenues for the
Federation for each financial year in the next three
financial years, based on the predetermined
Commodity Reference Price adopted;
• (ii) aggregate expenditure ceiling for the
Federation for each financial year in the next three
financial years;
• (iii) aggregate tax expenditure for each financial
year in the next three financial years; and
• (iv) minimum capital expenditure floor for each
financial year in the next three financial years;
Expected Impact on Nigeria Fiscal System
The Fiscal Responsibility Law will:
Commit all tiers of government to a set of
efficient rules for economic management
– Standardized planning and control of public
expenditure
Bring a long-term, as well as annual focus to
budgeting
Bring harmony between fiscal and monetary
policy
Enforcement mechanisms
• The Fiscal Management Council will be
responsible for monitoring and enforcement
• investigates and forwards violations to the
Attorney General for prosecution
• One year imprisonment and N500, 000 fine for
officers who failure to perform obligation or false
statement (Section 56).
• 3 years minimum jail sentence for contraventions
• Finance Minister/Commissioners held liable
and subject to punishment
Lessons Learned
• Need strong political support
• Ownership of program essential
• Build consensus among key arms of government;
compromise if necessary (we shared 50% of
saved amount in 1st year to encourage buy-in
• Some quick wins needed (e.g. publicize balance)
• Management of fund must be open &
transparent; let public know
• Top tier of government must lead by example in
prudent fiscal management.
Closing Thoughts
• Oil resources can be the blessing it should be;
the key is efficient mgt of revenue thru
appropriate fiscal rules
• There are different approaches to this: each
country will have to decide which model is most
appropriate to it
• Nigerian experience has been relatively
successful, but still ad hoc; FRB to underpin &
institutionalize it
• Essential to have a buy-in of key stakeholders;
ownership is critical; political support essential