Guyana’s Sovereign Wealth Fund: Safeguarding against the triad of oil & gas export-led crises

Introduction

In last week’s column I had advanced the opinion that there were three policy priorities seemingly driving government’s approach to the development of the oil and gas sector. If taken in their widest meaning, these priorities can be said to represent the overwhelming bulk of government’s policy concerns, as publicly indicated to date. To recall, these policy priorities are: 1) the establishment of a sovereign wealth fund (SWF) and relatedly designing a set of nationally-agreed fiscal rules to guide public spending of the anticipated increases in export revenues from its hydrocarbon export; 2) implantation of international best-practices in the sector’s governance (in the broadest sense), and, including specifically Guyana’s intended membership of the Extractive Industries Transparency Initiative; and, 3) enshrining a legal and regulatory framework which secures local content, along with structural, macroeconomic and financial linkages, as well as capacity building within the national economy. All three are in order to maximize benefits from the hydrocarbon sector expansion.

Today’s column starts an appraisal of the first policy priority listed above. Specifically, it begins with an appraisal of the much talked about SWF, which the authorities have been consistently advancing since the reported 2015 decision of Exxon and its partners to convert their hydrocarbon discoveries in the Stabroek block into oil and gas production and export in the early 2020s.

Why an SWF?

Worldwide, the empirical data unmistakably indicate that oil and gas finds, such as that Guyana anticipates, lead to significant expansions (booms) in export revenue inflows. These create invariably, what economists term ‘fiscal space’. In layperson’s language, this means room in the national budget, which allows governments to provide spending (resources) for desired purposes/policies/projects/programmes (as they themselves determine) without jeopardizing the sustainability of their financial positions and/or the stability of the macroeconomic system.

The notion of fiscal space will be further amplified in next week’s columns. For present purposes, it is sufficient to note that fiscal space allows for increased government spending on infrastructure; development priorities like health, education, social welfare, productivity enhancing products (hardware) and services (software); environmental sustainability; and so on. No wonder then that governments would uniformly pounce on this as a golden opportunity to exploit at the fullest.

Shockingly, in practice, one finds this fiscal space has more often than not, turned out to be rather short-lived, if not illusory. Worldwide, the empirical data also reveal that this plentitude of resources, has led, far too frequently, to acute macroeconomic imbalances and vulnerabilities. Typically, deficits and gaps have rapidly emerged in the fiscal and monetary accounts, so that both internal imbalance (domestic investment and savings) and external imbalance (external trade and payments) characterize the macroeconomy. Indeed, unhealthy exchange rate changes, domestic inflation, and rising public indebtedness come to typify economic conditions. The evidence of mismanaged, poorly-managed and corruptly-managed revenues from the extraction of hydrocarbon resources seems to have become all too frequent.

The triad of crises

Economists who have surveyed these developments over a wide swathe of countries, have found that, in developing countries, (particularly small, poor, and highly ‘open’ ones with limited institutional and human capacities and skills across wide areas vital to successful development like transparency, accountability, rule of law, and democratic governance) have led, almost invariably, to circumstances where three profound crises become endemic.

The first of these is known as the Dutch disease. Like the notion of fiscal space this will be further addressed in next week’s column. Briefly, for present purposes, this suggests a model of economic behaviour in which the curse of plenty is plainly manifested. Booms in hydrocarbons export revenues (and also other commodities) lead to 1) rising wages and prices in the non-oil and natural gas sectors; 2) falling productivity in these sectors; 3) appreciation of the exchange rate; 4) a consequential rise in the export price of non-oil and natural gas exports; 5) weak internal linkages between the oil and natural gas sectors and other domestic sectors, both traded and non-traded; and 6) last but not least, negative outcomes caused by the low absorptive capacity of the non-oil and natural gas sectors in response to increased investment and public spending.

The second crisis is the equally well-known crisis of a rigid pro-cyclical pattern and inclination, which becomes imbedded in public spending. By this is meant that, when there is a plentitude (windfall) in export revenues, governments almost reflexively spend (even at the expense of careful planning of projects and programmes). This may be political opportunism, but regrettably, spending when you have plenty, rather than saving for a rainy day, has indeed been more or less the norm.

The third crisis is functionally dependent on the size of the hydrocarbon resources find and the rate of its depletion. As the physical peak of hydrocarbon resource extraction is approached, consequential declines in the depletion rate accentuate the natural boom and bust elements of commodity-based cycles.

Avoidance and solution

It is in the context of such a political economy dynamic that SWFs are advanced as the best of possible mechanisms for avoiding, rectifying, or doing both, in a single solution mechanism. From the perspective of this analysis, therefore, the proposed Guyana SWF should accomplish, at the very minimum, the following: 1) balanced management of the anticipated oil and natural gas revenue flows arising from their production and export; 2) streamlined build-up of revenues from oil and gas fed through the national budget into the national economy; 3) stability and predictability in the pattern and trend of governments spending (including successive governments); 4) opportunities for saving some of the current revenue flows for future generations (inter-generational equity).

Conclusion

Next week’s column continues with this appraisal. It starts with an elaboration on the technical concepts of fiscal space and Dutch disease as promised. The following week I shall conclude by serially summarizing lessons which Guyana can learn from the rich global experience with SWFs.

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