III. Macroeconomic Challenges for Africa’s Oil Producers: How to Seize the Opportunities and Avoid the Pitfalls
- International Monetary Fund. African Dept.
- Published Date:
- April 2007
In the past three years buoyant oil prices, and in some countries increasing oil production, have allowed OPCs in SSA to substantially increase their oil exports and thus their revenues (Figure 3.1).18 Together with recent debt relief these resources, used judiciously, provide a unique opportunity to improve living standards and make significant progress toward the MDGs. The needs in OPCs for both physical infrastructure and social development are huge—and electorates are pressuring OPC policymakers to scale up public spending from the suddenly abundant resources.
Figure 3.1.SSA: Oil Production and Oil Prices, 1965-2006
Sources: BP, Statistical Review of World Energy, June 2006; and IMF, World Economic Outlook, 2006.
In the past, OPCs have been challenged to reap the full benefit of their resource endowments. Boom-bust cycles, poor public financial management (PFM), fragile institutions, and weak oversight have left many OPCs saddled with unsustainable amounts of debt even as income deteriorated and social conditions worsened.19 The risks of violent conflict have also been high.20 Although during the current boom most SSA OPCs have been more prudent in the use of oil resources than in the past, nevertheless public spending has increased—and could rise further if oil prices hold up.
Policymakers therefore face three constraints that are binding to differing degrees in different countries:
- Fiscal space is constrained by long-term oil revenue.
- Absorptive capacity is limited in the short term.
- Implementation capacity is often inadequate, varying with the quality of institutions and PFM.
These constraints are not immutable. The challenge for public policy is to address them and create the space needed for higher and more effective public spending.
Pressing needs, notably in infrastructure and social services, warrant a scaling-up of public spending, even if this temporarily raises fiscal deficits above levels that are sustainable over the long run. However, reaping the full benefits in terms of sustainable higher economic growth and poverty reduction will require careful management of the macroeconomic consequences of higher spending, and ensuring that spending is of high quality. Yet current institutions are not sufficiently developed to perform these tasks in a fully satisfactory manner, also in light of the OPC’s limited capacity to spend effectively. In addition, adequate structural reform will be required to increase potential output. Addressing these issues is critical if resources are to be used productively.21
The Evidence of Past and Present
Oil revenues are a significant source of fiscal income for the SSA OPCs, demonstrating the oil sector’s importance in output growth and capacity to generate export revenues. Revenues from oil account for more than half of all revenues in Angola, the Republic of Congo, Equatorial Guinea, Gabon, and Nigeria (Figure 3.2). They account for a much smaller share of total government revenues among mature producers like Cameroon and emerging ones like Chad and Côte d’Ivoire. In SSA OPCs as a group, government oil revenues increased in dollar terms about 3½ times between 2002 and 2006. While the meteoric rise of oil prices since 2002 is responsible for a substantial part of the revenue upsurge, production also expanded significantly, on average by 45 percent, particularly in Angola, Chad, and Equatorial Guinea. Oil output is expected to rise further in Angola and Nigeria, among other SSA OPCs, in the coming years.
Figure 3.2.SSA Oil-Producing Countries: Oil and Non-Oil Revenues, 2002 and 2006
Sources: Authorities' data; and IMF staff estimates.
Government expenditure has not been rising recently at the same rate as oil revenues. In 2002, before the oil boom, in many OPCs (e.g., Angola, Republic of Congo, and Nigeria) non-oil deficits exceeded oil revenues; since then, in all SSA OPCs the ratio of non-oil fiscal deficit to oil revenues has noticeably improved (Figure 3.3). This reflects mainly the rapid rise in oil revenues but in some cases also the narrowing of non-oil fiscal balances. As a result, in 2006 the SSA OPCs on average spent only about half their oil revenues to finance non-oil fiscal deficits.
Figure 3.3.SSA Oil-Producing Countries: Portion of Oil Revenue Spent, 2002 and 2006
Sources: Country authorities; and IMF staff estimates.
The relatively cautious fiscal policies in many SSA OPCs are helping reduce their macroeconomic vulnerabilities (Figure 3.4). SSA OPCs have used oil revenues to strengthen their external positions by reducing external debt (Gabon, Nigeria); accumulating external reserves (Angola, Republic of Congo, Equatorial Guinea, Gabon, and Nigeria); and reducing domestic and external arrears (Angola, Equatorial Guinea, Gabon, and Nigeria). Angola, Cameroon, and the Republic of Congo also improved their non-oil primary fiscal balances.
Figure 3.4.SSA Oil-Producing Countries: Change in International Reserves and Non-Oil Primary Fiscal Balances, 2002 and 2006
Sources: Country authorities; and IMF staff estimates.
SSA OPCs have experienced repeated boom-bust cycles over the past three decades (Figure 3.5). Before the first oil shock of the 1970s, SSA OPCs on average enjoyed favorable macroeconomic conditions: robust economic growth, moderate inflation, manageable fiscal deficits and external debt, and external current account surpluses. The procyclical policies they followed during the oil booms of the 1970s and 1980s were intended to use the oil bonanza for economic and social development and encourage economic diversification. These objectives were not achieved. Instead, the policies gave rise to economic imbalances that caused major distress when oil prices plunged in the 1980s and stayed low for over a decade.
Figure 3.5.SSA Oil-Producing Countries: Impact of Fiscal Policies, 1970-2006
Sources: Country authorities, and IMF staff estimates.
1 Arithmetic average for individual countries, weighted by GDP in U.S. dollars.
Disappointing performance during previous oil booms underlines the importance of sound macroeconomic policies and strong institutions. The large public investment projects in the 1970s and 1980s, when governance and institutions were extremely weak, were often undertaken with little scrutiny and accountability, and were accounted for outside government budgets. The return on public investment was correspondingly low. Meanwhile, poor macroeconomic management of oil cycles in some SSA OPCs resulted in high inflation, large exchange rate appreciation, and erosion of the competitiveness of non-oil sectors. Because many leveraged their oil wealth to access credit from foreign suppliers and governments, in several countries in the early 1990s external debt rose well above 100 percent of GDP. These macroeconomic imbalances eventually required difficult policy adjustments, such as sharp fiscal contraction, exchange rate adjustment, and debt rescheduling.
Compared with oil producers in other regions, those in SSA face larger developmental needs and greater institutional challenges. The differences are particularly stark in comparison with the OPCs in the Cooperation Council for the Arab States of the Gulf (GCC) (Figure 3.6). African oil producers have much shorter oil horizons and smaller oil reserves per capita, so spending their oil wealth must be planned more prudently. At the same time, their dependence on oil revenue is high, and they also face a far larger infrastructure gap and developmental challenges in the social areas, so their spending needs tend to exceed those of other OPCs.
Figure 3.6.Selected Indicators in Oil-Producing Countries, 2005
Sources: World Bank, World Development Indicators, 2006, and Governance Indicators, 2006.
1 SSA oil-producing countries are Angola, Cameroon, Chad, Republic of Congo, Côte d'Ivoire, Equatorial Guinea, Gabon, and Nigeria.
2 GCC-Gulf Cooperation Council members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
3 Others are Algeria, Azerbaijan, Ecuador, Islamic Republic of Iran, Libya, Russian Federation, Sudan, Syria, Trinidad and Tobago, Turkmenistan, Venezuela, and Yemen.
If public spending is to be scaled up in SSA OPCs, obstacles facing the private sector need to be addressed. On a series of international rankings, private investors in SSA OPCs face more hurdles than investors in other OPCs. The unfavorable business environment can impose significant costs on the private sector in terms of starting a business, the time it takes to register property, and the rigidity of labor markets. Such governance indicators as government effectiveness, the rule of law, and regulatory quality are markedly weaker in SSA OPCs. They also have immature financial sectors—a strong financial sector is typically a leading indicator of long-term economic growth22—and many private firms are forced to rely mainly on self-financing.
Policy Challenges Ahead
At current oil prices, SSA OPCs have the resources to address their most pressing social needs and accelerate socioeconomic development. But increasing government spending does not per se lead to higher growth or better social indicators. History, international comparisons, and institutional fragility suggest that if scaling up is not accompanied by a substantial strengthening of public institutions and budgetary procedures, it could bring on a repetition of the boom-bust cycles that previously failed to reduce poverty.
Economic policies need to address both short-term macroeconomic stability and long-term fiscal sustainability. In the short term, policymakers must ensure that increased public spending does not pose undue macroeconomic risks, particularly of inflation. At the same time, historical price volatility and finite oil resources point up the importance of long-term fiscal sustainability. In determining the pace and scale of additional public spending, policymakers confront, to differing degrees, the three main constraints: fiscal space, macroeconomic absorptive capacity, and administrative absorptive capacity.
Defining the fiscal space
Because oil revenues are temporary and volatile, a fiscal strategy must be designed that will transform current oil wealth into financial assets or high-yield public investment. If oil reserves were limitless, governments could consume oil revenues directly, but because resources are being depleted,23 public consumption needs to be financed from alternative revenue sources so that it can be sustained after reserves are exhausted.
Previous boom-bust cycles taught governments to avoid aligning government consumption with international oil prices. A possible approach based on a permanent-income hypothesis would suggest defining on the basis of available hydrocarbon reserves a long-term fiscal policy that has governments accumulate financial assets during the years of oil production, the returns from which can finance primary deficits in post-oil years (Box 3.1).24 A natural implication of this approach is that any fiscal stance that is more expansionary than is permanently sustainable will eventually have to be adjusted. Governments thus must choose between designing a gradual fiscal adjustment path while overall fiscal balances are in surplus or having to contract fiscal policy sharply and abruptly, often to the detriment of the most disadvantaged segments of society, once oil revenues start to decline.
Box 3.1.Limited Oil Reserves and Long-Term Fiscal Policies
A key question for fiscal policy is how to address the gradual depletion of oil reserves, often the main source of government revenue. Policymakers need to determine an appropriate mix of spending, including investing in physical and human capital, and financial savings. Different social preferences can yield different results, all of which may be consistent with long-term fiscal sustainability.
One approach is to choose a fiscal strategy that aims at preserving the sum of oil reserves and productive financial, infrastructure, and social assets. Like Friedman’s (1957) permanent-income hypothesis (PIH), such a policy would limit public consumption to the net present value of future oil and non-oil revenue streams (the government’s “permanent income”). The quantitative results presented here are based on Olters (2007), who applied the Barnett-Ossowski (2003) and Leigh-Olters (2006) framework to all SSA OPCs.
PIH models give OPCs long-run fiscal benchmarks. In the model, a social planner solves an infinite-horizon utility maximization problem that has an intertemporal budget constraint. The optimal policy would be to set spending on a constant path equal to the expected annuity value of oil wealth and non-oil revenue. Governments invest a certain fraction of their oil revenues in alternative forms of wealth (in this case, financial). These assets generate a rate of return from which, when oil reserves are depleted, the government can finance a primary deficit indefinitely.
Habits justify fiscal adjustment to sustainable levels over the medium term. While basic PIH models estimate long-run fiscal targets, Leigh and Olters (2006) expand this approach to permit “habits”—the notion that consumers become addicted to the level of public consumption enjoyed in previous periods. They alter the utility function so that current-period utility depends not only on current spending but also on past expenditure so that they can calculate both the permanently sustainable non-oil deficit and the optimal adjustment path toward that level. This model was recently applied to the Republic of Congo (Carcillo, Leigh, and Villafuerte, 2007), allowing for a temporary period of catch-up growth during which growth rates can exceed the real rate of interest.
Future research will have to specifically address a number of limitations, including the model’s implicit abstraction from productive investments as a policy variable. From an operational viewpoint, the PIH framework can be thought of as viewing the financial rate of return as a benchmark against which to judge the social desirability of capital expenditure. The implication is that the non-oil primary deficit could exceed the permanently sustainable level by public investments whose (social) rates of return exceed financial rates of return.
Any estimate of a fiscal deficit that could be financed ad infinitum is fraught with uncertainty, and any benchmark results need to be updated regularly as new information becomes available. Some critical factors determining whether fiscal policy is sustainable are outside the control of governments (exogenous). Others, however, are the direct result of policy choices. These endogenous factors define the principal challenges to policymakers in SSA OPCs over the medium term.
Exogenous factors. Estimates of recoverable oil reserves are imprecise and continuously revised. Oil in the ground is only considered a reserve if it can be recovered with a certain probability and within given economic constraints. Recovery probability of at least 90 percent typically refers to proven reserves, 50 percent to probable ones. Because the marginal cost of oil extraction is positive, both the size and the recovery factor of a given field are uncertain. New discoveries of oil and gas fields, improved technologies to exploit reserves in mature fields, and the ability to commercialize gas reserves and minimize flaring (see also Box 3.2) would all increase recoverable reserves and thus hydrocarbon production (Figure 3.7). Similarly, unexpected changes to international oil prices, especially if they are long-lasting, can have very substantial effects on oil revenue and fiscal sustainability.25 With all this uncertainty, it is important to avoid cyclical fiscal spending as well as basing policies on overly optimistic scenarios.26
Figure 3.7.SSA Oil-Producing Countries: Oil and Gas Production, 2001–561 Box 3.2.Oil and Gas Reserves in Sub-Saharan Africa
Oil. Sub-Saharan Africa has at its disposal proven oil reserves of more than 50 billion barrels (bbl), just over 4 percent of world reserves (figure). But its oil wealth might be considerably higher. Geologists think there are additional probable reserves of more than 60 billion bbl, mostly offshore in the Gulf of Guinea.
Gas. Some countries also have substantial reserves of natural gas, typically a byproduct of oil exploration. While there has been considerable progress in commercializing gas, notably in Côte d’Ivoire, Equatorial Guinea, and Nigeria, African countries generally have found it difficult to do so. As a result, this potentially very valuable commodity—an estimated 38 billion barrels of oil equivalents (boe) for proven reserves and another 31 billion boe of probable reserves—is still flared at high rates.
For both commodities, the following definitions of reserves have been applied:
- Proven (1P) reserves are the estimated quantities of oil that geological and engineering data demonstrate, generally with a probability of at least 90 percent, to be recoverable from already discovered fields under current economic and operating conditions. Proven reserves are a conservative estimate of future cumulative production.
- Probable (2P–1P) reserves are reserves that the geological and engineering data suggest, with a probability of at least 50 percent, can be extracted under given economic and technological conditions.
SSA Oil-Producing Countries: Proven and Probable Oil and Gas Reserves, 2006
Source: Olters (2007)
The simulations are based on four scenarios. In the most conservative (green), OPCs exploit all their proven oil reserves. In the most optimistic (red), OPCs commercialize all their proven and probable oil and gas reserves. Intermediary scenarios take into account the lower extraction likelihood of probable oil reserves and the technical obstacles to recovering gas.
Endogenous factors. Governments can devise effective financial investment strategies that promise to generate the highest possible rates of return on OPC oil saving for a given level of risk.27 Equally important, OPCs can implement structural reforms to increase the productivity of public investments so as to crowd in private investment, stimulate growth, and increase the sustainability of government expenditure.
Expectations of the ultimate recoverability of oil and gas reserves have considerable influence in assessing fiscal sustainability. Proven oil reserves alone—the most conservative assumption—would not be enough to maintain forever the current aggregate level of public expenditure in an SSA OPC economy, even if oil prices remain at their current heights.28 Proven reserves would only allow for a non-oil primary deficit of 8½ percent of non-oil GDP; the average for 2004–06 was 27 percent.
The gradual medium-term adjustment path shown in Figure 3.8 reflects the inclusion of habits, as proposed by Leigh and Olters (2006). The fiscal positions of individual SSA OPCs fluctuate considerably around the aggregate simulation. More optimistic reserve and recovery assumptions reduce the gap between the actual and the permanently sustainable fiscal position. On the most optimistic assumption—SSA OPCs recover all their proven and probable oil and gas reserves—the estimated permanently sustainable non-oil primary deficit for the aggregated SSA OPC economy would increase to about 28 percent of non-oil GDP, near the 2004–06 average.
Figure 3.8.SSA Oil-Producing Countries: Non-hydrocarbon Primary Balance, 2003–45
While providing a policy benchmark for the long-term design of fiscal policies, this analysis has two important policy implications:
- A proactive policy for increasing the rates of return on financial, infrastructure, and social investments would help expand the fiscal envelope. As summarized in Figures 3.9 and 3.10, even a relatively modest increase in the average real rate of return from 3.2 percent to 4 percent would increase the non-oil primary deficit that could be financed permanently from the return on accumulated savings.
Figure 3.9.SSA Oil-Producing Countries: Permanently Sustainable Non-Oil Primary Deficits (3.2 percent return) Figure 3.10.SSA Oil-Producing Countries: Permanently Sustainable Non-Oil Primary Deficits (4 percent return)
- Carefully designed and effectively implemented public investments to accelerate non-oil growth also increase the government’s fiscal space. The model treats the relation between public spending and non-oil growth rates as exogenous. But changing the growth assumptions29 so that government spending becomes more targeted and effective and thus capable of crowding in private investments sets off a virtuous cycle of accelerating non-oil growth, increasing non-oil tax revenues, and higher sustainable government expenditure (Figure 3.11). Clearly, with higher non-oil growth and more rapid diversification of the economy, the relative importance of oil funds would decrease.
Figure 3.11.SSA Oil-Producing Countries: Real Growth and Sustainable Government Expenditure, 2003–55
Identifying macroeconomic absorptive capacity
While scaling up public spending in SSA OPCs could be warranted by their vast developmental needs, the process must be managed carefully to avoid destabilizing the economy. Risks could arise from inflation, real appreciation, and loss of competitiveness (Dutch disease).30 Policymakers should therefore identify measures and policies to ensure that the economy can absorb higher spending effectively.31 Furthermore, the possible macroeconomic costs of higher spending need to be balanced against the long-term positive effect on growth that is expected to result from the spending. This section reviews the structural aspects of an economy that determine short-run absorptive capacity and the policy choices governments can make to help manage and improve macroeconomic outcomes. It quantifies the effects using Nigeria as an example.
Structural determinants of absorptive capacity
The initial macroeconomic impact of scaling up spending will vary depending on the structure of the economy. Initial domestic demand pressures will be less pronounced in smaller and more open economies that can draw on a large pool of labor either domestically or from abroad. The adjustment process will require a real exchange appreciation to return the economy to both internal and external equilibrium. The magnitude of the appreciation will depend on whether the initial increase in domestic demand is externalized or absorbed through a supply response.
- Import content and openness. In more open economies, the impact of higher government spending is more likely to be externalized.
- Short-run supply response. The short-run supply response will depend on whether there is labor available to absorb the increase in demand; thus, economies with high unemployment may initially experience a rise in output. Also, economies that are open to foreign workers and can draw on a skilled labor force in the region may also benefit from an increase in output.
The importance of the economic structure can be illustrated in a case study of Nigeria (Box 3.3). Because it is a large economy and thus less open, the import content of public spending in Nigeria is likely to be lower than elsewhere. It is also likely to be short of skilled labor. Thus, without corrective macroeconomic and structural policies, domestic demand pressures would be large and the short-term supply response muted. Nigeria would therefore probably experience a prolonged period of double-digit inflation if government spending increased to 10 percent of non-oil GDP (Figure 3.12—scenario with no sterilization). In contrast, SSA OPCs that have a higher propensity to import and whose labor markets are open to foreign workers would see less pressure from domestic demand and inflation.
Figure 3.12.Nigeria: Impact of Scaling Up Government Spending, 2002–12
Sources: Nigerian authorities, and IMF staff estimates and projections.
Note: Baseline scenarios reflect the country projection compiled for the May 2007 World Economic Outlook submission. In alternative scenarios, government permanently increases spending by 10 percent of non-oil GDP, and half of the increase in liquidity is sterilized.
Box 3.3.Simulating the Impact of Scaled-Up Public Spending
A simple financial programming model illustrates the range of possible outcomes of scaling up in Nigeria. The core behavioral equations are the quantity theory of money and the relationship between non-oil imports and the real exchange rate. Short-run dynamics are determined by the slope of the aggregate supply curve and shifts in aggregate demand, as proxied by changes in broad money. Medium-term dynamics are determined by shifts in aggregate supply as determined by the marginal product of capital and the composition of spending.
The simulations are based on a substantial scaling up of spending. A permanent increase in public spending of 10 percent of non-oil GDP (compared to the country-specific baseline projections from the World Economic Outlook) is assumed; this is consistent with the objectives of reducing poverty and reaching the MDGs. Half the spending increase is assumed to be for infrastructure and one-fourth each for education and health.
Parameters are determined from estimates in the literature. The import content of government spending is assumed to be 50 percent for infrastructure, 25 percent for health, and 5 percent for education. A higher import content for infrastructure could be justified if more capital-intensive projects were pursued. The medium-term return on investment is assumed to be 10 percent, which is consistent with the literature generally but slightly higher than a recent estimate by Caselli and Feyrer (2007). The lag on this return is assumed to be two years for infrastructure, five years for health, and seven years for education. Finally, estimates of import elasticity are based on Kee, Nicita, and Olareaga (2004), which studies import elasticities over a wide range of countries using commodity-level trade data.
Policy choices to help manage macroeconomic outcomes
SSA OPCs can use exchange rate policy to help mitigate inflationary pressures. A flexible exchange rate would allow at least part of the real appreciation necessary to occur through a nominal appreciation of the currency.32 In our scenario for Nigeria, the central bank opts to mop up a substantial portion of the injected liquidity with foreign exchange sales. This mitigates the inflationary impact (Figure 3.12—alternative scenario) and quickly increases the imports necessary to bring the economy back to equilibrium.33 SSA OPCs in a currency union would be unable to use the exchange rate as a shock absorber and would have to achieve real appreciation through price inflation.
Other supportive structural policies could improve the medium-term supply response, limiting both the inflationary impact and the loss of international competitiveness. Improving the business environment would boost foreign and domestic investment and help improve productivity and increase employment. Sound fiscal institutions and firm PFM would help ensure that public sector investment in infrastructure is well targeted and effective in alleviating bottlenecks to private sector activity. Further trade liberalization would facilitate a larger import response to any spending increase and limit the pressures on domestic demand.
In sum, the macroeconomic impact of scaling up could be managed as long as economic policies are accompanied by reforms directed to diversifying the non-oil economy. Depending on the initial macroeconomic situation and the structure of the economy, policymakers would need to implement a mix of macroeconomic and structural policies that would release additional fiscal resources to help reach overarching policy objectives, such as those outlined in poverty-reduction strategies and the MDGs.
Reinforcing administrative absorption capacity
The quality of a country’s PFM is critical if spending is to be scaled up effectively. Given the rent-seeking opportunities associated with the size and centralized receipt of oil revenues, oil-rich countries face particular PFM challenges. A careful budget formulation process is needed to direct large but exhaustible oil resources toward high priority areas, and budget implementation needs to ensure that spending is executed efficiently.
By most available measures institutional capacity is low in SSA OPCs. According to the World Bank’s Country Policy and Institutional Assessment (CPIA) index, on average public sector management in SSA is weak both in absolute terms and compared with other countries in the region and oil-producing countries in other regions. Some SSA OPCs, among them Angola, Chad, and Côte d’Ivoire, are postconflict countries, where weaknesses are pronounced across the board (Table 3.1). The capacity of most SSA OPCs to formulate, execute, and ensure the accountability of government budgets is below that of comparator countries,34 and public administration in general is ineffective.35 The low rating on the indicators for transparency and accountability for the use of public funds is a symptom of poor fiscal discipline.
|Quality of Budget and Financial Management||Efficiency of Revenue Mobilization||Quality of Public Administration||Transparency, Accountability and Corruption in the Public Sector||Average|
|Oil producing countries in Sub-Saharan Africa||2.9||3.2||2.5||2.4||2.6|
|Republic of Congo||3.0||3.0||2.5||2.5||2.7|
|Oil-producing countries in other regions||3.3||3.5||3.0||2.9||3.0|
|Non-oil producing countries in Sub-Sahara Africa||3.1||3.4||2.9||2.8||2.9|
|All IDA-eligible countries||3.2||3.4||3.0||2.9||3.0|
Addressing weaknesses in institutional capacity should be a priority if public spending is to be effective. The following areas require significant attention.
- The process of policy planning and budget preparation should ensure that fiscal policies achieve their goals for oil-revenue windfalls. Once the policies are designed, their spirit should be incorporated into annual budgets. To this end, except for Angola and Equatorial Guinea the SSA OPCs have adopted PRSP-like strategic policy documents and prepared medium-term fiscal or expenditure frameworks (MTEF). However, these strategic documents could be used more effectively. In particular, the MTEFs should be based on credible economic projections and incorporated into budgets. Moreover, budgets should cover all expenditures and fully integrate oil revenues. Such processes would help governments avoid using oil windfalls on an ad hoc basis without fully exploring the medium- and long-term implications of their choices.
- Effective public spending requires strict execution of the approved budget. The process depends on both the administrative capacity of public officials and political discipline to respect the budgets. For many SSA OPCs more discipline and the capacity to produce realistic economic assumptions and adequate cost information would better track the original budget. Moreover, it is important to ensure that spending is high quality. Systematic strengthening of government expenditure processes would concentrate on commitment control, accounting, and financial and management reporting. Internal auditing also needs to be supported by increased material resources and staff who have the needed skills.
- Regular reporting promotes transparency and thus accountability in both revenue administration and expenditure management. SSA OPCs rarely have the capacity to produce timely and informative fiscal information. Budget classification is the basis for understanding expenditure patterns but in many countries it is not adequate to this role. Budget reports should cover the operations of local governments and autonomous units, and audited budget reports generally need to be publicized faster to reinforce checks and balances and enhance fiscal discipline.
Given current weaknesses, strengthening administrative capacity in budget management should start with enhancing transparency. Governments should be encouraged to ensure that there is a steady and timely flow of up-to-date and credible information both internally and to the public on revenue and expenditure. This would support internal policy decision-making and accountability and also allow for public scrutiny of whether oil resources are being used to meet announced priorities. By adopting the Extractive Industries Transparency Initiative (EITI) process, some SSA OPCs have recently made great progress toward increasing oil transparency (Box 3.4).
Box 3.4.Implementation of the Extractive Industries Transparency Initiative (EITI) in Africa
Participation in the EITI, which was launched in 2003, has grown substantially in Africa, which accounts for about two-thirds of participating countries.1 The African Development Bank has strongly endorsed the EITI. So far four African countries have issued reports: Cameroon, Gabon, Guinea, and Nigeria, the last being by far the most comprehensive.
At its October 2006 High Level Conference in Oslo the EITI agreed on a governance structure that has a board representing all stakeholders (Gabon, Guinea, and Nigeria are members) and a permanent secretariat. It also agreed on a mechanism for validating compliance with the six EITI criteria:
- Regular publication of all material oil, gas, and mining payments by companies to governments, and all material revenues received by governments from oil, gas, and mining companies;
- Where such audits do not already exist, a credible independent audit of payments and revenues, applying international auditing standards;
- Reconciliation of payments and revenues by a credible, independent administrator, applying international auditing standards, and publication of the administrator’s opinion identifying discrepancies;
- Extension of this approach to all companies, including those that are state-owned;
- Active engagement of civil society in the design, monitoring, and evaluation of the EITI process; and
- A public, financially sustainable work plan for all the above drawn up by the host government, including measurable targets, a timetable for implementation, and an assessment of potential capacity constraints.
The criteria will be evaluated by independent validators to confirm the status of a country as either an EITI candidate, if it has at least completed the sign-up phase, or EITI compliant, if it has met the six criteria. A detailed scoring system will identify progress toward compliance. The first validation reports are expected in 2007.1 SSA participants are Angola, Cameroon, Chad, Democratic Republic of Congo, Republic of Congo, Equatorial Guinea, Gabon, Ghana, Guinea, Mali, Mauritania, Niger, Nigeria, São Tomé and Príncipe, and Sierra Leone. See www.eititransparency.org.
Special fiscal institutions (SFI)—oil funds, fiscal rules and fiscal responsibility legislation, and budgetary oil prices—can be valuable safeguards for national wealth. Evidence suggests that in many cases SFIs by themselves have not been able to overcome the difficulties associated with oil revenue management, institutional weaknesses and complex political dynamics. Nevertheless, under appropriate institutional frameworks, well-designed SFIs buttressed by political commitment may help support sound fiscal policies. Past evidence from OPCs suggests they have had mixed results, but if they are well designed, SFIs can support (not substitute for) sound fiscal policies, particularly when they complement other PFM and governance reforms.36 In view of how OPCs have met past challenges, reliable institutions are arguably even more important in OPCs than in other low-income countries. Notably, transparency and the observance of international standards like the IMF’s Special Data Dissemination Standard (SDDS) or the EITI can be valuable for providing more and better information, which will boost investor confidence and private development outside as well as within the oil sector.
The currently elevated international oil prices offer SSA OPCs an exceptional opportunity to address pressing socioeconomic challenges; the question is not whether to scale up public spending but how to ensure that it is effective. The historical performance of OPCs, marked by crippling boom-bust cycles and low rates of return on public spending, underlines the challenge they face. But saving is not easier than spending, particularly in countries where institutions to safeguard these savings are inadequate or nonexistent. And young democracies face impatient electorates that, legitimately, insist that their governments provide the public goods needed for development.
This chapter has therefore emphasized four issues that OPCs need to bear in mind as they proceed to use their additional resources:
- First, oil prices historically are volatile, and resource endowments are finite. In most OPCs economic policies have been more prudent during the current boom than in the past. Nevertheless, non-oil deficits are rising in many countries where scaled-up public spending is addressing pressing social and infrastructural needs. Higher deficits may be warranted if they are temporary, but they will need to return to sustainable levels eventually. Oil producers therefore need to ensure that the additional resources, whether invested in financial or real assets, yield high returns.
- Second, scaling up public spending will put pressure on macroeconomic policy in the short term. Risks could arise from inflation, real appreciation, and loss of competitiveness. Effective monetary and exchange rate policies and supportive structural reforms are necessary to contain these risks.
- Third, strong PFM is crucial to ensure that public resources are used optimally. OPCs in SSA are on average less able than other low-income countries to manage public expenditure well, so the reform agenda is long. But strengthening public sector capacity to manage and absorb additional resources is vital.
Finally, only sound domestic institutions will guarantee long-term stability in the management of oil revenue. Experience is mixed on the value of SFIs, such as fiscal rules and oil funds, but there is enough evidence to suggest that reliable institutions are even more important in oil-exporting countries than in other low-income countries because trustworthy institutions strengthen investor confidence and boost private sector development, within and outside the oil sector. Ultimately, durable private sector–led growth is the most valuable legacy the present generation can pass on to its children.
Note: This chapter was prepared under the guidance of Roger Nord and Dan Ghura. Principal contributors were Zuzana Murgasova, Jan-Peter Olters, Valeria Fichera, Arto Kovanen, Volker Treichel, Michael Gorbanyov, Chad Steinberg, Jiro Honda, Christiane Roehler, and Naly Carvalho.
This analysis deals with Angola, Cameroon, Chad, Republic of Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, and Nigeria, all of which exported oil for at least five years during the period under consideration.
There are, of course, alternatives to raising public spending, which is the theme of this chapter. In some advanced economies (e.g., Alaska and Alberta), a proportion of oil windfall revenue is distributed directly to the population. Sala-iMartin and Subramanian (2003) discuss this option for Nigeria. For Namibia, Strauss (2006) advocates conditional cash grants.
At current production levels, SSA OPCs will have depleted their proven oil reserves in less than 20 years.
There are, of course, dissenting voices. Takizawa, Gardner, and Ueda (2004), e.g., argue that countries could in principle be better off spending their oil wealth upfront—if government spending has positive externalities that would increase the return on private investments and stimulate growth. However, faced with the dual constraints of poor infrastructure and weak institutions, they conclude that there are advantages to postponing spending until it can be used more effectively. In a study of oil-revenue management in Chad, Dabán and Lacoche (2007) argue that, given the country’s immediate social and institutional challenges, keeping real oil wealth constant for future generations would imply excessive fiscal prudence today and thus not address the country’s needs effectively either today or in the future.
For a discussion of the effects of changing oil prices on the permanently sustainable non-oil primary deficit, see, e.g., Olters (2007).
In this regard, countries should conduct periodic updates of sustainability calculations and enhance their risk analysis.
The baseline simulations assume a real rate of return of 3.2 percent. While the rate exceeds the historical performance of oil funds in some SSA OPCs—notably those in the Central African Economic and Monetary Union (CEMAC) zone, for which the regional central bank pays only a marginally positive real rate—it is at the lower end of rates for diversified, long-term, low-risk portfolios in the major currencies. Oil funds with published returns have done considerably better. For example, Norges Bank (2006) reports a real return on the Norwegian Government Petroleum Insurance Fund in 2005 of 4.3 percent, measured in terms of the currency basket that corresponds to the composition of the fund’s benchmark portfolio.
The simulations are based on the IMF’s December 2006World Economic Outlook oil price assumptions through 2011 and constant real prices thereafter.
The non-oil growth assumptions are the same for all SSA OPCs and are identical to those used in Leigh and Olters (2006).
See Corden and Neary (1982), van Wijnbergen (1984), Corden (1984), and Neary and van Wijnbergen (1986). While there is no consensus on the effect of the real exchange rate on growth in African countries, recent research suggests that aid inflows can adversely affect competitiveness; see, in particular, Rajan and Subramanian (2005).
See, for example, Friedman (1953)ible exchange rate is its ability to help smooth adjustments to real shocks.
The central bank could also sell domestic assets to mop up liquidity. This would likely reduce domestic demand by crowding out private sector credit and then reduce the change in the real exchange rate necessary to bring the economy back to equilibrium. Alternatively, sales of foreign currency would help stimulate imports and facilitate the real resource transfer necessary to stimulate growth. For CEMAC countries the fixed exchange rate precludes sales of foreign exchange for liquidity management purposes, and sales of domestic assets would be difficult to implement because of coordination requirements and nonconvergence in economic development across member states.
According to IDA (2005), the indicator for the quality of budget and financial management assesses the extent to which there is (i) a comprehensive and credible budget linked to policy priorities; (ii) effective financial management to ensure that the budget is implemented as intended in a controlled and predictable way; and (iii) timely and accurate accounting and fiscal reporting, including audited public accounts and effective arrangements for follow-up.
The criterion for the quality of public administration measures the extent to which public officials design and implement government policies and deliver services effectively.