Using Extractive Revenues for Sustainable Development

3. Key policy recommendations

Non-renewable natural resource revenues can make an important contribution to harnessing inclusive growth and sustainable development, provided that resource revenues are appropriately managed to smooth revenue flows throughout the price cycle and effectively spent domestically to transform natural resource revenues into productive development gains. In order to translate finite assets into productive and long-lasting development gains policy makers need to address two main challenges and consider the following recommended policy responses.

Policy Challenge 1: How to reconcile long-term development and intergenerational equity objectives with the need to manage the volatility and uncertainty of exhaustible resource revenues.

Recommended policy responses:

• Policy makers need to adopt a clear and consistent fiscal policy and macroeconomic management framework that counters price volatility and helps to insulate the economy from price, production or other external shocks, while smoothing public expenditures over time in support of the achievement of long-term development objectives.

• Policy makers need to ensure budget stability and fiscal sustainability over time, including through the establishment, where appropriate, of properly sized stabilisation and savings funds as an integral part of the fiscal policy and macroeconomic management framework. “Where appropriate” refers to resource-dependent countries whose economies are highly correlated with commodity price volatility and who stand to benefit from the financial buffers offered by stabilisation funds. Establishing a framework for managing natural resource revenues including a stabilisation fund should occur before the commencement of production, or as soon as possible thereafter. This includes countries that have revenues from existing production. As a source of precautionary savings, stabilisation funds should be invested in safe foreign assets to ensure sufficient liquidity to counter price volatility. Stabilisation funds provide consistency in government expenditure and planning. They can also provide an insurance against unexpected negative economic shocks, giving the government extra resources at a time of need. Stabilisation funds are not effective vehicles for helping satisfy domestic capital needs, particularly in capital-starved developing economies where domestic assets are likely to be highly correlated with commodity prices given the structure of resource-dependent economies. Arbitrary withdrawals and manipulation of withdrawal rules must be avoided to prevent undermining the stabilisation policy objective and therefore reproducing the volatility of the natural resource revenues that the stabilisation fund has been tasked with eliminating. This safeguards the capacity of the fund as a renewable financial resource that can be called upon when needed under the auspices of the withdrawal rules and procedures. Savings funds provide a longer-term renewable financial resource once the natural resources no longer provide the income they once did. However, ensuring the permanence of savings funds as a renewable financial resource requires a robust investment governance and risk-management framework. Indeed, natural resource funds that are poorly governed risk destroying capital and providing opportunities for corruption.

• Policy makers need to manage the trade-off between investing in the domestic economy or abroad, and saving for future generations. In order to do so they should consider: 1) the capital stock and level of development of a country, and 2) whether resource revenues are long lasting or temporary in light of the resource depletion rate. Beyond the appropriate level of precautionary savings necessary to provide a financial buffer to ensure fiscal sustainability over time, the fiscal rules can be designed to favour current and medium-term expenditure of natural resource revenues or accumulating wealth for future generations in a savings fund, in a manner that is consistent with national development priorities, absorptive capacity constraints, and the volatility of natural resource revenues over the commodity price cycle. Countries where there is ample capital and where resource revenues are temporary may opt for accumulating sufficient financial savings for future generations. For countries where capital is scarce and where resource revenues are temporary, a balance should be struck between accumulating financial savings and spending resource revenue domestically to increase non-resource sector growth, also taking into account the borrowing position of the country on international markets. However, the decision to save for future generations must be set against the country’s borrowing costs and debt dynamics. If the risk-adjusted return on long-term savings is less than the country’s borrowing costs, the long-term savings represent a net loss for the country. For countries where there is ample capital and where resource revenues are long lasting, the priority should be on managing volatility and achieving macro-fiscal stability. For countries where capital is scarce and where resource revenues are long lasting, the priority should be to invest revenues domestically, while accounting for absorptive capacity constraints and maintaining macroeconomic stability. However, even if good investment opportunities exist in developing economies, issues around capabilities to choose and execute selected projects may arise. In such contexts, saving for future generations can be a prudent option while the necessary capabilities are built up.

Policy Challenge 2: How to transform finite natural resource revenues into long-standing and productive development gains, in order to put resource-rich developing countries on a sustainable development trajectory that outlives resource extraction.

Recommended policy responses:

When prioritising spending on domestic investment over saving:

• Policy makers need to ensure commitment on the part of the government, a strategic vision, and a clear long-term development plan that informs spending and investment decisions and recognises the inherent volatility and finitude of natural resource revenues and absorptive capacity constraints. Any prioritisation of development-related expenditure which underwrites broad-based and inclusive development must be preceded by a commitment to sound and consistent macroeconomic management of natural resource revenues (see recommended policy responses to address Policy Challenge 1).

• Policy makers need to avoid spending mechanisms that encourage procyclicality in public expenditures as this exacerbates the effects of commodity price volatility on the economy. Earmarking can encourage procyclicality and constrain budgetary flexibility, lead to inefficiency and over or underinvestment in certain public services. Without concomitant stabilisation mechanisms, direct distribution through cash transfers are also highly procyclical and may divert revenues from priority investments at scale such as in infrastructure, health and education. At the same time, targeted cash-transfer schemes that operate through the government budget may be useful to smooth the transition for gradually phasing out fossil fuel subsidies, which tend to be poorly targeted and inefficient, yet popularly supported and thus often difficult to reform.

• Policy makers need to ensure the quality and efficiency of public investment spending, including through the choice of appropriate spending mechanisms to translate natural resource wealth into productive capital accumulation, leading to broader development gains. Strategic investment funds can help natural resource-rich countries manage long-term financing challenges and shrinking fiscal space, while balancing policy and commercial objectives. With their double bottom-line objective, whereby all investment decisions must fulfil market-based risk and return criteria, and produce positive development outcomes, strategic investment funds offer a possible tool for resource-rich countries to catalyse economic development, alongside conventional spending via the budget. Such funds are most effective as part of a clear government investment policy that establishes the priorities, criteria and targets for investment, coupled with some level of co-ordination across government levels and different agencies to avoid duplication of public investment.