Oil Revenues and Fiscal Policy
Philip Daniel
Fiscal Affairs Department
International Monetary Fund
The PRMPS/COCPO Training Workshop
The World Bank
May 2007

The views in this presentation are those of the authors and should not be attributed to
the International Monetary Fund, its Executive Board, or its management.
Oil Revenues and Fiscal Policy
Overview
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Challenges posed by oil revenue
Fiscal policy and macroeconomic stability
The non-oil primary balance
Fiscal policy and intergenerational issues
Oil funds
Expenditure management
Some guidelines
Oil-Producing Countries Differ
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Importance of oil in the economy and fiscal accounts
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Development of the non-oil economy
Maturity of the oil industry / oil production horizon
Ownership of oil industry
Fiscal regime for the oil sector
Macroeconomic situation
Financial position of the government and the public sector
(gross and net debt, liquidity)
Quality of institutions
Petroleum Revenues and
Stabilization
Uncertainty and Instability
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Uncertainty about value of
resource and timing of
revenues
Instability caused by volatility
of oil prices
Taxes must respond robustly
to realised outcomes
Stabilization
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Stabilize by total expenditure
and revenue management,
not by reliance on “stable”
taxes
General economic stability
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Reduces investors’ risk premia
Avoids disruption of projects
Strengthens negotiating &
trading position
Vital to poverty reduction
Crude Oil Spot Prices, 1970-2006 1/
A Rollercoaster Ride
110
Real oil prices
100
90
80
U.S. dollars per barrel
70
60
50
40
30
Nominal oil prices
20
10
0
1970
1975
1980
1985
1990
1995
2000
Sources: IMF, World Economic Outlook (Washington, various issues); and IMF staff estimates.
1/ Average of U.K. Brent, Dubai, and West Texas Intermediate. Real oil prices deflated by the US CPI (December 2005 = 100.)
2005
Guidelines for Stability
Keep public sector demand in line with sustainable rate of capacity growth
 Save excess petroleum revenues abroad
 Use conservative price forecasts
 Save foreign assets in boom periods, use in downturns
 No need to “fine tune” the economy
 Rely on automatic stabilizers
 Oil funds are no substitute for sound fiscal management.
The Non-oil Primary Balance
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Key fiscal indicator in petroleum exporters.
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Derived from the overall fiscal balance, excluding oil-related
revenues & expenditures and net interest.
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Ideally, should include explicit or imputed expenditure on
petroleum product subsidies if applicable.
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Analytical importance of the non-oil primary balance:
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Reasonable indicator of domestic government demand
Measure of injection of oil revenue into the economy
Measure of fiscal effort and underlying fiscal policy stance
Key input into fiscal sustainability and intertemporal analysis
Size of the Non-oil Primary Deficit
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Some factors to take into account:
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macroeconomic objectives
short-run vulnerability
government wealth, including oil in the ground and net
accumulated financial assets—sustainability
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In some petroleum exporters, large non-oil primary deficits
are sustainable and do not pose vulnerability concerns.
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In others there may be a need to reduce the non-oil primary
deficit due to vulnerability and sustainability considerations.
In all cases, the non-oil primary deficit should be consistent
with macroeconomic stability objectives.
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Smoothing Fiscal Policy:
Fiscal Considerations (1)
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Costly and inefficient to adjust spending rapidly and
abruptly.
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The level of spending should be determined in light of its
likely quality and the capacity to execute it efficiently.
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The sudden creation or enlargement of spending programs
is risky.
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Increases in spending may exceed the government’s planning,
implementation, and management capacity  waste.
Spending should not rise faster than transparent and careful
procurement practices will allow.
Smoothing Fiscal Policy:
Fiscal Considerations (2)
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Spending typically proves difficult to contain or
streamline following expansions. Expenditure
becomes entrenched and takes a life of its own.
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Drastic spending cuts may lead to social instability,
discouraging investment and reducing future
growth.
The Non-oil Primary Balance
and Transparency
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Focus on the non-oil primary balance helps develop constituencies in support
of prudent policies, thereby contributing to a less procyclical and more long
term-oriented fiscal policy.
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This balance should be highlighted in budget documents used in
parliamentary and public discussion.
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A clear presentation of the non-oil primary balance helps:
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Make the use of oil revenue more transparent
Delineate policy choices more clearly
Example: Norway’s budget.
Long-Run Oil and Fiscal Dynamics:
Trajectory of Net Government Wealth
Total net wealth per capita
(In 1997 U.S. dollars)
16000
14000
12000
10000
8000
6000
4000
2000
0
1998
2003
2008
Oil wealth
2013
2018
2023
Residual oil in the ground
2028
2033
Financial assets
2038
A Path for Use of Oil Revenues:
Permanent Income
The Concept
 Current consumption limited
to maintain wealth for future
generations
 Sustainable use – resources
converted to other incomeproducing financial assets
 A guideline with uncertainties
 Advantage of making
intergenerational equity an
explicit goal
The Calculation
 Petroleum reserve data &
production profiles
 Production cost or state take
 Output price forecasts
 Real interest rate
 Population growth rate
 Subtract discounted present value
(adjusted for population growth)
from total real revenues
Oil Funds
Purposes
 Stabilization– shield economy
from revenue instability
 Savings – wealth for future
generations
 Precautionary – if projects are
uncertain or absorptive
capacity is in doubt
Links with Fiscal Policy
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Oil funds are no substitute for good
fiscal management; important
producers operate without oil funds
(UK, Saudi Arabia, Indonesia,
Australia, Russia)
Important features
1.
2.
3.
Consolidated budget framework
Liquidity constraint on the budget
Limits on domestic investment by the
oil fund
Types of Oil Funds, by Objective
Stabilization Funds
Savings Funds
Precautionary Funds
Receive all revenues & inject
regular amounts to budget
[Papua New Guinea –
wound up 2000]
Petroleum revenues in
excess of forecast budget
amount [Oman]
Fixed percentage of
petroleum revenues
[Alberta, Alaska]
Assign all or part of
revenues to fund in early
stages of petroleum
development
Percentage of total
government revenue
[Kuwait]
Goal to ensure financial
viability if revenues are
lower than expected
Finance deficit or receive
surplus [Norway]
Net government revenues
(budget surplus) [Norway]
Guards against poor
absorptive capacity
Receive deposits above a
reference price; can
withdraw when below floor
price [Chile, Venezuela until
2001]
Recent examples in
Azerbaijan and Timor-Leste
[now a Norway-type fund]
Types of Oil Fund,
by Operational Rules
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Contingent funds
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Revenue-share funds
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Mainly stabilization objectives
Deposit and withdrawal depend on rigid exogenous triggers, usually oil prices or fiscal
oil revenues.
Triggers: multiyear (fixed/moving average) or intra-annual (relative to budget oil price)
Examples: Venezuela Macroeconomic Stabilization Fund (1998 rules), Iran
Mainly savings objectives
A fixed share of revenues or oil revenues is deposited in the oil fund. Various rules (or
discretion) for withdrawals
Example: Kuwait Reserve Fund for Future Generations
Financing funds
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Both stabilization and savings objectives
Net oil revenue is deposited in the fund. The fund automatically finances the budget’s
non-oil deficit through a reverse transfer.
Example: Norway Government Pension Fund
Fund Management
Potential for poor management with or without oil fund: Key
elements for efficiency of oil fund –
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Regular public disclosure
Accountability to elected representatives
Independent audit of activities
Clear investment strategy – majority foreign assets
“Benchmarking” of desired investment returns
Competition in appointment of investment managers
Oil Funds, PFM, and Transparency
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Oil funds should not have the authority to spend
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avoid dual budgets: all spending should be transparently on budget.
Oil revenues should not be earmarked for specific
expenditures
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there should be genuine competition for fiscal resources.
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Avoid separate oil fund institutional frameworks
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Stringent mechanisms to ensure good governance,
transparency, and accountability are critical
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clarity of rules, disclosure, audit, and performance evaluation
The Need to Distinguish
Oil Funds from Fiscal Rules
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Oil funds are sometimes confused with fiscal rules.
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Oil funds do not constrain fiscal policy—unless the
government is liquidity-constrained.
Fiscal Rules in Oil-Producing Countries
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Attempt to insulate fiscal policy from political pressures.
 By placing restrictions or limits on fiscal variables (such as deficits,
expenditure, debt), rules seek to constrain fiscal policy.
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Design of fiscal rules in oil producers must take into account their specific
fiscal characteristics (oil volatility; expanded concept of sustainability).
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Rules should aim at decoupling expenditure and the non-oil deficit from
the short-term volatility of oil revenues. But many oil producers are
liquidity-constrained—can these countries afford to decouple spending in
the downswing?
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A sound fiscal management framework is a necessary (not sufficient)
condition for the success of a fiscal rule.
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Fiscal rules are no stronger than the will of the political class to abide by
them.
Medium-Term
Expenditure Frameworks
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MTEFs can help limit the extent of short-run spending responses to
rapidly-changing oil revenues.
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They can allow a better appreciation of future spending implications of
current policy decisions—including future recurrent costs of capital
spending.
Expenditure
Public Expenditure
Management
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No special rules for expenditure
from petroleum revenues
 Consistent base data
 Budget preparation procedures
 Budget execution system
 Cash planning and management
Extra-budgetary funds
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Better mobilization of public support?
Simulate market conditions?
Disadvantages
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Loss of central control and budget
integrity
Resource allocation distortion
Entrenching old priorities
Barrier to reallocation at the margin
Potential transparency concerns
Attempts in special circumstances proved
difficult (Chad example)
Final Remarks
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Target smooth responses of expenditure to oil revenues and prudent nonoil primary balances.
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Fiscal consolidation may be needed to reduce vulnerability and strengthen
fiscal sustainability.
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Pay attention to the non-oil primary balance and scaling factors.
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Establish sound budgetary systems.
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Have a long-term horizon.
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Enhance fiscal transparency, so that everybody can see how oil revenue is
used—or misused.