Femi Muibi SAIBU

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Nov 18, 2013 (3 years and 6 months ago)

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Oil Wealth Volatility, Sovereign Wealth Fund Management and Fiscal
Sustainability in Nigeria: An Analytical Framework


Femi Muibi SAIBU



Department
of Economics and Econometrics,

University of Johannesburg, Auckland Park 2006, Johannesburg, South Africa,

Email:
fsaibu@uj.ac.za,osaibu@unilag.edu.ng
,
omosaibu@yahoo.com
,

Ph #: +27785788874 +2348053381914

Outline of Presentation


Introduction


Pre SOW macroeconomic conditions


SOW Conceptual framework


International experiences


Lesson and Policy implications for Nigeria

Introduction


The first signal of Nigeria readiness to save for raining days
commenced with ECA in 2004



The objective is primarily to protect planned budgets against
shortfalls due to volatile crude oil prices and insulate the Nigerian
economy from external (negative) price shocks.



These spare funds help stabilize the economy against the negative
shock before oil prices rebounds after the 2009 downturn



Savings to ECA grown from $5.1 billion in 2005 to $20 billion in
2008 but has fallen to
less than $4 billion in 2010 due to budget
deficits at all levels of government in Nigeria.




However despite the role played by this fund in 2008 to 2010, during the global crisis, the law
establishing the ECA and its use has always been controversial.




It is seen by states as illegal and been contested by state in Court.


sections
162(1) and 162 (3) of the Constitution of the Federal Republic of Nigeria made it
mandatory for all revenues accruing to the nation to be paid into the Federation account and to be
distributed among the federating units in accordance with the existing revenue allocation formula



It aggravates the financial strains of states to meet development
-
related needs



It may be abused by federal and could become a political tool and undermines the constitutional
provision regarding revenue distribution across the three tiers of the executive.



the state governments propose that 80% of funds to be shared between the federal and state
governments and the balance of 20% of revenues should be maintained as balances in ECA account
monthly.
Finance Minister recommends a standing balance of $ 50billion



To address the legality and to strengthen the Fund, the Sovereign Oil Wealth (SOW) was established
by an Act of parliament in 2011 and to be
operational by 2013 March precisely with seed money of
$1 billion
and to be managed by
JBMorgan




The issues are


What is the optimal benchmark price?


How and where to save and invest


What and how do we share the proceed


How are other oil producing countries handling
small funds



The hallmark of this paper is to provide a
framework for these questions



Sovereign Oil Wealth (SOW) FUND
Concept


Sovereign wealth fund by definition is a state
-
owned pool of money that is invested in various
financial assets both locally and internationally



SOW fund is a pool of money derived from a country’s reserves, which are set aside for investment
purposes that will benefit the country’s economy and citizens



The funding for a sovereign wealth fund comes from central bank reserves that accumulate as a
result of budget and trade surpluses, and even from revenue generated from the exports of natural
resources as in the case with Nigeria



A state
-
owned
investment fund
established out of balance of payments surpluses, official foreign
currency operations, the proceeds of privatizations,
fiscal surpluses, and/or receipts resulting from
natural resource and or commodity exports”.



Nigeria belongs to the last category as the SWF is created from the resources in the Excess Crude
Account, ECA



SOW is an
investment
(Seed) while ECA is a
saving




According to the International Working Group of Sovereign Wealth Funds, a SOW fund is “a special
purpose investment funds or arrangements, owned by the general government



WHY SOWING?


Keynes (1936) identified seven reasons for saving


Precaution

( reserve against unforeseen contingencies)


foresight ( providing for anticipated relation between future income and needs


calculation (enjoy interests and appreciation


improvement ( enjoy gradual increase in expenditure and independence and power to do things


Enterprises (to carry out speculative and business project


Pride ( savings brings pride esteem )


avarices ( to guide against
averices



Similarly Keynes provided a list of motives for consumption:



Enjoyment,


short
-
sightedness, generosity,


miscalculation, ostentation,



extravagance.



Looking at the past history of Nigeria in oil management and the rational for the current effort,
there could not be any other reasons for setting aside some funds than to achieve this seven saving
commandments from Keynes and prevent some of the adversity of consuming all the wealth.

History of SOW


The first sovereign wealth fund was the
Kuwait

Investment
Authority, established in 1953 to invest excess oil revenues.



Kiribati
created a fund to hold its revenue reserves. : then
later



Qatar

Abu Dhabi's Investment Authority (1976)


Singapore
's Government Investment Corporation (1981)


Norway
's Government Pension Fund (1990)



globally SOW Fund is about $5 trillion invested by less
that 20 countries ( see appendix for the list)


Investment Options for Sovereign Wealth
Funds



Sovereign wealth funds are traditionally passive long
-
term investors and invested
in a wide range of asset classes including:


Government bonds


Equities


Foreign Direct Investment



However, a growing number of funds are turning to
alternative investment
such as
hedge funds or
private equity
, which are not accessible to most retail investors.



The IMF
(2008)

reports that sovereign wealth funds have a higher degree of risk
than traditional investment portfolios



Therefore to spread the risk, most countries with Sovereign wealth funds use a
variety of investment strategies:


Some funds invest exclusively in publicly listed financial assets
.


Others invest in all of the major asset classes
.

How is SOW Managed in Other
Countries


Norway Model


First establishes the
Petroleum Fund



Then transfers funds to into SOWF from where they are invested in bonds and corporate equities



Later the fund’s functions were integrated with the national insurance scheme, and the fund continued to function under the n
ame

of the
Pension Fund
.


The amount of the money the government may withdraw for the budget purposes from the Fund is not the function of the country’
s c
urrent oil production,


but function of the growth rate of the Fund separate from the current oil revenues. Ulrich F.W. Ernst (2006) characterizes N
orw
ay’s strategy in
managing the oil revenues in the following areas



The Fund reserves are entirely invested abroad



The investments are made in both fixed incomes and equity instruments



The Funds are invested in internationally responsible assets and not to invest in businesses involved
unpeaceful

and environmentally bad practices.



One major critical success factor for Norway oil management is adherence to a predetermined rules that do not allow politici
ans

or government
officials the ability to withdraw from the fund at their own discretion.



This

requires

the

fund’s

management

to

be

transparent

and

immune

to

the

whims

of

politicians

as

well

as

their

personal

obsession

with

power

and

materials

enrichment
.



One

major

critical

success

factor

for

Norway

oil

management

is

adherence

to

a

predetermined

rules

that

do

not

allow

politicians

or

government

officials

the

ability

to

withdraw

from

the

fund

at

their

own

discretion
.

This

requires

the

fund’s

management

to

be

transparent

and

immune

to

the

whims

of

politicians

as

well

as

their

personal

obsession

with

power

and

materials

enrichment
.




While

the

Norwegian

Pension

Fund

is

seen

as

a

model

for

many

countries,

it

in

fact

has

few

restrictions

set

in

place

to

control

what

policymakers

can

do

with

oil

funds,

making

it

susceptible

to

the

desires

of

political

objectives
.





A

better

example

of

a

fund

that

is

better

protected

from

political

motives

is

the

commodity

fund

of

Sao

Tome

and

Principe,

established

in

2004
.

It

includes

extensive

restrictions

that

guide

how

oil

revenues

are

to

be

saved,

invested,

or

spent
.

It

is

illegal

for

outflows

to

exceed

the

amount

that

can

be

sustained

in

perpetuity

(Frankel,

2010
)
.





US Model


There are seven different Sovereign wealth established by the states


The Alaska Permanent Fund
provide a reference point and a unique way of managing oil earnings and ensuring every member of the society benefits from
the yields of their sow in the funds. T


The State law in Alaska dictates that half of the investment earnings of the Fund are to be equally distributed to every stat
e r
esident on an annual basis
.


Theory behind this management strategy is that citizens know how to spend the money better than their government. One downsid
e t
o this approach is that
even if it was proven by economic and policy analysts to be effective, the government would face fierce public opposition in
cha
nging the fiscal policy when
the need arises.





Chile Model


The fund is governed by a set of rules that dictates the
government can only run a deficit larger than the target if output falls short of potential, in a
recession, or the price of copper is below its medium
-
term (10
-
year) equilibrium
.


Two panels of experts are chosen to biannually evaluate these two respective conditions.


Therefore, if it is determined that copper prices are experiencing a temporary spike, then these extra earnings are required
to
be transferred to savings..



In the case of Saudi Arabia, United Arab Emirates, the large increases in new oil revenues
were spent on massive infrastructure projects and welfare
programs,
while at the same time
it liberalized its trade structure hence this policy
allowed
the non
-
oil GDP sector to develop at outstanding rates,
today the two countries are part of top ten leading SWF investors in the World.



Other countries like Mexico Venezuela, Sao Tome and Principle have also implemented one form of policy rules in management of

th
eir oil.



Most of the UAE SWF are carried out by the city government while in Saudi Arabia is carried out by the central government



the experience of some European countries in recent is a signal to the consequences of welfare based policy of government


What is the Optimum Size of the Fund


Results of studies conducted in this area appear to be inconclusive. However, Crain and Devlin (2002) indicated
that larger funds created management problem especially when the design of the savings fund is not transparent.



In addition, they maintained that political pressures on the government usually result in the mismanagement of
the fund and recommended that there must be an in
-
built mechanism for control, reporting and evaluation of
fund resources and operations.



Heilbrum

(2002) stressed that the funds should be professionally managed with the supervision of the ministry of
finance or central bank. Citing an example of Norway, he indicated that the ministry of finance supervises the
activities of the fund and sets guidelines for investments and reporting requirements.



Economic literatures seem to be silent about the appropriate formula which must be applied to determine the
level of savings required.


However most studies suggested the basis for deriving a national savings fund:



firstly, the accumulation of excess revenue resulting from a price above the target price as in the case of Chile’s copper
stabilization fund;



secondly, revenue contingent sets a percentage of the commodity revenue as in the case of the Alaska’s permanent fund; and



thirdly, a mixture of both, a set percentage of commodity revenue and a reference price as in the case of Venezuela’s
stabilization fund are very common examples in the economic literatures




Appraisal of existing SWF Framework
in Nigeria


Before

the

Excess

crude

oil

account

all

the

money

realised

from

then

sales

of

this

natural

wealth

are

directly

plough

in

to

the

federation

account

and

allocated,




with

the

introduction

of

ECA,

in

2004
,

the

government

decides

to

allocate

part

of

the

revenues

from

the

oil

into

an

account

and




in

2001
,

a

proportion

of

funds

in

this

account

is

invested

to

generate

streams

of

income

and

or

apart

is

used

to

offset

existing

stock

of

debt
.

According

to

the

law

establishing

the

fund,

the

returns

from

the

funds

can

use

in

three

ways
:

for

stabilisation,

infrastructure

and

intergenerational

saving

in

the

ratio

of

20
:
20
:
20
:




with

the

balance

allocated

among

in

lie

with

the

board

discretion

based

on

macroeconomic

conditions

and

government

policy

expediencies
.




While

setting

the

rile

for

the

use

if

the

fund

is

good

and

follow

international

best

practises

but

the

retaining

of

over

40
%

of

the

sharing

power

under

the

discretion

of

few

political

appointees

of

the

government

in

power

create

serious

concern

about

the

sustainability

and

effectiveness

of

the

framework
.




The

recent

experience

with

Police

Pension

Fund

and

many

other

funds

in

the

past

should

have

been

a

good

guiding

point

for

government

to

reduce

the

discretion

power

of

the

board
.




Most

of

the

countries

that

have

succeed

in

this

respect

restricted

the

temptation

of

government

in

power

and

their

appointees

in

the

board

from

using

their

discretion

in

allocation

the

funds

and

if

we

also

want

to

achieve

a

meaning

fund

management

and

utilisation,

then

the

law

should

be

structured

to

restrict

such

temptation
.



Oil Wealth and Fiscal Sustainability
Empirical Strategy


Three rules must be set


Bench mark pricing Rule


Optimal spending and saving Rules


Optimal Spending Rule



Bench mark Rules






Optimal Saving Rule

under certain condition LRP approach
approximates the PIH approach


(i)



Fiscal Debt sustainability Rule


Where


d =

net public debt
-
to
-
GDP ratio (measured net of the net foreign assets
and public debt holdings of the central bank, and net of oil fund assets);


pd =

overall primary deficit as a share of GDP;


δ =

seigniorage

revenues


g =

real GDP growth rate;


r =

real interest rate on domestic debt,


r* =

real interest rate on external debt;


e=

real exchange rate calculated as EP/P*


b=

domestic borrowing


b*=

external borrowing


nfa
*

= Net foreign asset


Z=

other factors such as fiscal consequences of a bank bailout, and
one
-
off privatization


revenues.




Nigeria is to succeed in the current attempt to manage the oil revenue the government must avoid
the pitfalls of the past by



implementing a combination of the best international practices.



That is follows Norway’s lead in creating a fund of all oil revenues to be held abroad and sterilized from the
economy.



It is also recommended to follow similar investment and ethical practices of Norway.



However, as far as spending the revenues, we recommend that Nigeria uses a version of the Permanent
Income Hypothesis method that is implemented in Sao Tome Russia and Principe and Azerbaijan.



It is also vital to set similar legal restrictions on the limits of what can be transferred from the fund to the
state budget.



This will allow for predictable annual revenue transfers that will help Nigeria avoid the negative
consequences of pro
-
cyclical spending present in times of temporary spikes in oil prices.



Finally, given the knowledge of annual oil revenue transfer limits, Nigeria could follow a more sustainable
version of Saudi Arabia’s push for infrastructure and development of the non
-
oil economy.

Preliminary Conclusion


Budina
, N. and van
Wijnbergen
, S. (2008) adopted similar approach
to Nigeria for the ECA fund and conclude the only way to avoid
another debt overhang problem is to plan expenditure levels and
commitments low enough to avoid a crisis if and when oil prices
come down to earth again and revenues fall.


This implies non
-
oil deficits based on oil prices that is
commensurate with the long run average prices.



But recent events in Nigeria show clear dangers of slippage: non
-
oil
deficits have been above safe levels, particularly if off
-
budget
commitments and arrears are taken into account.


Those signs of slippage need to be reversed.


Conclusion


The government must ensure that :


Ensuring that fiscal policy frameworks and institutions lock in high rates of savings from resource revenues;



non
-
oil deficits based on oil prices that is commensurate with the long run average prices. But recent events
in Nigeria show clear dangers of slippage: non
-
oil deficits have been above safe levels, particularly if off
-
budget commitments and arrears are taken into account .Those signs of slippage need to be reversed



Strengthening overall institutions and building capacity to make good quality public investment; and



Delinking expenditure from volatile revenue in the short to medium term



Nigeria’s poor public investment performance makes it clear that reform of the public investment process,
including anti
-
corruption measures, should remain at the top of the policy agenda.



Only if the reform process is brought back on track and maintained in the years to come is there a
chance that Nigeria’s oil wealth will turn from a curse into a blessing