Transcript Characterizing the Business Cycles of Emerging

MANAGING NATURAL RESOURCES
REVENUE: The Case of Chile
Rodrigo Fuentes
Pontificia Universidad Católica de Chile
Maputo
March 25, 2009
Motivation
• NR: curse or blessing? Still open question
– Fiscal response is one of the key elements
– After a boom there is always a bust
• Why Chile?
– Chile supplies 43% of world copper exports
– CODELCO produced 16.4% of Gov. revenues in 2007
– Pressures for higher government expenditures
• Main goal of my presentation: show how
government ‘s copper revenues are managed to
avoid undesired outcomes
Are resources well managed? Yes!
• Transparency in the public finance
• Fiscal rule determines the timing of
spending copper revenues
• Fiscal rule + stabilization fund avoid
appreciation of the local currency
• Natural resources’ privatization
• Institutions and property rights are
essential to make the above policies work
This presentation
• The role of copper in the Chilean economy
• Early reforms on fiscal discipline and how
they survived over time
• The role of contracts with the private sector
• Government saving, intergenerational
transfers and financial crisis
• Policy lessons
The role of copper in the
Chilean economy
Price of Copper: Recent booming episode
450
400
350
300
250
200
150
100
50
Nominal
Real (*)
(*) Deflated by USA Wholesale Price Index, basis July 2008=100.
Source: Chilean Copper Commission.
20
0
20 5
07
20
00
19
95
19
90
19
85
19
80
19
75
19
70
19
65
19
60
0
Copper production by CODELCO versus
private producers
(thousands tons of fine copper)
6,000
5,000
4,000
3,000
2,000
1,000
0
1990
CODELCO
Source: Chilean Copper Commission.
1998
2007
Other Producers
Foreign direct investment
(nominal millions US$)
30,000
25,000
20,000
15,000
10,000
5,000
0
8,239.1
2,398.7
1974-1989
4,400.2
1990-1994
4,114.9
1995-1999
Mining and quarrying
Manufacturing Industries
Financial services
Other Sectors
Source: Foreign Investment Committee.
2000-2004
2,021.7
2005-2007
Electricity, gas & water supply
Mining investment in Chile
(nominal millions US$)
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1976-1989
1990-1994
Public
1995-1999
2000-2004
2005-2007
FDI
Source: CODELCO, ENAMI and Foreign Investment Committee. Data for 19741975 was not available for public investment.
Government's revenues
(million Chilean $ of 2007)
100%
80%
60%
40%
20%
0%
1990
Tax revenue
1998
Copper
Source: The Budget Office of the Ministry of Finance (DIPRES).
2007
Other revenues
Early reforms on fiscal discipline
and how they survived over time
Fiscal reforms: Initial conditions
• How was a responsible fiscal rule shaped
over time? How and when did it start?
• Long history of failure: WWII to1970
• Nationalization of large copper mines, 1971
• Budget deficit (12%) financed by the
Central Bank: 1973
• High barriers to trade, financial repression,
price control: 1973
Balancing fiscal accounts
• The Military government after 1973
– moved toward market economy
– liberalized prices and interest rates
– introduced a drastic trade reform
– privatized SOEs
– established a new pension fund system and
– enforced fiscal and monetary responsibility
Some of the principles
behind the reforms
• Secured property rights
• Fiscal consolidation and orthodox
management of monetary and foreign
exchange policies
• Favoring rules instead of public discretion
• Institutionalization of “rules of the game”
New environment
• Drastic reduction of public spending, tax
reforms and privatization of SOE
• New fiscal institutionalism. 1975: State
Financial Administration Law
• New constitution to shape political
structure:
– preserve continuity of policies
– strong presidential system: President controls
budget and legislative agenda
Democratic government: 1990 • Keeps fiscal austerity: surplus in the 90s
• 2000: Explicit fiscal rule
– structural surplus of 1%
– recently cut to 0.5%
• Structural balance
– tax revenues estimated at long-term trend GDP
– prices of copper and molybdenum at their longrun level
• Structural balance isolates cyclical effects
Fiscal deficit of central government
1960-2007
(percentage of GDP)
Source: The Budget Office of the Minister of Finance (DIPRES), Jofré, Lüders and Wagner (2000).

*

 Yt  
*

Bt  Bt  NMTRt  NMTRt     MTRt  MTRt*  CRt  CRt*  MRt  MRt*

 Yt  


 
B *t 
Structural balance
Bt 
NMTRt 
MTRt 
Effective balance
Net non-mining tax revenues and social security payments
MTR *t 
Structural tax revenues from private mining companies
Yt 
Effective GDP
Yt * 
Trend GDP
CRt 
Effective transfers from CODELCO (copper sales)
CR*t 
Structural transfers from CODELCO ( copper sales)
MRt 
Effective transfers from CODELCO (molybdenum sales)
MRt* 
Structural transfers from CODELCO ( molybdenum sales)
GDP elasticity of non-mining tax revenues
=
Tax revenues from private mining companies
 

Contracts with the private sector
Private sector is important in
harnessing the revenues from NR
• Provides required capital
• Faces risks of expropriation
• Shares NR rents with the State
→ Government needs to provide right
incentives to promote investment
Chilean policies for FDI and copper
• Decree Law 600 for FDI, 1974
– guarantees rights to transfer capital and benefits
– establishes non-discrimination principle between
foreign and domestic investors
– tax treatment
• invariability of tax system
• accelerated depreciation, cumulative losses and
interest payment deducted for tax purpose
• Organic Constitution Law of Mining
Concessions, 1982
– compensation in case of expropriation=NPV of
verified reserves
Chilean policies for FDI and copper
• Chilean Mining Code, 1983
– State is absolute owner of all mines
– Can grant concessions for exploitation and
exploration
• Before 2005, fiscal regime targeted profits rather
than revenues
• Problem: government did not collect much taxes
from mining activities
• Is there rents in copper mining?
• Royalty on mining from 2006 and on
Royalty tax according to the annual
sales of a mining operator
Annual sales of the mine operator
1. Mine operator with annual sales equal to or less than the equivalent of 12,000 MFT
Rate
Not subject
to the tax
2. Mine operator with annual sales equal to or less than the equivalent of 50,000 MFT,
and greater than the equivalent of 12,000 MFT
2.1 Regarding that portion in excess of 12,000 and no greater than 15,000 MFT
2.2 Regarding that portion in excess of 15,000 and no greater than 20,000 MFT
2.3 Regarding that portion in excess of 20,000 and no greater than 25,000 MFT
2.4 Regarding that portion in excess of 25,000 and no greater than 30,000 MFT
2.5 Regarding that portion in excess of 30,000 and no greater than 35,000 MFT
2.6 Regarding that portion in excess of 35,000 and no greater than 40,000 MFT
2.7 Regarding that portion in excess of 40,000 MFT
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
4.5%
3. Mine operator with annual sales greater than 50,000 MFT
5.0%
Source: Foreign Investment Committee.
Government savings,
intergenerational transfers and
financial crisis
Planned uses of copper resources
• Revenues from royalty → Fund for Innovation
and Competitiveness
• Fund for Social and Economic Stabilization, FESS
– smoothes effects of copper’s price
• Pension Reserve Fund, PRF
– minimum and solidarity pensions
– must be increased by 0.2% (min) to 0.5% (max) of
previous year’s GDP
Sovereign Wealth Funds (SWF)
• Ministry of Finance decides:
– Investments of and withdrawals from funds
• Central Bank intermediates both funds
– delivers daily, monthly and quarterly reports
– FESS: 12% of GDP (08/2008)
– PRF: 1.5% of GDP (08/2008)
• According to Walsh et al. (2008)
– management of the SWF is transparent and
according to best practice
Chile’s sovereign wealth
funds allocation
(percent of total assets )
Sovereign Bonds (Nominal)
Sovereign Bonds (Inflation-Indexed)
Money Market Assets
Corporate Bonds
Equities
Total
Current*
69
1
30
0
0
End-2008 target
45
15
5
20
15
100
100
*As of August 2008.
Sources: Ministry of Finance (2008 a, b) and Walsh et al. (2008).
Fiscal policy may worsen the crisis
• Evidence
– Deliberate ‘countercyclical’ discretionary policy
has not contributed to economic stability
(Feldstein, 2002)
– Let the automatic stabilizers work (Taylor, 2009)
• Carefully financial assistance to financial
sector and new regulation scheme
• Role for monetary policy
• Chile: fiscal rule is an automatic stabilizer
Concluding remarks and
policy lessons
Main lessons from the Chilean case
• Private sector involvement is crucial for
extracting NR under financial capital scarcity
– How to share NR rents
– How to ensure property rights
• Fiscal rule
• SWF smooth government expenditures
• Government reputation, good institutions and
policy improvements → save in good times
for bad times
MANAGING NATURAL RESOURCES
REVENUE: The Case of Chile
Rodrigo Fuentes
Pontificia Universidad Católica de Chile
Maputo
March 25, 2009