IMFSurvey Magazine: IMF Research
OIL REVENUE SWINGS
Oil Boom Tests Producing Countries
By Rolando Ossowski, Mauricio Villafuerte, and Paulo Medas
IMF Fiscal Affairs Department
and Theo Thomas
IMF Asia and Pacific Department
August 30, 2007
- Average price of oil more than tripled between 1999 and 2006
- Many oil-producers have traditionally had difficulties managing oil revenues
- Some oil producers using special fiscal institutions to help manage fiscal policy
Consumers around the world may cheer when the price of gasoline to fill their cars falls even slightly.
But the frequently sharp changes in the price of oil and related foreign exchange inflows, together with the nonrenewable nature of the resource, complicate macro-fiscal management in oil-producing countries.
In response, a number of oil producers have established special fiscal institutions (SFIs) such as oil funds, fiscal rules, fiscal responsibility legislation, and budgetary oil prices to help fiscal management. In some cases, this has also been triggered by political economy and institutional considerations, for example in some countries where governments have had difficulties containing spending.
A study by the IMF's Fiscal Affairs Department examines how governments of oil producers have managed their fiscal policies in response to the recent oil revenue boom, and the role of SFIs in fiscal management in oil-producing countries. The IMF study covers countries where fiscal oil revenue accounted for at least 20 percent of total fiscal revenue in 2004, and where sufficient information was available.
The study notes that the average price of oil tripled from $18 a barrel in 1999 to $53 in 2005 and rose further in 2006. The associated increase in oil exports and fiscal oil revenues has had major macroeconomic and fiscal implications for oil producers that depend heavily on oil revenues. The paper outlines three main fiscal responses of oil producers to the oil boom:
• On average, during 2000-2005 governments used close to half of the additional fiscal oil revenue to increase non-oil primary spending and/or lower non-oil primary revenue. Oil producers turned overall fiscal deficits in the late 1990s into growing fiscal surpluses. The variance across countries, however, is significant.
• Higher oil revenues allowed oil producers an opportunity to increase public spending on priority economic and social goals, which could be an appropriate response to rising oil prices. At the same time, many oil producers that have increased spending rapidly show low indices of government effectiveness, which may raise questions about their ability to use the additional resources effectively and efficiently.
Special fiscal institutions
Oil funds— they have proliferated in recent years. Policy objectives of oil funds include stabilization, financial savings, asset management, and fiscal transparency. They typically have relatively rigid operational rules for depositing and withdrawing resources, often been based on the expectation that removing "high" oil revenues from the budget will help moderate and stabilize expenditures, and reduce policy discretion. However, the evidence shows that in a number of cases rigid oil fund rules have been changed, bypassed, or eliminated. As oil prices have risen, oil funds are increasingly focusing on long-term saving objectives. The resources of some oil funds are earmarked for specific purposes.
Fiscal rules, fiscal responsibility legislation—mechanisms intended to permanently shape fiscal policy design and implementation. They are often enshrined in constitutional or legal provisions. Oil funds are more common, but fiscal rules and fiscal responsibility laws can have a more critical role as they are intended to constrain overall fiscal policy. In several cases, fiscal rules or frameworks have been weakened over time or ignored.
Budgetary oil price forecasts—most oil producers have used a conservative oil price or revenue forecast to determine a budget's resource envelope. Such assumptions are viewed as a prudent way to reduce the risk of a large deficit or fiscal adjustment in the event of an unanticipated decline in oil revenue. However, while there is a case for an element of prudence in budget oil forecasts, the use of artificially low oil prices as a strategy to contain spending is unlikely to be sustainable and may lead to spending inefficiencies.
The IMF study covers oil producing countries where fiscal oil revenue accounted for at least 20 percent of total fiscal revenue in 2004, and where sufficient information was available: Algeria, Angola, Azerbaijan, Bahrain, Brunei, Cameroon, Chad, Republic of Congo, Ecuador, Equatorial Guinea, Gabon, Indonesia, Iran, Kazakhstan, Kuwait, Libya, Mexico, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia, Sudan, Syria, Timor-Leste, Trinidad and Tobago, United Arab Emirates, Venezuela, Vietnam, and Yemen.
• The long-term fiscal sustainability of a number of oil producers improved between 2000 and 2005, assessed on the basis of a standardized sustainability benchmark, but in a few it deteriorated, mainly due to the expansion in non-oil primary deficits. Some countries remain vulnerable to oil price shocks and the possible need for adjustments.
Fiscal management, role of SFIs
The experience highlights the importance of sound institutions, public financial management systems, and medium-to long-term perspectives to ensure the quality of spending and the sustainability of fiscal policies. The evidence suggests that the quality of institutions (including in areas such as accountability and the quality of public administration) matters for fiscal outcomes, and that priority should be given to enhancing public financial management systems where appropriate.
Developing a medium-term framework (MTF) can help link annual budgets to longer-term policies and fiscal sustainability objectives, and enhance risk analysis. The budgets of many oil-producing countries are characterized by short-term horizons, with little reference to longer-term policies and objectives.
MTFs that explicitly incorporate a longer-term perspective can help promote predictability, improve resource allocation, and enhance transparency and accountability. MTFs can also be specifically designed to help address the fiscal risks posed by volatile, unpredictable, and exhaustible oil revenues.
The study also finds that, under appropriate institutional frameworks, well designed SFIs may help support sound fiscal policies, though they are not a panacea. Successful SFIs require strong institutions and political commitment.
The development of SFIs should not detract from other more fundamental public financial management and governance reforms as appropriate. In addition, international experience suggests the advisability of adopting some specific principles for the design and implementation of effective SFIs.
Oil funds should be integrated with the budget to enhance fiscal policy coordination and public spending efficiency, the study says. They should not have the authority to spend. Financing funds should be preferred to funds with rigid rules. Mechanisms to ensure transparency, good governance, and accountability should be in place.
While the implementation of quantitative fiscal rules remains challenging in oil-producing countries, fiscal responsibility laws with comprehensive procedural and transparency requirements may work better to sustain the credibility of the fiscal framework, the study says. Success, however, hinges on proper design, consistency with public financial management capacity, and enforcement of the provisions.