II. Fiscal Managementof Kazakhstan’soil Wealth1
1. Higher oil revenue, together with the prospect of a further substantial rise in the future, has permitted a rapid expansion of public spending and a widening of Kazakhstan’s non-oil budget deficit in recent years. Although the overall budget remains in surplus, pressures to further increase public expenditure have intensified and the authorities have undertaken to redesign the fiscal strategy for managing the country’s oil wealth.
This chapter seeks to address the following questions:
- In light of the prospects for oil production and fiscal revenue for oil, what level of non-oil deficit can be sustained while maintaining oil wealth?
- How does the near-term fiscal stance compare with this “sustainable” level?
- What sort of framework can help ensure that the fiscal stance remains sustainable over the longer term?
A. Oil Production and Revenue
2. Oil output and the associated fiscal revenue has increased sharply in recent years. In 2004, the output of oil and gas condensate reached 59 million metric tons (about 1.2 million barrels per day), increasing about two-fold since 1999 (29.4 million metric tons). In 2004, oil-related activity is estimated to account for about 30 percent of the country’s nominal GDP and half of its export earnings.2 About 30 percent of total government revenues were derived from the oil sector in 2004, compared to 6 percent in 1999.3
|Oil production (million metric tons)||29.4||35.4||39.3||47.3||51.3||59.4|
|Crude oil and oil products export revenues to total export revenues (in percent)||…||48.8||51.4||51.5||54.9||57.5|
|Government oil revenues (in percent of GDP)||5.5||3.3||6.6||4.4||6.0||7.4|
3. Oil production and revenues are expected to rise much further over the long term. Proven and probable oil reserves in Kazakhstan reach 35 billion barrels. Total reserves are estimated at around 50–60 billion barrels, although industry and official estimates vary.4 Under the current official scenario, oil production is expected to double by the beginning of next decade, and triple over the next 10–15 years, reaching 3.5 million barrels per day (bpd). Production volumes are then projected to moderate to around 2.5 million bpd by 2030. The government’s oil revenue is expected to grow from $4.2 billion in 2005 to about $16 billion during 2015–30.5
4. However, the country’s oil wealth is associated with significant uncertainties. Since much of oil earnings come in the distant future, several potential obstacles—such as inadequate transport capacities, environmental considerations, or technological challenges associated with off-shore drilling—may restrain the realization of the full production potential.6 Also, the production projections depend critically on continued sizable foreign investments, which are subject to exogenous shocks.
Projected Oil Production and Government Revenues
Sources: Kazakhstani authorities; and Fund staff estimates.
B. The National Fund of the Republic of Kazakhstan (NFRK)
5. The NFRK was established in 2001 to reduce the economic impact of volatile oil prices and to serve as a vehicle for saving part of the oil income for future generations. The rules governing the NFRK are complex and have changed over time. Initially, the authorities identified 12 major companies in the natural resources sector whose fiscal payments were subject to transfer to the NFRK; this list was reduced to 7 petroleum companies in 2004. Flows to the fund consist of a “savings” component equal to 10 percent of budgeted baseline revenue from the listed companies, which is invariant to oil price changes, and a “stabilization” component. The latter includes all revenues from listed companies in excess of receipts that would be realized at a reference oil price, which has remained fixed at $19 a barrel. In principle, the NFRK could be drawn down if oil prices fall below the reference price, although this has not happened yet. The authorities have also allocated privatization receipts, special bonus payments, and royalties from certain natural resource companies to the fund. The NFRK is an off-budget fund that is managed by the NBK on behalf of the government. All NFRK assets are invested abroad.
6. A prudent fiscal stance has been maintained. Since the NFRK was established, about 40 percent of the revenue from the oil sector, including one-off bonus payments, has been saved, and the NFRK has accumulated over $5 billion in assets.7 Nevertheless, the increase in oil revenue has given room to expand public spending, which has increased by 27 percent a year on average during 2000–04. While the share of total spending in relation to GDP has risen only moderately, the share of capital spending has doubled and social spending has also increased.
7. The authorities are in the process of redesigning the NFRK rules. The modifications being studied aim to fully integrate the NFRK with the budget, and devise a rule to guide the use of oil revenue, possibly by linking the non-oil fiscal deficit to the amount of development spending. Development spending, according to the Budget Law, is a key component of the government’s programs to increase the longer-term capacity and productivity of the economy, and is in broad terms equal to public capital spending. In this way, the portion of oil revenue to be spent (the non-oil deficit) would be used to enhance the economy’s longer-term capacity.
C. The Sustainable Non-oil Deficit Path
8. Since revenues from oil are volatile and exhaustible, an assessment of fiscal sustainability is challenging. Decisions about spending oil revenues have to be based on assumptions about oil prices, extracting costs, and the time horizon during which exhaustible resources may be depleted. Since most assumptions are likely to be subject to frequent revisions, estimates of the sustainable deficit path need to be updated regularly.
9. A range of fiscal rules to manage natural resource wealth has been discussed in the literature. These rules address a variety of trade-offs with regard to expenditure dynamics and intergenerational oil wealth distribution. One extreme is the Bird-In-Hand rule, where only the interest earned on financial assets originating from oil revenues is used for consumption. In this case, the bulk of oil revenue is saved in the early part of the oil extraction cycle, but at the expense of foregone spending with potentially high social and/or economic returns. The other extreme is a rule where all oil revenues are spent, while keeping the overall budget balanced. In this case, fiscal spending is subject to a high degree of volatility, which may lead to undesirable outcomes, and oil wealth is depleted over time. Constant expenditure rules and the Permanent Income Hypothesis (PIH) rule are examples of intermediate rules. Expenditure rules maintain a constant real expenditure stream, either in real terms or in real per capita terms.8
10. Under the standard PIH framework, the value of oil wealth is maintained in real per capita terms. In effect, the framework envisages spending the expected income from this wealth, which is the present discounted value of future oil earnings. Roughly, this translates into spending the present discounted value of oil wealth multiplied by the expected long-term rate of earning from this wealth (adjusted for the projected rate of population growth). Then, the non-oil deficit is set equal to such amount. Over time, as the economy grows, the sustainable non-oil deficit will narrow in relation to GDP.9
11. Key assumptions regarding future oil production, prices, and other variables are required to assess the sustainable non-oil deficit path. In this chapter, an illustrative baseline scenario is presented, based on WEO assumptions for 2005-10 and staff projections for 2011-49. Oil production is estimated to peak at 3.5 million bpd in 2017-18, while oil prices are projected to decline to $40 per barrel by 2020, remaining constant in real terms thereafter. The non-oil economy’s growth is projected to moderate from about 7–8 percent a year in the near term to an average of 4.5 percent a year over the long term (after 2020).
Sustainable Non-Oil Deficit Implied by the PIH 1/
Source: Fund staff estimates.
1/ Non-oil deficit that would maintain oil wealth in real per capita terms.
|Oil production (in million bpd)||1.3||1.4||1.5||1.6||1.9||2.1||3.1||3.4||2.8||1.2||0.6|
|Government oil revenues (in billions of tenge)||538||515||500||481||558||574||1,087||1,532||1,263||529||217|
|Non-oil GDP growth (in percent)||7.6||7.9||7.5||7.1||6.7||6.5||5.5||4.5||4.5||4.5||4.5|
|6-m LIBOR on US$ (in percent)||3.31||4.12||4.35||4.35||4.35||4.35||4.35||4.35||4.35||4.35||4.35|
|World inflation rate, CPI (in percent)||2.1||1.9||2.1||2.1||2.2||2.2||2.0||2.0||2.0||2.0||2.0|
12. Based on these assumptions, the non-oil deficit that maintains oil wealth in real per capita terms is equivalent to 6-7 percent of GDP in the near term, and declines markedly relative to GDP over the long run.10 However, the estimated sustainable path is highly sensitive to changes in the assumptions on oil prices and production volumes. For example, a permanent reduction in oil production by 20 percent, starting in 2010, would reduce the average sustainable non-oil deficit for 2005–10 by 1 percent of GDP. Similarly, a permanent decrease in the oil price by 20 percent (relative to the baseline) would reduce the average sustainable non-oil deficit for 2005–10 by about 2 percent of GDP.
Sustainable Non-Oil Defict (PIH) Under Different Oil Price Scenarios
Source: Fund staff estimates.
Sustainable Non-Oil Deficit (PIH) Under Different Oil Production Scenarios
Source: Fund staff estimates.
13. It should be noted, moreover, that the PIH framework ensures that oil wealth stays constant in real per capita terms over time. If some depletion of oil wealth is judged to be appropriate as economic development proceeds and living standards improve, the implied deficit path would be higher.
D. Implications for the Near-term Fiscal Stance
14. Kazakhstan’s projected non-oil deficit over the near term is broadly in line with the baseline PIH, but over the medium term it will need to narrow relative to GDP in order to maintain oil wealth at its present level. For 2005, the non-oil deficit is projected at 5.4 percent of GDP, which is well within the sustainable level under the baseline scenario. If oil prices and production move in line with expectations, and other baseline assumptions remain valid, the non-oil deficit will need to narrow to 3-4 percent of GDP over the medium term and to about 1-2 percent of GDP over the longer run.
15. Adoption of a simple fiscal rule can help operationalize the PIH framework and set the overall fiscal strategy. One possibility currently under consideration is to link the non-oil deficit to the amount of budgetary development expenditures. Such a link would be transparent and easily understood. By itself, however, the rule will not ensure that oil wealth is maintained—or that a given target for future oil wealth is met—since the rule under consideration does not provide guidance on setting the level of development spending.11 Moreover, such a rule can limit budget flexibility to raise other types of spending that could carry a higher social return. Hence, determining the level of the non-oil deficit in a PIH-type framework, with regular updating, is critical for ensuring sustainability.
16. Another mechanism under consideration could also ensure fiscal sustainability under appropriate parameter choices. Under such a mechanism, the non-oil deficit, which would be financed from oil revenue, would be determined by a formula of the form:
NODeft = A + bFt+1,
where Ft-1 represents the outstanding assets of the NFRK at the start of the year. The variable b could be set equal to the expected annual return on NFRK assets over the long term, while A could be fixed in tenge terms for a period of, say, three years. In the near term, when the A term is expected to dominate, this would result in a steady reduction of the nonoil deficit in relation to GDP, consistent with the declining path of the sustainable deficit based on a PIH framework. Of course, sufficient flexibility would need to be retained to be able to alter the formula if oil prices or production prospects change substantially.
17. Given the prospects for oil production and fiscal revenues for oil, Kazakhstan can sustain non-oil deficits of over 5 percent of GDP in the near term without reducing the value of oil wealth. This is broadly in line with the fiscal stance projected by the staff on the basis of current policies. However, the sustainable deficit will decline markedly in relation to GDP over the longer term. Moreover, as the analysis illustrates, the sustainable path is very sensitive to unanticipated developments in oil prices, production, reserves, and key macroeconomic variables. In order to ensure that the budgetary position remains sustainable, the fiscal strategy guiding the use of oil revenues will need to be cast within a longer-term fiscal framework and should retain sufficient flexibility to respond to major changes in expectations regarding the value of future oil earnings.
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