## 1. Nigeria: Federal Government Operations

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---

### I. Introduction — Key challenges for oil producing countries (OPCs)
- Oil revenue characteristics that shape fiscal policy:
  - High volatility and uncertainty due to oil prices and reserves.
  - Exhaustibility of resources—today’s choices (investment, extraction rate, use of oil revenue) have long-term implications.
  - Oil receipts largely originate from abroad (exports) and can materially affect the real exchange rate depending on management of foreign currency inflows.
- Critical fiscal policy questions for OPCs:
  - How to accurately assess the macro-fiscal stance given oil revenue’s special nature?
  - How to shield public expenditures and the non-oil economy from oil revenue volatility and avoid costly “boom and bust” cycles (including “voracity effect”)?
  - How to address sustainability and intergenerational equity given exhaustible reserves (how much to save vs. invest vs. consume)?

### II. Assessing the macro-fiscal stance — Multiple-indicator approach
- Limitations of conventional indicators in OPCs:
  - Overall and primary balances can be misleading when oil revenues move.
  - Traditional DSA may not capture intergenerational allocation of government wealth (including oil in the ground).
  - Stabilizing a positive net debt-to-GDP ratio alone can be suboptimal and may generate explosive debt dynamics when oil is exhausted if non-oil deficits are large and non-oil growth weak.
- Central role of non-oil fiscal indicators:
  - Non-oil primary balance (NOPB) defined as:
    - NOPB = NOR - NOE + I
      - NOR = non-oil revenue
      - NOE = non-oil expenditure
      - I = net interest payments (interest payments minus interest receipts)
  - NOPB excludes oil revenue and better measures fiscal policy impact on domestic demand than the overall primary balance.
  - Other non-oil indicators:
    - Changes in non-oil expenditure — proxy for injection of oil revenue into the domestic economy and capacity constraints.
    - Non-oil revenue relative to non-oil GDP — measure of tax effort and cross-country comparability.
- Complementarity and sensitivity analysis:
  - Non-oil indicators complement, not replace, conventional indicators; overall balance remains important for net financing needs.
  - Sensitivity analysis under alternative oil price scenarios is essential for medium-term financing vulnerabilities and short-term gross borrowing requirement risks.

### III. Using the non-oil balance concept in practice
- Operational definitions:
  - For fiscal sustainability analysis: NOPB excludes all oil-related revenues and expenditures and net interest payments.
  - For short-term domestic-demand assessment: the non-oil domestic balance — overall balance excluding oil export revenue, public expenditures on imports (including oil-related imports), and net interest payments on foreign debt.
- Cyclically-adjusted non-oil balance (CANOB):
  - Purpose: remove automatic stabilizers and nondiscretionary effects to reveal discretionary fiscal stance (example adjustments cited from Norway).
- Scaling and presentation:
  - Express non-oil balance in percent of non-oil GDP to avoid distortions from total GDP fluctuations driven by oil price/production changes.
  - Where non-oil GDP estimates are unavailable, use changes in NOPB or real non-oil expenditures to gauge fiscal direction.
- Caution:
  - Exclusive reliance on domestic balance may bias toward import-intensive projects, encourage creative accounting, and weaken spending quality—coordinate short- and long-term objectives and use multiple indicators.

### IV. Empirical evidence and illustrative material
- High correlation of the primary balance with oil prices across OPCs is noted.
- Box 1 (direction by changes in the NOPB) — key points:
  - Increase in the non-oil primary deficit signals expansionary policy (higher non-oil spending or relaxed non-oil revenue collection).
  - Spending of oil revenue that is absorbed widens the non-oil current account with marginal inflation impact; spending that is not absorbed can cause inflation and Dutch disease unless sterilized.
  - Sterilization is costly and may crowd out the private sector; repaying external debt with oil revenue can sterilize oil-related foreign exchange inflows.
  - Repaying domestic debt can crowd in private investment but may increase liquidity and inflationary pressures, possibly necessitating tighter monetary policy.

### V. Nigeria: Federal Government Operations, 2004–08 (Table 1, percent of GDP)
- Federal operations 2004–2008 (presented exactly):
  - Total revenue: 12.7 (2004), 13.9 (2005), 13.0 (2006), 11.0 (2007), 14.4 (2008)
  - Oil: 10.6 (2004), 12.2 (2005), 11.6 (2006), 8.4 (2007), 12.1 (2008)
  - Non-oil: 2.1 (2004), 1.8 (2005), 1.4 (2006), 2.6 (2007), 2.4 (2008)
  - Total expenditure: 9.2 (2004), 9.8 (2005), 8.9 (2006), 11.2 (2007), 12.7 (2008)
  - Wages: 3.8 (2004), 3.6 (2005), 3.6 (2006), 4.4 (2007), 5.2 (2008)
  - Other non-interest current expenditures: 1.5 (2004), 1.9 (2005), 1.7 (2006), 2.2 (2007), 3.0 (2008)
  - Interest: 2.0 (2004), 2.6 (2005), 1.0 (2006), 1.0 (2007), 1.5 (2008)
  - Capital: 2.0 (2004), 1.7 (2005), 2.6 (2006), 3.7 (2007), 3.0 (2008)
  - Primary balance: 5.5 (2004), 6.7 (2005), 5.0 (2006), 0.8 (2007), 3.2 (2008)
  - Overall balance: 3.5 (2004), 4.1 (2005), 4.0 (2006), (0.2) (2007), 1.7 (2008)
  - Non-oil primary balance: (5.1) (2004), (5.4) (2005), (6.5) (2006), (7.7) (2007), (8.9) (2008)
- Memorandum items (presented exactly):
  - Non-oil revenue (in percent of non-oil GDP): 3.5 (2004), 2.9 (2005), 2.2 (2006), 4.1 (2007), 3.7 (2008)
  - Non-oil primary balance (in percent of non-oil GDP): (8.3) (2004), (9.0) (2005), (10.6) (2006), (12.1) (2007), (14.1) (2008)
  - Inflation (end of period): 10.1 (2004), 11.6 (2005), 8.5 (2006), 6.6 (2007), 15.1 (2008)
- Sources for table: Nigerian authorities and Fund staff estimates.

### VI. Operational and policy implications (from chapter discussion)
- Use a multiple-indicator framework for fiscal analysis in OPCs:
  - Combine conventional indicators (overall and primary balances, DSA) with non-oil indicators (NOPB, non-oil domestic balance, CANOB), and sensitivity analysis to oil price/volume shocks.
- Short-term macro management:
  - Monitor non-oil domestic balance to assess fiscal impact on domestic demand and inflationary pressures.
  - Consider sterilization and prudent external debt repayments to manage foreign exchange inflows, recognizing sterilization costs and potential crowding out.
- Long-term sustainability and intergenerational equity:
  - Target net government wealth consistent with a sustainable non-oil deficit.
  - Adjust fiscal rules and medium-term fiscal frameworks (MTFFs) to reflect oil revenue exhaustibility and uncertainty.
- Institutional recommendations:
  - Coordinate short-run domestic-focused policies with long-run sustainability objectives.
  - Build fiscal institutions and transparency measures to avoid creative accounting and to maintain spending quality during boom periods.

### Box 2 — Non-Oil Fiscal Indicators in Nigeria and Yemen (selected exact figures)
- Nigeria: Selected Fiscal Indicators (presented as "In percent of GDP" and "In percent of non-oil GDP"):
  - I. Total revenue and grants 30.9 42.2
  - a. Oil and gas revenue 22.3 30.3
  - II. Non-oil revenue and grants 8.6 11.9
  - III. Total expenditure and net lending 35.6 48.5
  - b. Petroleum subsidies 7.5 10.2
  - c. Interest 2.0 2.8
  - IV. Non-oil primary balance (II-III+c) -25.0 -33.9
  - Source: IMF country documents. 1/ IMF staff projections.
- Yemen: Selected Fiscal Indicators, 2007 (presented as "In percent of GDP" and "In percent of non-oil GDP"):
  - I. Total revenue 28.5 44.0
  - a. Oil and gas revenue 21.9 33.9
  - II. Non-oil revenue 6.5 10.1
  - III. Total consolidated expenditure 28.7 44.5
  - b. Oil expenditure 1/ 2.6 4.1
  - c. Cash interest payments 1.0 1.5
  - d. of which: foreign interest 0.1 0.2
  - e. Foreign content of large infrastructure projects 0.8 1.2
  - f. Explicit fuel subsidy 0.2 0.4
  - IV. Non-oil primary balance (II-III+b+c) -18.6 -28.7
  - V. Domestic balance (II-III+b+d+e) -18.7 -28.9
  - Source: IMF country documents.
- Observed trends and guidance:
  - Both countries experienced a notable decline in non-oil revenue, indicating weakening tax effort as oil prices increased.
  - Using non-oil GDP to assess non-oil revenues gives an accurate assessment of revenue performance and indicates how much adjustment (or borrowing) would be needed in the absence of oil.

### Macro-fiscal consequences of oil revenue volatility (findings)
- Foreign exchange inflows from oil revenue often lead to real exchange rate appreciation through nominal appreciation or higher inflation (Dutch disease).
- Asset price bubbles and increased financial sector vulnerability can arise from positive wealth effects of oil revenues.
- Fiscal policy is often the main channel transmitting oil price shocks to the non-oil economy; empirical evidence points to a strong correlation between oil revenue and fiscal expenditure in OPCs.
- Specific undesirable consequences:
  - Macroeconomic volatility: expenditure volatility linked to slower growth in OPCs.
  - Expenditure quality: booms can reduce project selection and result in low-rate-of-return investments; proliferation of energy subsidies can weaken expenditure quality.
  - Budget flexibility: expansionary spending during booms often benefits politically influential groups and becomes difficult to curtail when revenues fall.
- Historical box evidence:
  - Mid-1970s and late-1970s oil price increases led to primary spending annual changes peaking at 133 percent in Saudi Arabia, 114 percent in Nigeria, and 102 percent in the UAE; inflation peaked at 36 percent during the oil peak in Nigeria and Saudi Arabia, and over 20 percent in the UAE.

### Box 4 — Petroleum Product Subsidies in OPCs (preserved policy points and examples)
- Nature and evolution:
  - Some OPCs set domestic retail prices below international levels; subsidy costs rose with world oil prices.
  - Country examples: Algeria, Azerbaijan, Bolivia, and Nigeria.
  - Examples:
    - In 2006 implicit energy subsidies in Algeria were comparable in size to the overall budget surplus.
    - In Iran implicit energy subsidies were more than double the size of capital outlays.
    - In Yemen explicit fuel subsidies were higher than the central government budget allocations for health and education in 2007.
  - Baig et al (2007) estimate an average pass-through from world to domestic prices of 46 percent.
- Costs and distributional consequences:
  - Energy subsidies favor energy-intensive, low labor-intensity sectors and are poorly targeted (most petroleum products disproportionately consumed by high-income households).
  - Subsidies can fuel smuggling and are costly to the budget.
  - Environmental problems can be exacerbated by elevated consumption levels.
- Policy alternatives:
  - Means-tested social safety nets and targeted subsidies for products largely consumed by the poor can better achieve social objectives.
- Link to fiscal sustainability and long-term management:
  - In high oil price environments, incentives to reduce subsidies are low, but subsidies may threaten fiscal sustainability.
  - Long-term approaches:
    - “Bird-in-hand” rule: save all oil revenue and spend only the yield.
    - Spend a constant share of overall net government wealth.
    - Spend all current period oil revenue: risky and volatile.
  - Permanent Oil Income Model (POIM):
    - Key premise: government net wealth—oil wealth plus net financial assets—is spent at a gradual pace to ensure a constant share for each generation based on welfare criteria.
    - POIM can construct sustainability benchmarks and translate them into sustainable non-oil primary deficit paths.

### Box 5 — Application of POIM to OPCs (country case summaries and implications)
- Yemen:
  - Sustainability benchmark indicates high vulnerability and need for large fiscal adjustment absent new discoveries.
  - Recent overall deficit: an average of 1 percent of GDP in 2004–06.
  - Non-oil primary deficit around 40 percent of non-oil GDP in recent years; should be adjusted to well below present levels given projected depletion.
  - Even under constant real prices at the IMF WEO oil price in 2008, a significant adjustment over time is needed.
  - Policy focus: medium-term fiscal adjustment path, accelerated non-oil growth, large fuel subsidy, and wage bills.
- Azerbaijan:
  - Revenue boom and large expenditure increases produced a substantial rise in the non-oil deficit.
  - Present primary non-oil deficit around 30 percent of non-oil GDP is judged unsustainable under a benchmark based on spending a constant share in terms of non-oil GDP.
  - Sustaining present non-oil deficit levels over the medium term would require a significant future adjustment to avoid unsustainable long-term debt dynamics.
- Norway:
  - Authorities’ fiscal guideline: over the cycle the non-oil deficit should average 4 percent of the financial wealth accumulated in the oil fund.
  - Rule implies limited short-term use of oil wealth but increasing use over time; benchmarks indicate the present fiscal stance is broadly sustainable while implying some gradual decline in the non-oil deficit in the long term.
  - When future pension liabilities are accounted for, the present fiscal rule would not be sustainable without further fiscal adjustment (or a pension reform).
- Intergenerational equity and productive spending:
  - Spending more early favors poorer current generations but requires future adjustment in non-oil balance (higher taxes or declining expenditures as share of non-oil GDP).
  - Public investment may raise future non-oil growth and justify higher short-term non-oil deficits, but evidence is inconclusive and depends on investment quality and crowding-out effects.
  - Two approaches:
    - Conservative: gradually adjust sustainable non-oil deficit benchmark as investment impacts on growth become clearer.
    - Van der Ploeg and Venables (2008) approach for indebted countries with windfalls: initial modest consumption increase, accumulate capital, later higher consumption as investment boosts growth, then potential decline as oil runs out.
- Addressing uncertainty:
  - Main uncertainties: size of economically viable reserves, production path, and oil price.
  - Objective: reduce need for sudden, large, and costly fiscal adjustments.
  - Build financial buffers (accumulate assets or repay debt) during rising oil prices to shield budgets from transitory shocks.
- Risk analysis tools for buffer sizing:
  - Scenario and stress-test analysis (simple, limited data requirements).
  - Value-at-Risk analysis and fan charts (assess probabilities across shocks; data intensive).
  - Strategy for very large shocks: save some (or most) additional revenue beyond the “normal” buffer until nature/size of shock is clearer.
- Role of MTFFs:
  - MTFFs can reduce boom-bust expenditure patterns and link annual budgets to longer-term sustainability objectives.
  - MTFFs help develop strategies for managing external shocks and plan contingency reserves, including stress tests.
  - Anchoring in conservative benchmarks (e.g., bird-in-hand) can manage uncertainty; vulnerable OPCs may adopt conservative benchmarks if no buffers and limited market access.

### Additional operational guidance from Box 2 and Appendix material
- Treatment of implicit subsidies and non-oil balance definition:
  - Implicit subsidies could be excluded from the domestic non-oil balance for short-term demand assessment but included for long-term sustainability considerations.
  - Treatment is symmetric: when oil prices decline and retail prices remain unchanged, the non-oil balance declines and fiscal effort reflects authorities’ choice not to adjust retail prices.
  - Taxes that affect petroleum products (e.g., VAT and customs duties on refined petroleum products) should be considered when defining non-oil balances.
- Oil-related capital investments and coverage:
  - If non-oil balance is used for short-term stabilization assessment, include oil-related capital investment when it has a high domestic component.
  - If concern is sustainability or investment is largely imported, exclude oil-related spending from non-oil balance.
  - Domestic spending by state oil companies on non-oil activities should be included in the non-oil balance on sustainability and domestic-demand grounds.
- Design principles for special fiscal institutions:
  - Oil funds should be well integrated with the budget; avoid rigid operational rules and ensure transparency and accountability.
  - Financing funds, where fund resources finance the non-oil deficit as needed, are preferred.
  - Fiscal rules experience is mixed; strong political consensus and transparency are essential for effectiveness.
- Scenario assumptions referenced in the Appendix:
  - Use November 2008 WEO oil price projections and, for alternatives, constant 2008 WEO prices where the 2008 WEO price used for the second scenario is US$100.
  - Reference years: Yemen reference year is 2006; Azerbaijan reference year is 2007; Norway reference year is 2006.

_Italic: Source: IMF staff chapter “1. Nigeria: Federal Government Operations” and Boxes 2, 4, and 5 (selected excerpts) as presented in the supplied PDF._

### 1. Nigeria: Federal Government Operations ..............................................................................

### 1. Nigeria: Federal Government Operations

### I. Introduction — Key challenges for oil producing countries (OPCs)
- Oil revenue characteristics that shape fiscal policy:
  - High volatility and uncertainty due to oil prices and reserves.
  - Exhaustibility of resources—today’s choices (investment, extraction rate, use of oil revenue) have long-term implications.
  - Oil receipts largely originate from abroad (exports) and can materially affect the real exchange rate depending on management of foreign currency inflows.
- Critical fiscal policy questions for OPCs:
  - How to accurately assess the macro-fiscal stance given oil revenue’s special nature?
  - How to shield public expenditures and the non-oil economy from oil revenue volatility and avoid costly “boom and bust” cycles (including “voracity effect”)?
  - How to address sustainability and intergenerational equity given exhaustible reserves (how much to save vs. invest vs. consume)?

### II. Assessing the macro-fiscal stance — Multiple-indicator approach
- Limitations of conventional indicators in OPCs:
  - Overall and primary balances can be misleading when oil revenues move: an improving primary balance may mask a relaxation in fiscal stance if driven by temporary oil revenues.
  - Traditional DSA focusing on gross debt and sustainable primary balance may not capture intergenerational allocation of government wealth (including oil in the ground).
  - Strategies aimed solely at stabilizing a positive net debt-to-GDP ratio can be suboptimal and may generate explosive debt dynamics when oil is exhausted if non-oil deficits are large and non-oil growth weak.
- The central role of non-oil fiscal indicators:
  - Non-oil primary balance (NOPB) defined as:
    - NOPB = NOR - NOE + I
      - NOR = non-oil revenue
      - NOE = non-oil expenditure
      - I = net interest payments (interest payments minus interest receipts)
  - NOPB excludes oil revenue and therefore better measures fiscal policy impact on domestic demand than the overall primary balance.
  - Other useful non-oil indicators:
    - Changes in non-oil expenditure — proxy for injection of oil revenue into the domestic economy and capacity constraints.
    - Non-oil revenue relative to non-oil GDP — measure of tax effort and cross-country comparability.
  - Non-oil indicators should feed into long-term sustainability and intertemporal analysis targeting net government wealth consistent with a sustainable non-oil deficit.
- Complementarity of indicators:
  - Non-oil indicators complement, not replace, conventional indicators. The overall balance remains important for net financing needs and fiscal vulnerability assessment (domestic vs. external financing, gross borrowing requirement).
  - Sensitivity analysis under alternative oil price scenarios is essential for assessing medium-term financing vulnerabilities and short-term gross borrowing requirement risks.

### III. Using the non-oil balance concept in practice
- Operational definitions vary by analytical objective:
  - For fiscal sustainability analysis: use NOPB that excludes all oil-related revenues and expenditures and net interest payments.
  - For short-term domestic-demand assessment: use the non-oil domestic balance — overall balance excluding oil export revenue, public expenditures on imports (including oil-related imports), and net interest payments on foreign debt.
- Cyclically-adjusted non-oil balance (CANOB):
  - Purpose: remove automatic stabilizers and nondiscretionary effects to reveal discretionary fiscal stance.
  - Example: Norway’s CANOB adjustments exclude budget oil-related revenues and expenditures, cyclical mainland activity, deviations in Norges Bank transfers, deviations of net interest payments from trend, and nonrecurring technical/accounting items.
- Scaling and presentation:
  - Non-oil balance should be expressed in percent of non-oil GDP to avoid distortions from total GDP fluctuations driven by oil price/production changes.
  - Where non-oil GDP estimates are unavailable, changes in NOPB or real non-oil expenditures can be used to gauge fiscal direction.
- Caution:
  - Basing policy exclusively on domestic balance may bias toward import-intensive projects, encourage creative accounting, and weaken spending quality—coordination between short- and long-term objectives and use of multiple indicators is essential.

### IV. Empirical evidence and illustrative material (summarized)
- Figures referenced in the chapter show:
  - High correlation of the primary balance with oil prices across OPCs (Figure 1).
  - Variation in oil revenue, primary balance, and non-oil primary balance across OPCs (Figure 2).
- Box 1 (Assessing direction by changes in the NOPB) — key points:
  - Increase in the non-oil primary deficit signals expansionary policy (higher non-oil spending or relaxed non-oil revenue collection).
  - Spending of oil revenue that is absorbed widens the non-oil current account with marginal inflation impact; spending that is not absorbed can cause inflation and Dutch disease unless sterilized.
  - Sterilization is costly and may crowd out the private sector; repaying external debt with oil revenue can sterilize oil-related foreign exchange inflows.
  - Repaying domestic debt can crowd in private investment but may increase liquidity and inflationary pressures, possibly necessitating tighter monetary policy.

### V. Nigeria: Federal Government Operations, 2004–08 (Table 1)
- Federal operations presented in percent of GDP for 2004–2008:
  - Total revenue: 12.7 (2004), 13.9 (2005), 13.0 (2006), 11.0 (2007), 14.4 (2008)
  - Oil: 10.6 (2004), 12.2 (2005), 11.6 (2006), 8.4 (2007), 12.1 (2008)
  - Non-oil: 2.1 (2004), 1.8 (2005), 1.4 (2006), 2.6 (2007), 2.4 (2008)
  - Total expenditure: 9.2 (2004), 9.8 (2005), 8.9 (2006), 11.2 (2007), 12.7 (2008)
  - Wages: 3.8 (2004), 3.6 (2005), 3.6 (2006), 4.4 (2007), 5.2 (2008)
  - Other non-interest current expenditures: 1.5 (2004), 1.9 (2005), 1.7 (2006), 2.2 (2007), 3.0 (2008)
  - Interest: 2.0 (2004), 2.6 (2005), 1.0 (2006), 1.0 (2007), 1.5 (2008)
  - Capital: 2.0 (2004), 1.7 (2005), 2.6 (2006), 3.7 (2007), 3.0 (2008)
  - Primary balance: 5.5 (2004), 6.7 (2005), 5.0 (2006), 0.8 (2007), 3.2 (2008)
  - Overall balance: 3.5 (2004), 4.1 (2005), 4.0 (2006), (0.2) (2007), 1.7 (2008)
  - Non-oil primary balance: (5.1) (2004), (5.4) (2005), (6.5) (2006), (7.7) (2007), (8.9) (2008)
- Memorandum items:
  - Non-oil revenue (in percent of non-oil GDP): 3.5 (2004), 2.9 (2005), 2.2 (2006), 4.1 (2007), 3.7 (2008)
  - Non-oil primary balance (in percent of non-oil GDP): (8.3) (2004), (9.0) (2005), (10.6) (2006), (12.1) (2007), (14.1) (2008)
  - Inflation (end of period): 10.1 (2004), 11.6 (2005), 8.5 (2006), 6.6 (2007), 15.1 (2008)
- Sources for table: Nigerian authorities and Fund staff estimates.

### VI. Operational and policy implications (derived from chapter discussion)
- Use a multiple-indicator framework for fiscal analysis in OPCs:
  - Combine conventional indicators (overall and primary balances, DSA) with non-oil indicators (NOPB, non-oil domestic balance, CANOB), and sensitivity analysis to oil price/volume shocks.
- For short-term macro management:
  - Monitor non-oil domestic balance to assess fiscal impact on domestic demand and inflationary pressures.
  - Consider sterilization and prudent external debt repayments to manage foreign exchange inflows, recognizing sterilization costs and potential crowding out.
- For long-term sustainability and intergenerational equity:
  - Target net government wealth consistent with a sustainable non-oil deficit.
  - Adjust fiscal rules and medium-term fiscal frameworks (MTFFs) to reflect oil revenue exhaustibility and uncertainty.
- Institutional recommendations:
  - Coordinate short-run domestic-focused policies with long-run sustainability objectives.
  - Build fiscal institutions and transparency measures to avoid creative accounting and to maintain spending quality during boom periods.

*Source: IMF staff chapter “1. Nigeria: Federal Government Operations” (selected excerpts).*

### Box 2. Non-Oil Fiscal Indicators in Nigeria and Yemen

### Box 2. Non-Oil Fiscal Indicators in Nigeria and Yemen

### Key country challenges and context
- Nigeria: enjoys large proven oil reserves, estimated to last at least for the next 40 years. Policy focus in 2007–08 shifted toward managing the impact of the fiscal stance on short-term economic stability and containing domestic demand pressures and keeping inflation in single digits. Debt relief completed (Paris Club debt relief, end-2007), external debt was just 2 percent of GDP at end-2007. Authorities monitor the non-oil primary balance to ensure short-term fiscal policy consistency with longer-term sustainability objectives; consideration is being given to anchor the near-term fiscal framework by the domestic balance.
- Yemen: could run out of oil in about 10 years, barring new discoveries. Oil revenue accounts for three quarters of government revenue in Yemen (22 percent of GDP). Fiscal and external sustainability would be at risk without a large fiscal adjustment. Fiscal sustainability is a pressing concern; the non-oil primary balance is a central indicator guiding fiscal policy because, with projected depletion of oil wealth, the non-oil balance will converge to the overall balance in less than a decade.

### Fiscal sustainability projections and pressures (Yemen)
- Under unchanged policies, net public debt would increase from 29 percent of GDP to 75 percent by 2012, putting Yemen at a high risk of debt distress.
- To contain public debt at a sustainable level Yemen would need to:
  - increase non-oil revenue by broadening the tax base and improving compliance,
  - reduce unproductive spending, including the ballooning fuel subsidy that in 2006 was larger than the entire budget for social spending and was barely covered by the non-oil revenue.

### Selected fiscal indicators (preserved exactly as in source)
- Nigeria: Selected Fiscal Indicators (presented as "In percent of GDP" and "In percent of non-oil GDP"):
  - I. Total revenue and grants 30.9 42.2
  - a. Oil and gas revenue 22.3 30.3
  - II. Non-oil revenue and grants 8.6 11.9
  - III. Total expenditure and net lending 35.6 48.5
  - b. Petroleum subsidies 7.5 10.2
  - c. Interest 2.0 2.8
  - IV. Non-oil primary balance (II-III+c) -25.0 -33.9
  - Source: IMF country documents. 1/ IMF staff projections.
- Yemen: Selected Fiscal Indicators, 2007 (presented as "In percent of GDP" and "In percent of non-oil GDP"):
  - I. Total revenue 28.5 44.0
  - a. Oil and gas revenue 21.9 33.9
  - II. Non-oil revenue 6.5 10.1
  - III. Total consolidated expenditure 28.7 44.5
  - b. Oil expenditure 1/ 2.6 4.1
  - c. Cash interest payments 1.0 1.5
  - d. of which: foreign interest 0.1 0.2
  - e. Foreign content of large infrastructure projects 0.8 1.2
  - f. Explicit fuel subsidy 0.2 0.4
  - IV. Non-oil primary balance (II-III+b+c) -18.6 -28.7
  - V. Domestic balance (II-III+b+d+e) -18.7 -28.9
  - Source: IMF country documents.
- Note: Nigeria table noted as "Selected Fiscal Indicators (cash basis), 2007" and "1/ Cash call payments."

### Observed revenue trends and measurement guidance
- Both countries have recently experienced a notable decline in non-oil revenue, indicating a weakening of tax effort as oil prices increased (Figure 3).
- Using non-oil GDP to assess non-oil revenues gives an accurate assessment of revenue performance—facilitating international comparisons and policy actions—while helping to provide an indication of how much adjustment (or borrowing) would be needed in the absence of oil.

### Macro-fiscal consequences of oil revenue volatility (findings)
- Foreign exchange inflows from oil revenue often lead to real exchange rate appreciation through nominal appreciation or higher inflation, which can undermine tradable goods sectors (Dutch disease) and leave the economy vulnerable to oil price drops.
- Asset price bubbles and increased financial sector vulnerability can arise from positive wealth effects of oil revenues.
- Fiscal policy is often the main channel transmitting oil price shocks to the non-oil economy; empirical evidence points to a strong correlation between oil revenue and fiscal expenditure in OPCs.
- Specific undesirable consequences of oil-price-driven expenditure volatility:
  - Macroeconomic volatility: sharp changes in government spending add volatility to aggregate demand and prices, exchange rates, and investor risk in the non-oil sector; expenditure volatility has been linked to slower growth in OPCs.
  - Expenditure quality: oil booms can reduce project selection and implementation standards, overstretch administrative capacity, and produce low-rate-of-return investments; proliferation of energy subsidies can weaken expenditure quality.
  - Budget flexibility: expansionary spending during booms often benefits politically influential groups and becomes difficult to curtail when revenues fall; statutory outlays can make fiscal consolidation result in cuts to more productive spending like infrastructure investment and maintenance.
- Box 3 evidence: mid-1970s and late-1970s oil price increases led to primary spending annual changes peaking at 133 percent in Saudi Arabia, 114 percent in Nigeria, and 102 percent in the UAE; inflation peaked at 36 percent during the oil peak in Nigeria and Saudi Arabia, and over 20 percent in the UAE.

### Policy measures to manage oil revenue volatility (preserved policy recommendations)
- Gradually de-link expenditure decisions from oil revenue volatility:
  - Save some oil revenue during booms to buffer services during temporary downturns.
  - Base spending decisions on a longer-term perspective; use a sustainable level of the non-oil balance as an anchor embedded in the medium-term fiscal framework.
- Safeguard expenditure quality:
  - Base spending on rigorous cost-benefit analysis, especially when prices and liquidity are high.
  - Strengthen public financial management (PFM) systems, effective project selection, implementation, monitoring, and evaluation procedures.
  - Maintain effective cash management under strained market access.
- Improve budget flexibility:
  - Complement expenditure policy with non-oil revenue policy; maintain non-oil taxation capacity even when it is not needed to finance the budget.
- Broaden fiscal coverage and reduce quasi-fiscal activity:
  - Include state oil companies and significant quasi-fiscal activities in fiscal institutions and statistics for macroeconomic purposes.
  - Monitor public enterprises that pose fiscal risks and include their operating balances in fiscal targets and indicators.
- Improve fiscal institutions:
  - Consider special fiscal institutions (e.g., oil funds, fiscal rules, fiscal responsibility laws) while noting mixed results; strong PFM systems and overall macro-fiscal policies are critical.
- Coordinate fiscal and monetary policies:
  - Strong coordination is required to manage oil revenue impacts on the non-oil economy; for example, monetary tightening to curb inflation could cause private credit squeezes and exchange rate effects that harm non-oil private sector growth.

_Italic: Source: IMF country documents and IMF staff projections as presented in Box 2. Non-Oil Fiscal Indicators in Nigeria and Yemen._

### Box 4. Petroleum Product Subsidies in OPCs

### Box 4. Petroleum Product Subsidies in OPCs

### Nature and recent evolution of petroleum product subsidies
- Some OPCs choose to subsidize domestic consumption of petroleum products by setting domestic retail prices below international levels.
- With a lack of adjustment in retail prices of fuels and the dramatic increase in world oil prices over the past few years, the cost of these subsidies has increased considerably.
- Country examples mentioned: Algeria, Azerbaijan, Bolivia, and Nigeria.
- Examples of fiscal magnitude:
  - In 2006 implicit energy subsidies in Algeria were comparable in size to the overall budget surplus.
  - In Iran implicit energy subsidies were more than double the size of capital outlays.
  - In Yemen explicit fuel subsidies were higher than the central government budget allocations for health and education in 2007.
- Baig et al (2007) estimate an average pass-through from world to domestic prices of 46 percent.

### Costs, inefficiencies, and distributional consequences
- Energy subsidies undermine an efficient allocation of resources by favoring energy-intensive sectors that tend to have low labor intensity and therefore are unlikely to generate much additional employment. Also, energy intensive goods and services may be difficult to export.
- Since most petroleum products, with a notable exception of kerosene, are disproportionately consumed by high-income households, energy subsidies are poorly targeted and tend to benefit the better off (Coady, 2006).
- Maintaining domestic fuel prices below regional levels may lead to subsidizing fuel consumption in neighboring countries through smuggling (Bolivia, Iran, Yemen).
- Subsidies are costly to the budget and may prevent other, potentially higher priority spending. The cost of open-ended subsidies is difficult to predict and budget for.
- Energy subsidies and the resulting elevated consumption levels may exacerbate environmental problems.

### Policy alternatives and targeting
- A government’s social objectives can be more effectively achieved through alternative instruments than fuel subsidies.
- In countries where sufficient capacity exists to target the poor, a means-tested social safety net could deliver a much better targeted benefit than fuel subsidies.
- For products that are largely consumed by the poor, targeted subsidies for those products can be an effective interim solution.

### Context for fiscal sustainability and management of oil wealth (link to long-term considerations)
- In an environment of high oil prices, OPCs have little incentive to reduce fuel subsidies, despite their increasing magnitude; yet, in some cases, these subsidies may threaten fiscal sustainability, especially because they would be difficult to finance or to phase out.
- The broader discussion on long-term sustainability of macro-fiscal policy in OPCs emphasizes uncertainty about the economic value of oil reserves and outlines alternative long-term approaches to managing oil wealth:
  - “Bird-in-hand” rule: save all oil revenue as financial assets, spend only the yield from accumulated financial assets; seen as most conservative (example: Norway).
  - Spend a constant share of overall net government wealth (net financial assets plus oil wealth), allowing higher short-to-medium-term non-oil deficits than the “bird-in-hand” rule.
  - Spend all current period oil revenue: poses significant risks and leads to highly volatile spending; more likely for liquidity-constrained governments or where oil reserves and revenue are relatively small.
- The Permanent Oil Income Model (POIM) is an increasingly used approach to assess fiscal sustainability in OPCs:
  - Key premise: government net wealth—oil wealth plus net financial assets—is spent at a gradual pace that ensures a constant share for each generation according to some social welfare criteria.
  - The POIM can be used to construct a sustainability benchmark and translate it into a sustainable path for the non-oil primary deficit.
  - Welfare criteria examples for distributing government net wealth include:
    - Constant distribution as a share of non-oil GDP (the rate at which net wealth is spent equals the financial rate of return on the wealth adjusted for non-oil GDP growth). This implies a stable non-oil deficit on average over time.
    - Constant distribution in real terms (maintain purchasing power of the annual distribution), implying a declining annuity as a share of non-oil GDP if non-oil real GDP grows.
  - The POIM tends to allow for larger non-oil deficits in the short-to-medium term than the “bird-in-hand” rule, but lower non-oil deficits in the longer term, implying a higher fiscal adjustment as oil wealth is depleted.
  - Design of a POIM-based sustainability benchmark must consider country-specific circumstances, social welfare criteria, impacts of using oil wealth on non-oil growth (e.g., investment in infrastructure and human capital), and must be periodically reassessed in light of exogenous shocks (for example, new oil discoveries or price shocks).

*Source: _wp0956 - Box 4. Petroleum Product Subsidies in OPCs*

### Box 5. Application of POIM to OPCs

### _wp0956 - Box 5. Application of POIM to OPCs

### Application of POIM to country cases
- Yemen
  - Sustainability benchmark indicates a high degree of vulnerability and a need for a large fiscal adjustment in the next few years absent new oil discoveries.
  - Recent overall deficit: an average of 1 percent of GDP in 2004–06.
  - Large non-oil deficit and limited government new wealth indicate an unsustainable fiscal position (Appendix Figure A.1).
  - Non-oil primary deficit has been around 40 percent of non-oil GDP in recent years and should be adjusted to well below its present level given projected depletion of oil reserves over the next decade.
  - Even under an alternative scenario of relatively high prices (constant real prices at the IMF WEO oil price in 2008), Yemen would need to undergo a significant adjustment over time.
  - Policy focus: develop a medium-term fiscal adjustment path that ensures macro-stability, is consistent with financing constraints, and accounts for adjustment costs; address accelerated non-oil growth, the large fuel subsidy, and wage bills.

- Azerbaijan
  - Experienced a revenue boom from rising oil prices and a large (temporary) increase in oil production; has undertaken very large expenditure increases with a substantial rise in the non-oil deficit.
  - Assessment of fiscal sustainability is very sensitive to welfare criteria (Appendix Figure A.2) and to a lesser degree oil price assumptions.
  - Present primary non-oil deficit around 30 percent of non-oil GDP is judged unsustainable under the benchmark based on spending a constant share in terms of non-oil GDP.
  - A benchmark using real consumption of the net government wealth would allow a much larger non-oil deficit in the medium term but would imply a massive and unrealistic adjustment in the non-oil deficit over time.
  - Sustaining present non-oil deficit levels over the medium term is feasible but would require a significant future adjustment to avoid unsustainable long-term debt dynamics.
  - Risks: macroeconomic instability (high inflation, boom-bust cycles), undermining private non-oil sector, limited capacity to manage volatility/uncertainty, and capacity constraints limiting effectiveness of large expenditure increases.

- Norway
  - Key concern: using oil reserves to cover future non-oil deficits due to depletion and pension liabilities.
  - Authorities’ fiscal guideline: over the cycle the non-oil deficit should average 4 percent of the financial wealth accumulated in the oil fund (approximately equal to the average real rate of return on financial investments).
  - Rule implies limited use of oil wealth in the short term but increasing use over time; usual sustainability benchmarks indicate the present fiscal stance is broadly sustainable while implying some gradual decline in the non-oil deficit in the long term (Appendix Figure A.3).
  - When future pension liabilities are accounted for, the present fiscal rule would not be sustainable without further fiscal adjustment (or a pension reform).
  - The guideline isolates annual budget from oil price volatility but makes it sensitive to variations in the value of financial wealth (e.g., stock market changes).

### Intergenerational equity, productive spending, and POIM implications
- Equitability question: whether oil wealth should be used upfront given that future generations will likely have higher non-oil incomes; answer depends on country preferences but framework must remain sustainable over time.
- If the policy is to spend more early (benefit poorer current generations), the fiscal framework must assume fiscal adjustment in the non-oil balance over time—either rising non-oil taxes and/or declining expenditures as share of non-oil GDP. This is partially reflected in the POIM based on constant spending in real terms (Figure 7).
- Returns on productive spending
  - Public investment can increase physical and human capital and potentially raise future non-oil growth, which could justify higher short-term non-oil deficits.
  - Analysis requires estimating the impact of public investment on growth; evidence is inconclusive and depends on quality of investment and crowding-out effects.
  - Incremental non-oil tax revenue from higher growth will only partially translate into government revenue depending on the fiscal regime and country characteristics.
- Two approaches to incorporate investment and equity concerns
  - Conservative: gradually adjust the sustainable non-oil deficit benchmark as investment’s impact on non-oil growth becomes clearer.
  - Van der Ploeg and Venables (2008) approach for highly-indebted countries with temporary windfalls: increase current consumption to raise incomes of poorer generations and accumulate capital to accelerate development while reducing debt; initial incremental consumption lower than POIM, then rises as higher investment boosts growth and allows consumption above POIM later; as oil runs out, incremental consumption may drop below POIM but higher capital stock sustains total consumption.

### Addressing uncertainty in OPCs
- Main sources of uncertainty: size of economically viable reserves, likely production path, and especially oil price.
- Oil price uncertainty complicates fiscal management because it is difficult to assess whether shocks are permanent or temporary.
- Objective under uncertainty: reduce need for sudden, large, and costly fiscal adjustments, including after debt build-up.
- Evidence shows high correlation between spending and contemporaneous oil revenue, implying significant disruption risk from oil price movements.
- Medium-term fiscal frameworks (MTFFs) linked to a long-term sustainability strategy and risk analysis can help assess risks and identify longer-term implications of present policies.
- Building financial buffers (accumulating financial assets or repaying debt) during rising oil prices is prudent to shield budgets from transitory shocks and allow more gradual adjustment during negative shocks.

### Risk analysis tools and buffer sizing
- Scenario and stress-test analysis (similar to IMF DSA)
  - Advantages: limited data requirements, relative simplicity.
  - Provide measures of potential financing needs or required fiscal adjustment after negative oil price shocks.
- Value-at-Risk analysis and fan charts
  - Useful to assess probabilities across a range of shocks and expected policy responses.
  - Help identify financial buffer size or public debt reduction needed given risk profiles and country circumstances.
  - More demanding on data than stress tests.
- Strategy for very large shocks
  - If oil prices rise well beyond historical mean, prudent to save some (or most) additional revenue beyond the “normal” buffer until nature/size of shock is clearer to avoid vulnerability to large reversions.
- Fan charts advantage: account for co-movements of key variables and estimate policy reaction functions based on past data.
- Limitations: tools mainly useful for variations around steady state; may be limited during large structural breaks or when past correlations no longer hold.

### Role of MTFFs in managing oil revenue uncertainty (Box 6 key points)
- MTFFs can reduce boom-bust expenditure patterns and link annual budgets to longer-term sustainability objectives.
- MTFF contributions:
  - Develop explicit strategies for managing external shocks (oil price, exchange rate) to enable less disruptive adjustment processes.
  - Adequately plan contingency reserves to smooth spending over the medium term, including stress tests.
  - Encourage multi-year planning to ensure future generations benefit from nonrenewable resources and deliver stable public services.
- Anchoring fiscal policy in more conservative long-term sustainability benchmarks (e.g., bird-in-hand rule) can manage uncertainty; vulnerable OPCs may adopt conservative benchmarks if no buffers and limited market access.
- Countries with large financial reserves could gradually increase non-oil deficits consistent with macrostability and sustainability.
- Transparency about tradeoffs and assumptions in annual budgets and MTFF discussions is important to garner political support and reduce pressure to increase spending during high oil price periods.

### Conclusions and policy recommendations (synthesis)
- Complement conventional fiscal indicators with non-oil indicators to assess fiscal stance in OPCs.
- De-link government expenditure evolution from short-term oil revenue developments to reduce macro-fiscal costs of revenue volatility.
- Safeguard expenditure quality by strengthening PFM systems and maintain a non-oil revenue base to enhance budgetary flexibility.
- Expand fiscal indicators, targets, and reduce quasi-fiscal activities to better identify and manage fiscal risks.
- Apply long-term sustainability benchmarks and use MTFFs with risk assessment to understand long-term consequences of current policies and manage oil revenue uncertainty.

*Source: _wp0956 - Box 5. Application of POIM to OPCs.*

### Box 2 provides numerical examples of calculating the non-oil balances in Yemen and Nigeria.

### _wp0956 - Box 2 provides numerical examples of calculating the non-oil balances in Yemen and Nigeria.

### Treatment of implicit subsidies and non-oil balance definition
- Implicit subsidies could be excluded from the definition of a domestic non-oil balance because they are likely to have at most an indirect impact on domestic demand.
- Implicit subsidies should be included in the definition of a non-oil balance on grounds of their impact on long-term fiscal sustainability.
- Regardless of classification, developments in the size and composition of these subsidies should be carefully monitored to contain further deterioration in the quality of spending.
- The treatment is symmetric: when oil prices decline and retail prices remain unchanged, the non-oil balance declines and fiscal effort reflects the authorities’ choice not to maintain the oil subsidy by reducing retail prices in line with world oil prices.
- Taxes that affect petroleum products should be considered when defining non-oil balances; these include VAT and customs duties on refined petroleum products.

### Oil-related capital investments and coverage of non-oil indicators
- Oil-related capital investments:
  - If the non-oil balance is primarily used to assess the contribution of fiscal policy to short-term macroeconomic stabilization, it can be reasonable to include oil-related capital investment in the underlying deficit when such investment has a high domestic component (because it can affect aggregate demand or inflation).
  - If investment is largely imported or the main concern is sustainability of government spending, then all oil-related spending should be excluded from the definition of the non-oil balance.
  - Domestic spending by state oil companies on non-oil activities (e.g., infrastructure projects and social spending not related to oil production) should be included in the non-oil balance on sustainability and domestic-demand grounds.
- Desirable qualities of non-oil indicators:
  - Well defined regarding the budget and institutional coverage.
  - Easily monitorable.
  - Simple and transparent to serve as effective instruments of communication of government policy objectives.

### Special fiscal institutions: oil funds, asset-liability management, and fiscal rules
- Oil funds and asset-liability management: observed international experience and limitations
  - Purpose: accumulate assets for stabilization and long-term savings; operational rules often aim to constrain fiscal policy.
  - Empirical limits:
    - Oil funds have had limited ability to impose budget constraints—countries may borrow or bypass fund rules.
    - Oil funds can undermine the budget process and fiscal transparency if they enable extrabudgetary spending.
    - Rigid rules can complicate cash management and asset-liability strategy and, in some cases, exacerbate expenditure volatility.
    - Many countries have changed or eliminated fund rules when inconsistent with financing needs or shifting fiscal priorities.
  - Principles for designing oil funds:
    - Funds should be well integrated with the budget to enhance coordination of fiscal policy and efficiency of public spending; avoid rigid operational rules.
    - Funds should preferably not have the authority to spend; any spending should follow the same procedures and transparency requirements as budgetary spending.
    - Financing funds, where fund resources are used to finance the non-oil deficit as needed, are preferred.
    - Promote transparency, good governance, and accountability provisions to limit misuse of resources.

- Fiscal rules and fiscal responsibility frameworks (FRL)
  - Forms of fiscal rules used in OPCs include numerical targets applied to:
    - Overall balances (example countries: Alberta, Mexico).
    - Non-oil balances (example countries: Ecuador, Norway).
    - Expenditure levels (example: Equatorial Guinea).
    - Expenditure growth (example countries: Ecuador, Venezuela).
    - Ratio of public debt to GDP (example countries: Alberta, Ecuador, Venezuela).
  - Other approaches include strengthening transparency, coverage, and accountability in public financial management (example: Timor-Leste), and setting a conservative budget oil price with the difference saved or used to repay debt.
  - Experience and cautions:
    - OPCs’ experience with fiscal rules has been mixed; the oil revenue upsurge increased spending pressures and numerical fiscal rules were often revised to accommodate higher spending.
    - Strong political consensus is needed for fiscal rules to be effective.
    - Basing budgets on artificially low oil prices is unlikely to deliver lower spending for long; it can undermine budget transparency and encourage extrabudgetary spending of excess oil revenues.
    - FRL focused on improving budget procedures can strengthen transparency and accountability and institutional quality.
    - Political commitment to fiscal discipline and willingness to adopt structural reforms are key to the success of FRL.

### Scenarios and illustrative projections referenced
- The Appendix includes scenario charts for Yemen, Azerbaijan, and Norway that:
  - Use November 2008 WEO oil price projections and, for alternative scenarios, constant 2008 WEO prices where the 2008 WEO price used for the second scenario is US$100.
  - Note reference years: Yemen reference year is 2006; Azerbaijan reference year is 2007; Norway reference year is 2006.
  - Scenario outcomes depend on assumptions on the long-term growth rate and the real financial rate of return and are indicative of broad long-term tendencies.

*Source: IMF working paper content (Box 2 and Appendix II material provided in the supplied PDF).*

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