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Chapter 7. Safeguarding the Public Interest

Author(s):
Charlotte Lundgren, Alun Thomas, and Robert York
Published Date:
August 2013
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Good governance is critical to ensuring that the state gets a fair financial return from the exploitation of its natural resources and that resource revenue is effectively and fairly used. Although the effects of waste and abuse of public assets are particularly large in resource-rich developing economies, their capacity to prevent or prosecute abuse tends to be limited. Opportunities for corruption are magnified by the limited number of players involved, the technical complexity of resource operations, and the size of resource rents that can be captured. Meanwhile, the loss of revenue can impede development policy and expose the economy to external volatility.

Safeguarding the public interest requires action across the whole value chain of extractive industries. From the granting of exploration and development rights, to the sharing of rents and profits, to the monitoring of subsequent public expenditure or savings, national authorities need to actively close off opportunities for corruption and abuse. For instance, a lack of competition in the granting of mineral rights both constrains the state’s ability to ensure efficient production and presents potential for corruption through insider deals. Similarly, failing to provide adequate resources for tax administration gives free rein to well-informed producers to exploit tax loopholes. Yet such deficiencies may not be evident to the general population because, as long as some positive benefits are visible from resource revenue, less attention may be paid to lost opportunities and waste.

Policy Challenge: Establishing Credibility and Support for Institutional Change

A commitment to transparency and accountability is generally the key to improved governance. Again, this commitment must apply to the whole of the value chain. Before the extraction process starts, an open and competitive bidding system for exploration and production rights, with full access to relevant data, will attract the most efficient operators and limit the potential for political connections or bribes to determine the granting or terms of contracts. Further down the chain, publication of authenticated reconciliations of company payments to governments with revenue receipts by governments will help ensure that money is not misappropriated or diverted to other uses (Box 7.1). And to promote efficient and fair use of the revenue, provision of adequate internal and external audit capacity, together with open scrutiny by parliament of the audit reports, will reduce the scope for wasteful spending or fraudulent payments.

Box 7.1.Oil Revenue Certification: The Republic of Congo

Oil revenue accounts for nearly 80 percent of the Republic of Congo’s total government revenue. In response to weaknesses in most areas related to the country’s oil management and, in particular, the monitoring of oil-related production and receipts, the Congolese authorities established a quarterly certification process, which is conducted by external auditors. The certification process is not an “audit” strictly speaking but a report prepared by an independent audit firm hired by the government and published on the Internet.

The certification process involves the use of a monthly oil-revenue model, which was developed by the first firm hired by the authorities several years ago. The model uses fiscal parameters (tax, royalties, dividends, and so on) from all of Congo’s production-sharing contracts, as well as the actual costs of oil production and oil prices, to generate a precise revenue stream owed to the government. Using the model, the auditor also (1) compares the volume of oil owed to the government (based on the production-sharing contracts) with the amount declared by the oil companies, and comments on any discrepancies; and (2) identifies the amount of cash revenue that should accrue to Congo’s state treasury. The certification reports attempt to verify all information against independent sources: statements from banks and terminal operators, shipping documents, information from the SNPC (state-owned oil company) and private oil companies, information from the treasury, independent reports on shipments and storage, and international exchange rates. But it cannot dissect all individual transactions. The auditor reports differences that cannot be explained as “discrepancies.”

In principle, Congo’s oil certification process can be a good model for other countries with weak capacity and governance concerns. However, the effectiveness of the process depends not only on the competence and independence of the auditing firm, and the accuracy of the information provided, but also critically on the government’s active follow-up, because oil contracts can change frequently. Without such information, the nature of the discrepancies will not be known and, more important, missing data would make the process less useful.

The international community is supplying an increasing amount of support for capacity building in transparency and governance.

  • One element is the codification of good practices in this area, summarized in the IMF Guide on Resource Revenue Transparency (IMF, 2007b), which has become the major source for guidance and examples in resource-rich countries. The Natural Resource Charter (Natural Resource Charter, 2010) also seeks to encapsulate best practice.
  • A second strand is the provision of technical assistance, particularly in tax policies, contracts, regulation, public financial management, and asset management.1
  • A third approach is the encouragement of peer support, such as the Extractive Industries Transparency Initiative (EITI), in which 37 resource-rich countries were participating as of March 2013, including 20 from SSA.
  • A fourth dimension recognizes explicitly that international companies and governments suffer from the same deficiencies in governance and are equally responsible for facilitating corrupt practices and restricting access to information about their activities and payments. Legislation to prevent abuse and publish payment records is now becoming more extensive among resource-importing countries. The U.S. Dodd-Frank Act is a case in point.

Some governments have put transparency at the forefront of their arrangements for managing new resource revenue. Liberia, the first country in SSA to become compliant with the EITI, enshrined its commitment to the EITI in law as it recovered from civil war. In Asia, Timor-Leste decided to complement its early compliance with the EITI by adopting five transparency pillars (see Box 7.2).

Policy Challenge: Stronger Governance and Transparency

On what issues should policymakers in natural resource exporters focus their efforts to strengthen governance and transparency? Priorities for action will differ substantially across countries. New entrants into the natural resource sector, for instance, may concentrate on the clarity of the legal framework for mineral extraction, whereas more established oil exporters may need to give attention to stimulating public debate on alternative fiscal options as revenue declines. Approaches will also vary according to history, culture, and legal framework. But some common themes can be identified by clustering action areas within the four primary pillars of fiscal transparency: (1) clarifying roles and responsibilities, (2) opening processes for determining the collection and use of revenue, (3) disseminating fiscal information actively, and (4) strengthening oversight.

Box 7.2.Timor-Leste’s Five Principles for Governance and Transparency in the Management of Natural Resources

In 2010, Timor-Leste was the first country in Asia and the third in the world to be declared fully compliant with the EITI (see Box 7.3). Since then, the country has decided to extend its formal commitment to better, more transparent, and more inclusive management of natural resource revenue by adopting a five-pillar Model of Transparency:

Adherence to Global Standards includes full compliance with the revenue verification and participation requirements of the EITI. All receipts from taxes and royalties from oil extraction are transferred to the Timor-Leste Petroleum Fund. To provide full accountability for resources, the inflow of funds and their consistency with payments reported by extraction companies are monitored by a board with representatives from other countries, donors, extractive industry companies, civil society organizations, investors, and international organizations.

Best Practice in Sovereign Wealth Management is ensured by the rules governing the Petroleum Fund and the fiscal framework, as described in Box 3.4 in Chapter 3.

Education and Information is fostered by broadcasting through radio and TV (about half of the population is illiterate) the 13-day parliamentary debate on the budget with ministers proposing and defending their budgets.

Accountability and Accessibility is ensured by the establishment of the Timor-Leste Transparency Portal (www.transparency.gov.tl), which is a gateway to four specialized portals focusing on transparency in the budget, procurement, government results (financial and physical progress on major projects in accordance with priorities in the national Strategic Development Plan), and aid management (information on past, current, and future donor support).

Communications and Good Governance is strengthened by the publication on the official government website of all decisions by the Council of Ministers (the highest decision-making body in the country) within two days of the weekly council meetings.

Roles and Responsibilities

The starting point is a clear legal framework that establishes with what entity the ownership of natural resources resides and what powers different levels of government have to grant rights of extraction, to tax, and to regulate. To limit possible abuse arising from uncertain and unclear roles and responsibilities, the following action should be taken:

  • Procedures for awarding licenses and contracts should be open and nondiscretionary. All potential participants need to have full access to relevant technical information and knowledge of the tax regime that will be in operation. Angola and Nigeria, for example, have opened up their licensing rounds by publishing draft contracts and awarding at least some tenders on the basis of single-variable bids. Good practice also calls for publishing all contracts, a process followed in some periods by the Republic of Congo.
  • A national resource company that has policy or regulatory roles should not also engage in commercial activities. Although some countries minimize the potential for conflicts of interest by separating responsibilities within the national resource company, convincing operating partners or competitors that the national company’s privileged position is not being abused is always difficult.
  • If the government has equity stakes in the resource sector, it should explain how these stakes contribute to an effective balance of control, revenue maximization, and efficiency in the sector.
  • Any requirements placed on national or private natural resource companies to carry out noncommercial activities on behalf of the government without reimbursement should be clearly identified. Such activities might include training, infrastructure development, or community support. Unless explained in budget documentation, these activities can obscure the government’s spending priorities and the allocation of resources.

Revenue Collection, Spending, and Savings

Pressures to spend resource revenue as soon as it is received and suspicions that the country is receiving less than it should will always be present. Carefully explaining why the government is being prudent about volatile and exhaustible natural resources and publishing evidence that resource wealth is being fairly and effectively managed can calm these concerns:

  • The government’s fiscal framework should include a clearly defined role for resource revenue, recognizing its exhaustibility and volatility, and institutional rules and structures that promote fiscal sustainability, as described in Chapter 4. Clear statements of the objectives and rules will help to protect resource-derived wealth from pressures for short-term plundering.
  • Special attention should be paid to tax administration and public financial management systems because of the stresses induced by large and concentrated revenue streams.
  • The government should produce regular reports showing all revenue associated with resource extraction and how the revenue has been collected and managed. To guard against theft of company tax and other payments before they have reached the treasury, participation in the EITI offers countries a useful structure for reconciling payments made and received (Box 7.3).
  • Mechanisms to invest and manage the proceeds from revenue extraction—whether in financial assets (such as a sovereign wealth fund) or in physical investment (including public infrastructure)—should be subject to transparent operational rules that provide well-targeted managerial incentives and are fully integrated with fiscal policy.

Information Provision

The publication of the government’s budget proposals offers a good opportunity to enhance accountability for resource revenue. If the legislature, civil society, and the general public are given a clear and comprehensive picture of the contributions made by the extractive sector, with policy proposals and prospects, it is more likely that mistakes will be corrected and good alternatives will be considered. Full disclosure requires the following:

  • Release of in-depth information about all past resource-related transactions and balances, including debt (with any collateral), assets (funds or deposits and “wealth in the ground”), and quasi-fiscal activities.
  • Detailed reporting by national resource companies on their objectives, activities, governance, finances, relationships with the private sector, and contributions to government revenue.
  • Discussion of how expected future developments, including contingent liabilities and other risks, will support the government’s fiscal policy objectives and contribute to fiscal sustainability.
  • In-year reports to provide assurance that transparency is being maintained and to allow continued tracking of developments. These reports should include regular publication of data on mineral extraction, prices, and revenue payments (at least monthly in the case of hydrocarbon production). Nigeria’s national oil company publishes monthly production figures, albeit with some delay.
  • Independently verified reconciliations of company resource revenue payments with government revenue receipts, preferably as recorded in budget documentation. EITI reports offer an ideal medium for reconciliation. Active dissemination of all such information through the Internet, press, TV, radio, and international publications. Fiscal information in Burkina Faso is widely promulgated.

Oversight

Without competent and honestly run public financial management and tax administration systems, resource revenue will be plundered and wasted. The following should be in place to help buttress these institutions:

  • Internal control and audit procedures provide a first line of defense. They should cover all parts of the revenue chain, including national resource companies and asset management. Autonomous agencies, such as the Nigeria Economic and Financial Crimes Commission, can supplement their work. Any scope for discretion by tax officials should be limited and clearly understood.
  • External arrangements may provide a useful supplement to national independent oversight mechanisms, such as a national audit office, which are often limited in capacity or autonomy. International companies may, for instance, be used to conduct independent financial and effectiveness audits. The EITI process provides an internationally recognized framework for reporting company revenue payments.
  • Resource companies—including national resource companies—should follow internationally accepted accounting and auditing standards, including on publication. The home countries of many international resource companies also set anticorruption standards; reporting requirements on revenue payments are now also being legislated in the United States, through provisions in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and in Europe.

Box 7.3.Extractive Industries Transparency Initiative (EITI)

Some 20 countries in sub-Saharan Africa were participating in the EITI as of March 2013. Seven of these countries were, or will soon become, major oil producers. The remaining countries, with more limited known reserves of hydrocarbons, look instead to metals, precious stones, or timber as sources of current or future natural resource revenue.

The EITI provides participating countries with a credible mechanism for informing their citizens and the international community about their annual revenue from natural resources. Launched in 2002 as a pioneer multistakeholder initiative involving governments, companies, and civil society, the EITI offers a standardized methodology for compiling data on what governments say they receive from natural resource extraction and what extraction companies say they pay to governments. Regular country EITI reports explore any apparent differences between government and company data and provide background information about the relevant extractive sectors.

EITI participants are designated as either “candidate” or “compliant” countries. To achieve EITI compliance, countries must satisfy a validation mechanism that sets minimum standards for EITI reports including frequency, coverage, data verification, and involvement of civil society. By March 2013, 11 countries in SSA had satisfied these requirements. EITI reports are accessible via www.eiti.org.

EITI compliant countries in SSA (March 2013) were Burkina Faso, the Central African Republic, the Republic of Congo, Ghana, Liberia, Mali, Mozambique, Niger, Nigeria, Tanzania, and Zambia.

EITI candidate countries in SSA (March 2013) were1 Cameroon, Chad, Côte d’Ivoire, the Democratic Republic of the Congo, Guinea, Madagascar, São Tomé and Príncipe, Sierra Leone, and Togo. Candidate countries are implementing EITI, but do not yet meet all of the requirements.

1 Madagascar and Sierra Leone were temporarily suspended from candidate status pending “resolution of the current international situation” in Madagascar and “remedial actions to achieve compliance” in Sierra Leone.

Recommended Reading

The principal source for good practices on safeguarding the public interest in resource-rich economies is the IMF Guide on Resource Revenue Transparency. It comprehensively covers governance issues across the whole extractive sector value chain, from contract and license awards through revenue collection to expenditure management. It is organized according to the IMF Code of Good Practices on Fiscal Transparency and identifies the need for clarity on roles and responsibilities, budget processes, public availability of information, and assurances of integrity. The Natural Resources Charter covers similar ground, including a multilevel guide to best practice for governments handling large natural resource discoveries.

The Extractive Industries Transparency Initiative (EITI) has published important materials on the measurement and reconciliation of resource revenue data, including the EITI source book and advancing the EITI in the mining sector. EITI reports can be accessed via www.eiti.org. Many of the civil society groups supporting the EITI have themselves produced important analytical and reference material, including Revenue Watch and Global Witness.

1The multidonor Managing Natural Resource Wealth–Topical Trust Fund has recently enabled a substantial increase in IMF support in this area.

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