IMF Survey: Finance for Africa's Post-Oil Deficits
August 30, 2007
- Governments should gather net financial assets during oil production years
- From their returns, governments can finance primary deficits in post-oil years
- Most sub-Saharan African oil producers' current public spending unsustainable
Oil prices, like prices of most other commodities, are volatile and hard to predict.
AFRICA'S OIL PRODUCERS
Oil-producing governments are learning not to base their long-term spending plans on such fickle earnings, particularly as oil is a finite resource that in some countries will run out fairly soon.
Previous episodes of energy price-driven boom-bust cycles have taught governments to avoid an excessively close correlation between international oil prices and government consumption. To that end, research literature has developed a theoretical framework to define, on the basis of available estimates of oil (and gas) reserves, a long-term fiscal-policy strategy that has governments accumulate net financial assets during the years of oil production.
From their returns, governments can finance primary deficits after oil reserves have been exhausted. The implication of this approach is, of course, that any current fiscal stance that is considerably more expansionary than is permanently sustainable will, eventually, need to be adjusted.
Governments thus face a choice between designing a gradual fiscal adjustment path while overall fiscal balances are in surplus, or having to contract fiscal policy sharply and abruptly once oil revenues start to decline, often to the detriment of the most disadvantaged segments of society.
The optimal policy would set spending at a constant level of GDP, equal to the expected annuity value of oil wealth and non-oil revenue. Governments invest a certain fraction of their oil revenues in alternative forms of wealth (in this case, financial). These assets generate a rate of return from which—when oil reserves are depleted—governments can finance a primary deficit indefinitely.
Fiscal benchmarks simulated in the IMF Working Paper "Old Curses, New Approaches? Fiscal Benchmarks for Oil-Producing Countries in Sub-Saharan Africa" imply that the current fiscal policy stance of most sub-Saharan African oil producers will need to be adjusted. Even on the basis of optimistic assumptions on key parameters, including those on the size of economically exploitable oil and gas reserves, most of these oil producers will not be able to maintain the current level of public expenditure.
Relative to an average non-oil primary deficit of 27 percent of non-oil GDP in 2004-06, when aggregated for all sub-Saharan oil producers, the corresponding estimates of a permanently sustainable deficit ranges between 11 percent (assuming the exploration of proven oil reserves) and 22 percent (assuming the exploration also of one-half of probable oil reserves as well as one-half of all proven and one-quarter of probable gas reserves).
For operational purposes, the benchmarks in the Working Paper represent an indication of the degree to which fiscal positions will have to be adjusted. The implementation of a long-term fiscal-policy framework would be aided by the definition of a clear fiscal benchmark, anchored in an appropriate definition of sustainability. This would provide policymakers, legislators, and civil society with a simple benchmark to distinguish sound and forward-looking policies from those designed only to address immediate demands.
The oil market has proven more volatile than other markets, and uncertainty regarding future economic conditions gives risk-averse policymakers additional precautionary motives for fiscal restraint in years of overall surpluses. At the same time, an appropriate investment strategy for net financial assets, which might imply changes to the institutional environment (especially for those oil producers with regional arrangements), could increase the permanently sustainable non-oil primary deficit by a considerable margin.
In addition, governments in sub-Saharan African oil-producing countries need to pay particular attention to measures aimed at raising the quality of public expenditure so as to ensure adequate growth and social payoffs. Governments have the tools at hands to raise the rate of return from public expenditure and, in so doing, foster non-oil growth and increase their fiscal space for maneuver (that is, the level of government expenditure that is consistent with long-term sustainability).
The Working Paper analysis, while capturing critical elements, remains incomplete. One avenue for future research would involve relaxing the assumption that government expenditure is consumption without any effects on productivity and growth. A richer model would allow for different rates of return on financial, physical, and social investments.
Future work could also emphasize that some of the rates of return on non-financial assets are under direct control of governments and could be raised by taking measures to ensure the maximum quality of public investments within a given expenditure envelope.
A clearly defined medium-term policy path, paired with efforts at improving public financial management, can help to prevent a repetition of previous boom-bust cycles and advance socioeconomic development in countries where large segments of the population have benefited only marginally from the countries' oil wealth.
If the governments of the oil-producing countries in sub-Saharan Africa realize, at a sufficiently early stage, that their fiscal policies are not sustainable, they will help to steer the economy away from yet another boom-bust episode, further worsening income inequalities, while ensuring that currently available oil revenues are used to maintain macroeconomic stability and foster sustainable rates of economic growth and an acceleration of socioeconomic development.