Speech

The EITI in a Volatile World, Remarks by Takatoshi Kato, IMF Deputy Managing Director at the 4th Extractive Industries Transparency Initiative (EITI) Global Conference

February 19, 2009

As Prepared for Delivery

Introduction

Let me begin by thanking the Board of the EITI for having invited me to join these discussions today in Doha and congratulating them on the solid foundation that they and the Oslo Secretariat have built for the EITI. The International Monetary Fund has been associated with the EITI from its earliest days, and this is now the third conference for which I have had the privilege of representing the IMF.

At the IMF, we strongly support the emphasis the EITI places on transparency as a method for establishing credibility and accountability for the collection and use of natural resource revenues. For us, transparency is a cornerstone of successful fiscal policy. That is why we produced and recently updated our Guide on Resource Revenue Transparency, which applies the IMF Code of Good Practices on Fiscal Transparency to the needs of resource rich countries. The IMF is working closely with the EITI on developing its policy stance and in assisting countries to implement their commitments under EITI. Indeed, the IMF has decided to seek additional funds from donors through a new trust fund so that we can step up our assistance to countries with natural resource-related issues. It should be said, the IMF also benefits from the EITI, especially as it broadens the public debate in countries on how best to manage country’s extractive resources over the long term.

World Economic Outlook

Let me turn now to the subjects of discussion this afternoon, price volatility and how it relates to the EITI; how the EITI can help with energy security; and how to engage emerging economies in the EITI.

For a start, allow me to sketch the dire economic backdrop to our meeting today. According to our projections, the world economy is facing a deep downturn. The most severe financial crisis since the Great Depression has pushed advanced economies into recession. According to the IMF’s January forecasts, the output in these economies is expected to contract by 2 percent in 2009. This would be the first annual contraction in the post-war period for this group of countries as a whole. Emerging economies are also seriously affected. While growth in these economies is still projected to above 3 percent in 2009, many of them face a difficult adjustment to the weakening global economic environment. Overall, global growth in 2009 will be no more than one-half percent, with the oil price assumption of 50 dollars per barrel for 2009 and 60 dollars per barrel for 2010 and gradually recovering to 3 percent in 2010, compared to growth of more than 5 percent in 2007 and more than 3 percent in 2008.

Commodity Price Volatility

The link from this extraordinary financial and economic crisis to commodity price volatility—our first topic—is obvious. Commodity prices have always been volatile. Long-term studies have shown that volatility increased with the advent in 1972 of flexible exchange rates. Prices are affected by long-term supply and demand factors, but also by cyclical factors. Moreover, because commodities are assets, their prices are sensitive to expectations about future prices informed by perceptions of such elements as geopolitical developments, commodity price cycles, exchange rate movements, or financial market developments. What we observed last year was dramatic by historical standards: a drop in oil prices from 140 dollars per barrel in July 2008 to around 42 dollars at the end of January. Probably all of the factors I mentioned were at play but the implosion of the financial sector and the drop in world economic activity dominated.

Such extreme price volatility presents sizeable challenges to the extractive industry and to the producer countries. Volatility complicates the environment in which decisions are made about capital investments and research and development. Investment projects, which looked very attractive a year ago in high-cost oil fields, are being cancelled or postponed because they do not break even at current prices. This may threaten future supplies. Volatility provokes investors to reduce holdings of commodity assets because of increasing concerns about counterparty risks, availability of credit, and liquidity. Finally—and this is directly relevant to the EITI—more volatility means extractive industry revenues are harder to project, and that in turn complicates the task of making sure all revenue is properly captured in the budget planning.

Volatility can be reduced through transparency. An important lesson being drawn out of the current crisis is that markets, and the institutions meant to regulate them, perform better in a transparent environment. Transparency generates confidence, integrity, and accountability, all necessary for the efficient functioning of markets. It also enhances predictability and stability of prices. The Joint Oil Data Initiative (JODI), launched in 2001, can be of enormous help in reducing noise in oil markets by ensuring the supply of more and better information on the global supply and demand of petroleum products. Already, about 90 countries participate in JODI, but of the 24 EITI candidate countries, only five do. Hopefully, as EITI countries become used to transparency, more of them will sign up to JODI. International transparency initiatives such as JODI and the EITI have an additional benefit as they create new cooperative relations between producing and consuming countries, which should help better balance supply and demand.

Commodity prices will remain volatile, and therefore producer countries must take this into account in their policies. Expenditures should not follow the year-to-year fluctuations in commodity revenues. They should aim for a medium-term expenditure path that is consistent with long-term fiscal sustainability given the exhaustible nature of the EI resources. This may involve creating stabilization funds or building up a comfortable buffer of international reserves. Protecting spending in the short term from volatility in commodity prices will also be counter-cyclical—providing useful support in current circumstances. Finally, and most importantly, countries whose economies are now heavily dependent on commodities extraction should strive to diversify their economies. In this connection, we believe the Generally Accepted Principles and Practices—so called “Santiago Principles” proposed by an International Working Group on Sovereign Wealth Fund will provide useful guiding principles resource-rich countries can turn to.

Energy Security

The EITI also helps to promote energy security. The EITI enhances public knowledge about the extractive industries, their production, investments, revenues, and many others. Thanks to that, the public is building more realistic expectations about future benefits and trust in public institutions is bolstered. That in turn should put relations between governments and their extractive companies on a more stable footing. As the EITI matures and expands, the transparency it promotes will help create in countries rich in natural resources a climate that is favorable to investment in exploration and exploitation. The extractive companies—and their customers—will appreciate knowing that their exploitation of depletable resources is compatible with the long-term interest of their host countries.

Engaging Emerging Market Economies in the EITI

Finally, I would like to discuss approaches to engage emerging economies in the EITI. In today’s globalized world, no international initiative can succeed without the active participation of the large emerging market economies. Therefore, we must convince them that joining the EITI is in their interest, for it clearly is. Some are themselves large producers of oil, gas and minerals, and as such stand to benefit from the accountability framework offered by the EITI. Others are home to the extractive companies operating abroad, and they therefore have responsibility to make sure those companies behave in the best interest of the countries in which they operate.

It has not been easy to convince many of them yet of the benefits of EITI. Perhaps they could be given a greater sense of ownership with certain changes to the EITI governance structure, such as modifying the distinction between supporting and participating countries. In that connection, we should welcome Norway’s decision to both implement and support EITI. Other supporting countries could explain publicly how their accountability and transparency arrangements substantially achieve the EITI’s objectives, short of implementing EITI. Thus, EITI could become a useful tool not only for developing but also for all countries, including emerging market countries.

Broadening and Deepening EITI

Let me conclude with a few thoughts on broadening and deepening the EITI. Out of 48 countries the IMF considers rich in natural resources, only 24 are currently EITI candidates. It is not only emerging markets that are missing. Of the 24 candidates, only 10 have produced any sort of EITI report. More countries should become candidates and more candidates should produce reports, and those reports should be more timely. The validation process should help instill discipline in implementation and in upholding the EITI Criteria. The simplicity of the EITI’s objective—publication of extractive industry payments and revenues—is the reason for its popular appeal. However, pursuing it properly requires great cooperation from the extractive companies, and it is demanding on the candidate countries, particularly on the capacity of their revenue administrations. EITI reports can provide meaningful accountability only if all extractive companies participate, and if all material revenue streams are covered. Rigor requires that they be clear on the extent of participation and the completeness of coverage. Moreover, they should show how the amounts reported to EITI relate to the actual extractive industry revenues in the budget. After all, it is through the budgetary process that the utilization of revenues should be decided.

Thank you.