Uroprism Research Member of the European Network of Economic Policy Research Institutes (ENEPRI) Dos and Donts of Natural Wealth Management Leonor Coutinho

€uroprism ResearchMember of the European Network of Economic Policy Research Institutes (ENEPRI)

Do’s and Don’ts of Natural Wealth Management

Leonor CoutinhoEuroprism Research

Saturday, 26 November 2011

Presentation for the Conference “The Hydrocarbon Wealth of Cyprus: Equitable Distribution and Regional Politics”, organized by the Friedrich Ebert Foundation (FES) and the PRIO Cyprus Centre (PCC), Nicosia Buffer Zone, Chateau Status, Cyprus.


Outline of the Presentation

• Risks of Natural Resource Exploitation• Optimal Natural Resource Management Principles• The Don’ts• Some Examples (Don’ts)

NigeriaSaudi ArabiaMexico

• Selected Success StoriesBotswanaIndonesiaChile


The Risks of Natural Resource Exploitation

• Problems of associated with hydrocarbon wealth are shared by other types of natural resource wealth.

• Malaises associated with natural resource exploitation:The Dutch Disease: contraction of other tradable sectors of the

economyDeterioration of governance: the “Voracity Effect”Poor investment decisions (e.g. overcapacity in infrastructure)Under investment in human capitalUnderdeveloped financial markets: too much government weightMacroeconomic instability: output volatility correlated with ups

and downs of resource prices; amplified economic cycles


Optimal Natural Resource Management Principles

• Consumption smoothing and inter-generational equity: take into account the volatility of prices and the resource exhaustibility => base expenditures on measures of permanent income• National revenue funds as vehicles for savings• Fiscal rules to control government expenditures• The optimal amount of savings and the control of government

budget deficits requires measures of permanent income: Independent forecasts Use of hedging instruments to reduce risks

• Optimal investment strategies: maximize returns• Government vs private decisions (distribute dividends) or a

combination of both• Independent investment council


The Don’ts

• Allow expenditures to be highly correlated to resource prices real exchange rate appreciation and exchange rate volatilityamplification of business cycles sudden cuts in investment

• Borrow on natural resource collateral: Debt Overhang macroeconomic instability nominal devaluations undermined by price inflation

• Large governments: crowding out of the private sector• Lack of economic diversification• Short sighted investment decisions


Some examples…

• Nigeria (oil)Collapse of agriculture and failure to industrializeMigration to urban areas: desertification and inequalityAccumulation of unsustainable debt• Saudi Arabia (oil)Poor diversification: real exchange rate overvaluationPublic sector expansion as the main mechanism for job creationOverinvestment in infrastructure• Mexico (oil)Public overinvestment in infrastructure: crowding out of private sectorLarge current account imbalances; accumulation of government debtNominal devaluation undermined by inflationCurrency crisis


Selected Success Stories of Natural Resource Exploitation

• Botswana (diamonds)Revenue Stabilization FundMedium term expenditure plans based on long-term projectionsMineral revenues used mostly for planned investment and the

rest savedCurrency peg to South African rand has worked as an anchor for

inflationRelatively open trade policySome diversification achieved through manufacturing, but limitedStill risks are always looming:

Investment policy did not prevent unproductive public investment Social tensions and inequality HIV prevalence


Selected Success Stories

• Indonesia (oil)Accumulation of de-facto government surpluses (although

formally there is a balanced-budget rule that could have meant high volatility of expenditure)

Control over the borrowing of state-owned oil companiesExpenditure focusing on non-oil exporting sector, specially

agriculture (R&D, and infrastructure), and health and educationPrivate investment and development of labour-intensive industryReduction of poverty and inequalityNominal devaluationsSpecial conditions:

Role of technocratsStrong non-oil interest groups


Selected Success Stories

• Chile (copper) Copper Stabilization Fund Fiscal Policy Rules: target for structural budget balance; independent

forecasts for the trend price of copper and trend output Mixed of public and private ownership in copper sector guarantees

that some profits are re-invested in the country but also attracts FDI with positive spillovers

Contained inflation and relatively good business climate allowed for diversification: fisheries, wine, tourism

Special conditions:Role of technocratsCompetitive RER policy via a PPP crawling band-rule (and occasionally

through significant discrete nominal devaluations) and capital controls from some time; recently inflation targeting and floating with possibility of intervention

Documents

Uroprism Research Member of the European Network of Economic Policy Research Institutes (ENEPRI) Dos and Donts of Natural Wealth Management Leonor Coutinho