Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Aiming to Balance Saving, Spending
May 28, 2007
- Oil booms often fueled waste, corruption—not growth, poverty reduction
- Abundant oil revenues create illusion that budget constraints do not exist
- Effective public spending requires strict execution of approved budgets
Oil prices have been near record highs for more than two years, and oil-producing countries have seen exports and revenues skyrocket.
Well testing 50 miles off coast of Angola, one of Africa's oil exporters currently receiving significantly higher revenues (photo: Jeff Barbee/BlackStar)
AFRICA'S OIL EXPORTERS
In Africa, high prices have often been accompanied by higher production, as more remote oil fields become economically viable. Government coffers have swelled.
This revenue bonanza offers African countries enormous opportunities to tackle difficult and long-standing problems and make decisive progress in reducing poverty. But history has shown how difficult it can be to use natural resource wealth effectively and productively.
Previous oil booms have often fueled waste and corruption rather than growth and poverty reduction. This time, many oil exporters have used windfall revenue to reduce debt and accumulate reserves, while spending increases have been relatively prudent. Spending pressures, however, are mounting and the challenge facing African countries is how to ensure an optimal balance between saving and spending that benefits both current and future generations.
Boom-bust cycles
The recent regional economic outlook for sub-Saharan Africa (SSA) and a new IMF Working Paper address some of the major macroeconomic challenges that high oil revenues present for fiscal policymaking in the region. Oil booms present very particular policy problems, raising expectations that suddenly abundant oil revenues will be used to address pressing social needs and fragile public infrastructures.
But there are considerable macroeconomic threats—in both the long and the short term—to scaling up government expenditure too quickly. To avoid a repetition of past boom-bust cycles, oil producers need to take into account long-term fiscal sustainability, short-term macroeconomic pressures, and institutional absorptive capacity.
Defining fiscal space
Abundant oil revenues create an illusion that binding budget constraints do not exist. If oil reserves were limitless, governments could simply consume all oil revenues directly. But oil resources are being gradually depleted, and some day in the not too distant future oil revenues will run out.
To prepare for that time, governments must run surpluses during periods of oil production and invest those surpluses in alternative sources of wealth, such as financial assets or productive public investments. These alternative sources of wealth will generate a return that could indefinitely make up the difference between a reasonable government spending level and non-oil revenues after oil reserves are depleted.
For policymakers, then, it is important to define a clear benchmark to distinguish sound and forward-looking policies from those designed to address only immediate demands. To this end, the IMF Working Paper "Old Curses, New Approaches? Fiscal Benchmarks for Oil-Producing Countries in Sub-Saharan Africa" uses a formal model to estimate the fiscal paths that SSA oil-producing countries should follow to allow non-oil public spending to remain constant as a percentage of non-oil GDP for the foreseeable future.
Income from investments
While oil revenues are present, that benchmark produces surpluses that can be invested; after oil resources are depleted, the benchmark spending level can be sustained with the help of the income from investments made when balances were in surplus.
As a group, the SSA oil-producing countries—Angola, Cameroon, Chad, Republic of Congo, Côte d'Ivoire, Equatorial Guinea, Gabon, and Nigeria—ran a non-oil primary (excluding interest payments) deficit of 27 percent of non-oil GDP during 2004-06. The model simulations show that even if oil prices remain at their current highs, the oil producers, in the aggregate, will not be able to maintain forever that level of public expenditure (see chart).
The benchmark estimates of a permanently sustainable non-oil deficit range from 11 percent, in the most conservative assumption that only today's proven oil reserves are exploited, to 22 percent, assuming the additional exploitation of half of "probable" oil reserves and one-half of all proven and one-fourth of probable gas reserves.
The fiscal positions of individual SSA oil producers fluctuate considerably around the aggregate simulation, showing that—under baseline assumptions—the current fiscal positions of all major oil producers cannot be maintained. However, these policy benchmarks are not immutable.
Any estimate of a fiscal deficit that could be financed ad infinitum is fraught with uncertainty with respect to variables that are outside a government's control (oil reserves, oil prices) or are partially the result of policies being implemented (financial rate of return, productivity of public investments). Proactive policies aimed at increasing the rates of return on financial, infrastructure, and social investments would help expand the overall sustainable fiscal envelope.
Identifying absorptive capacity
Raising public spending sharply over a short period of time could pose significant inflationary risks and lead to a rapid appreciation of the real exchange rate, damaging the international competitiveness of the non-oil economy (so-called Dutch disease). However, the magnitude of these effects depends on many factors, including the degree to which the spending increase can be externalized or can be absorbed through a supply response.
To mitigate inflationary pressures and overcome the erosion of international competitiveness, the central bank could sell foreign exchange (if operating within a flexible exchange rate regime) and mop up a substantial portion of the injected liquidity. At the same time, the government could consider measures to improve the medium-term supply response (by improving the business environment) and reinforce fiscal institutions to ensure that public sector investments alleviate bottlenecks to private sector activity.
Strengthen budget planning
Oil-rich countries face particular challenges in public financial management to ensure that additional spending does not overwhelm institutional capacity and budgetary control mechanisms, which tend to be underdeveloped. Many of the oil exporters have already taken some steps to strengthen budget planning and budget preparation to ensure that fiscal policies achieve stated goals. To this end, the governments of several SSA oil-producing countries are seeking to prioritize expenditures within medium-term expenditure frameworks.
Similarly, effective public spending requires the strict execution of approved budgets—while ensuring that spending is of high quality. To achieve this, regular reporting in revenue administration and expenditure management promotes transparency and accountability and improves internal policy decision making.
Oil transparency
By adopting the Extractive Industries Transparency Initiative, which calls for verification and publication of company payments and government revenues from oil, gas, and mining, SSA oil-producing countries have made considerable progress toward oil transparency. Still, considerable challenges remain.
Historical experience, international comparison, and economic analysis hold ample lessons for sub-Saharan Africa on how to avoid the pitfalls of previous oil booms and seize the exceptional opportunity offered by the currently high oil prices. The challenge will lie in resisting the short-term spending pressures and providing an institutional and policy environment that will ensure long-term sustainable growth and tangible poverty reduction.