Oil Wealth Volatility, Sovereign Wealth Fund Management and Fiscal
Sustainability in Nigeria: An Analytical Framework
Femi Muibi SAIBU
Department of Economics and Econometrics,
University of Johannesburg, Auckland Park 2006, Johannesburg, South Africa,
Email: fsaibu@uj.ac.za,osaibu@unilag.edu.ng, omosaibu@yahoo.com,
Ph #: +27785788874 +2348053381914
Outline of Presentation
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Introduction
Pre SOW macroeconomic conditions
SOW Conceptual framework
International experiences
Lesson and Policy implications for Nigeria
Introduction
• The first signal of Nigeria readiness to save for raining days
commenced with ECA in 2004
• The objective is primarily to protect planned budgets against
shortfalls due to volatile crude oil prices and insulate the Nigerian
economy from external (negative) price shocks.
• These spare funds help stabilize the economy against the negative
shock before oil prices rebounds after the 2009 downturn
• Savings to ECA grown from $5.1 billion in 2005 to $20 billion in
2008 but has fallen to less than $4 billion in 2010 due to budget
deficits at all levels of government in Nigeria.
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However despite the role played by this fund in 2008 to 2010, during the global crisis, the law
establishing the ECA and its use has always been controversial.
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It is seen by states as illegal and been contested by state in Court.
sections 162(1) and 162 (3) of the Constitution of the Federal Republic of Nigeria made it
mandatory for all revenues accruing to the nation to be paid into the Federation account and to be
distributed among the federating units in accordance with the existing revenue allocation formula
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It aggravates the financial strains of states to meet development-related needs
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It may be abused by federal and could become a political tool and undermines the constitutional
provision regarding revenue distribution across the three tiers of the executive.
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the state governments propose that 80% of funds to be shared between the federal and state
governments and the balance of 20% of revenues should be maintained as balances in ECA account
monthly. Finance Minister recommends a standing balance of $ 50billion
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To address the legality and to strengthen the Fund, the Sovereign Oil Wealth (SOW) was established
by an Act of parliament in 2011 and to be operational by 2013 March precisely with seed money of
$1 billion and to be managed by JBMorgan
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The issues are
What is the optimal benchmark price?
How and where to save and invest
What and how do we share the proceed
How are other oil producing countries handling
small funds
• The hallmark of this paper is to provide a
framework for these questions
Sovereign Oil Wealth (SOW) FUND
Concept
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Sovereign wealth fund by definition is a state-owned pool of money that is invested in various
financial assets both locally and internationally
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SOW fund is a pool of money derived from a country’s reserves, which are set aside for investment
purposes that will benefit the country’s economy and citizens
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The funding for a sovereign wealth fund comes from central bank reserves that accumulate as a
result of budget and trade surpluses, and even from revenue generated from the exports of natural
resources as in the case with Nigeria
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A state-owned investment fund established out of balance of payments surpluses, official foreign
currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from
natural resource and or commodity exports”.
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Nigeria belongs to the last category as the SWF is created from the resources in the Excess Crude
Account, ECA
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SOW is an investment (Seed) while ECA is a saving
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According to the International Working Group of Sovereign Wealth Funds, a SOW fund is “a special
purpose investment funds or arrangements, owned by the general government
WHY SOWING?
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Keynes (1936) identified seven reasons for saving
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Precaution ( reserve against unforeseen contingencies)
foresight ( providing for anticipated relation between future income and needs
calculation (enjoy interests and appreciation
improvement ( enjoy gradual increase in expenditure and independence and power to do things
Enterprises (to carry out speculative and business project
Pride ( savings brings pride esteem )
avarices ( to guide against averices
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Similarly Keynes provided a list of motives for consumption:
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Enjoyment,
short-sightedness, generosity,
miscalculation, ostentation,
extravagance.
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Looking at the past history of Nigeria in oil management and the rational for the current effort,
there could not be any other reasons for setting aside some funds than to achieve this seven saving
commandments from Keynes and prevent some of the adversity of consuming all the wealth.
History of SOW
• The first sovereign wealth fund was the Kuwait Investment
Authority, established in 1953 to invest excess oil revenues.
• Kiribati created a fund to hold its revenue reserves. : then
later
• Qatar Abu Dhabi's Investment Authority (1976)
• Singapore's Government Investment Corporation (1981)
• Norway's Government Pension Fund (1990)
• globally SOW Fund is about $5 trillion invested by less
that 20 countries ( see appendix for the list)
Investment Options for Sovereign Wealth
Funds
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Sovereign wealth funds are traditionally passive long-term investors and invested
in a wide range of asset classes including:
Government bonds
Equities
Foreign Direct Investment
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However, a growing number of funds are turning to alternative investment such as
hedge funds or private equity, which are not accessible to most retail investors.
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The IMF(2008) reports that sovereign wealth funds have a higher degree of risk
than traditional investment portfolios
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Therefore to spread the risk, most countries with Sovereign wealth funds use a
variety of investment strategies:
Some funds invest exclusively in publicly listed financial assets.
Others invest in all of the major asset classes.
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How is SOW Managed in Other
Countries
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Norway Model
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First establishes the Petroleum Fund
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Then transfers funds to into SOWF from where they are invested in bonds and corporate equities
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Later the fund’s functions were integrated with the national insurance scheme, and the fund continued to function under the name of the Pension Fund.
The amount of the money the government may withdraw for the budget purposes from the Fund is not the function of the country’s current oil production,
but function of the growth rate of the Fund separate from the current oil revenues. Ulrich F.W. Ernst (2006) characterizes Norway’s strategy in
managing the oil revenues in the following areas
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The Fund reserves are entirely invested abroad
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The investments are made in both fixed incomes and equity instruments
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The Funds are invested in internationally responsible assets and not to invest in businesses involved unpeaceful and environmentally bad practices.
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One major critical success factor for Norway oil management is adherence to a predetermined rules that do not allow politicians or government
officials the ability to withdraw from the fund at their own discretion.
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This requires the fund’s management to be transparent and immune to the whims of politicians as well as their personal obsession with power and materials
enrichment.
One major critical success factor for Norway oil management is adherence to a predetermined rules that do not allow politicians or government officials the ability to
withdraw from the fund at their own discretion. This requires the fund’s management to be transparent and immune to the whims of politicians as well as their
personal obsession with power and materials enrichment.
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While the Norwegian Pension Fund is seen as a model for many countries, it in fact has few restrictions set in place to control what policymakers can do with oil
funds, making it susceptible to the desires of political objectives.
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A better example of a fund that is better protected from political motives is the commodity fund of Sao Tome and Principe, established in 2004. It includes extensive
restrictions that guide how oil revenues are to be saved, invested, or spent. It is illegal for outflows to exceed the amount that can be sustained in perpetuity
(Frankel, 2010).
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US Model
There are seven different Sovereign wealth established by the states
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The Alaska Permanent Fund provide a reference point and a unique way of managing oil earnings and ensuring every member of the society benefits from
the yields of their sow in the funds. T
The State law in Alaska dictates that half of the investment earnings of the Fund are to be equally distributed to every state resident on an annual basis.
Theory behind this management strategy is that citizens know how to spend the money better than their government. One downside to this approach is that
even if it was proven by economic and policy analysts to be effective, the government would face fierce public opposition in changing the fiscal policy when
the need arises.
Chile Model
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The fund is governed by a set of rules that dictates the government can only run a deficit larger than the target if output falls short of potential, in a
recession, or the price of copper is below its medium-term (10-year) equilibrium.
Two panels of experts are chosen to biannually evaluate these two respective conditions.
Therefore, if it is determined that copper prices are experiencing a temporary spike, then these extra earnings are required to be transferred to savings..
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In the case of Saudi Arabia, United Arab Emirates, the large increases in new oil revenues were spent on massive infrastructure projects and welfare
programs, while at the same time it liberalized its trade structure hence this policy allowed the non-oil GDP sector to develop at outstanding rates,
today the two countries are part of top ten leading SWF investors in the World.
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Other countries like Mexico Venezuela, Sao Tome and Principle have also implemented one form of policy rules in management of their oil.
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Most of the UAE SWF are carried out by the city government while in Saudi Arabia is carried out by the central government
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the experience of some European countries in recent is a signal to the consequences of welfare based policy of government
What is the Optimum Size of the Fund
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Results of studies conducted in this area appear to be inconclusive. However, Crain and Devlin (2002) indicated
that larger funds created management problem especially when the design of the savings fund is not transparent.
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In addition, they maintained that political pressures on the government usually result in the mismanagement of
the fund and recommended that there must be an in-built mechanism for control, reporting and evaluation of
fund resources and operations.
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Heilbrum (2002) stressed that the funds should be professionally managed with the supervision of the ministry of
finance or central bank. Citing an example of Norway, he indicated that the ministry of finance supervises the
activities of the fund and sets guidelines for investments and reporting requirements.
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Economic literatures seem to be silent about the appropriate formula which must be applied to determine the
level of savings required.
However most studies suggested the basis for deriving a national savings fund:
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firstly, the accumulation of excess revenue resulting from a price above the target price as in the case of Chile’s copper
stabilization fund;
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secondly, revenue contingent sets a percentage of the commodity revenue as in the case of the Alaska’s permanent fund; and
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thirdly, a mixture of both, a set percentage of commodity revenue and a reference price as in the case of Venezuela’s
stabilization fund are very common examples in the economic literatures
Appraisal of existing SWF Framework
in Nigeria
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Before the Excess crude oil account all the money realised from then sales of this natural wealth are directly
plough in to the federation account and allocated,
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with the introduction of ECA, in 2004, the government decides to allocate part of the revenues from the oil into an
account and
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in 2001, a proportion of funds in this account is invested to generate streams of income and or apart is used to
offset existing stock of debt. According to the law establishing the fund, the returns from the funds can use in
three ways: for stabilisation, infrastructure and intergenerational saving in the ratio of 20:20:20:
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with the balance allocated among in lie with the board discretion based on macroeconomic conditions and
government policy expediencies.
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While setting the rile for the use if the fund is good and follow international best practises but the retaining of
over 40% of the sharing power under the discretion of few political appointees of the government in power
create serious concern about the sustainability and effectiveness of the framework.
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The recent experience with Police Pension Fund and many other funds in the past should have been a good
guiding point for government to reduce the discretion power of the board.
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Most of the countries that have succeed in this respect restricted the temptation of government in power and
their appointees in the board from using their discretion in allocation the funds and if we also want to achieve a
meaning fund management and utilisation, then the law should be structured to restrict such temptation.
Oil Wealth and Fiscal Sustainability
Empirical Strategy
• Three rules must be set
– Bench mark pricing Rule
– Optimal spending and saving Rules
– Optimal Spending Rule
Bench mark Rules
Optimal Saving Rule
(i)
under certain condition LRP approach
approximates the PIH approach
Fiscal Debt sustainability Rule
• Where
• d = net public debt-to-GDP ratio (measured net of the net foreign assets
and public debt holdings of the central bank, and net of oil fund assets);
• pd = overall primary deficit as a share of GDP;
• δ = seigniorage revenues
• g = real GDP growth rate;
• r = real interest rate on domestic debt,
• r* = real interest rate on external debt;
• e= real exchange rate calculated as EP/P*
• b= domestic borrowing
• b*= external borrowing
• nfa* = Net foreign asset
• Z= other factors such as fiscal consequences of a bank bailout, and
one-off privatization
revenues.
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Nigeria is to succeed in the current attempt to manage the oil revenue the government must avoid
the pitfalls of the past by
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implementing a combination of the best international practices.
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That is follows Norway’s lead in creating a fund of all oil revenues to be held abroad and sterilized from the
economy.
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It is also recommended to follow similar investment and ethical practices of Norway.
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However, as far as spending the revenues, we recommend that Nigeria uses a version of the Permanent
Income Hypothesis method that is implemented in Sao Tome Russia and Principe and Azerbaijan.
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It is also vital to set similar legal restrictions on the limits of what can be transferred from the fund to the
state budget.
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This will allow for predictable annual revenue transfers that will help Nigeria avoid the negative
consequences of pro-cyclical spending present in times of temporary spikes in oil prices.
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Finally, given the knowledge of annual oil revenue transfer limits, Nigeria could follow a more sustainable
version of Saudi Arabia’s push for infrastructure and development of the non-oil economy.
Preliminary Conclusion
• Budina, N. and van Wijnbergen, S. (2008) adopted similar approach
to Nigeria for the ECA fund and conclude the only way to avoid
another debt overhang problem is to plan expenditure levels and
commitments low enough to avoid a crisis if and when oil prices
come down to earth again and revenues fall.
• This implies non-oil deficits based on oil prices that is
commensurate with the long run average prices.
• But recent events in Nigeria show clear dangers of slippage: non-oil
deficits have been above safe levels, particularly if off-budget
commitments and arrears are taken into account.
• Those signs of slippage need to be reversed.
Conclusion
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The government must ensure that :
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Ensuring that fiscal policy frameworks and institutions lock in high rates of savings from resource revenues;
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non-oil deficits based on oil prices that is commensurate with the long run average prices. But recent events
in Nigeria show clear dangers of slippage: non-oil deficits have been above safe levels, particularly if offbudget commitments and arrears are taken into account .Those signs of slippage need to be reversed
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Strengthening overall institutions and building capacity to make good quality public investment; and
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Delinking expenditure from volatile revenue in the short to medium term
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Nigeria’s poor public investment performance makes it clear that reform of the public investment process,
including anti-corruption measures, should remain at the top of the policy agenda.
Only if the reform process is brought back on track and maintained in the years to come is there a
chance that Nigeria’s oil wealth will turn from a curse into a blessing