mongolia swf eric parrado

Natural Resource Booms and Fiscal ResponsibilityEric ParradoUniversidad Adolfo Ibáñez

Sovereign Wealth Management for Mongolia - A YPAD FocusMongolia YGL Learning Journey

Terelj Hotel, MongoliaSeptember 10, 2011

Agenda

•Motivation•Fiscal rules•Fiscal stabilization in Chile:

▫Management of flows▫Management of stocks

• Institutional arrangement and investment policy

•A commitment to transparency•Common and unique features of Mongolia

“Fiscal Stability Law” (FSL)•Some lessons that I learned regarding SWFs•Concluding remarks

Motivation: Importance of copper• In terms of Chilean GDP, copper has

represented more than 6% of GDP in recent years, while the mining sector accounted for almost 7.5%

• In terms of exports, copper contributed with

almost 30% of total exports

• In terms of fiscal revenues, copper accounted for more than 15% of government’s revenues.

• Internationally, Chilean copper production represented more than 35% of global production.

Real Copper Price (Jan.90-Dec.03)March 2011 US$ per pound

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

5,00

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Jan-

06Ja

n-07

Jan-

08Ja

n-09

Jan-

10Ja

n-11

Real Copper Price (Jan.90-Apr.08)March 2011 US$ per pound

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

5,00

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Jan-

06Ja

n-07

Jan-

08Ja

n-09

Jan-

10Ja

n-11

Real Copper Price (Jan.90-Dec.08)March 2011 US$ per pound

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

5,00

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Jan-

06Ja

n-07

Jan-

08Ja

n-09

Jan-

10Ja

n-11

Real Copper Price (Jan.90-Mar.11)March 2011 US$ per pound

0,000,501,001,502,002,503,003,504,004,505,00

Jan-

90Ja

n-91

Jan-

92Ja

n-93

Jan-

94Ja

n-95

Jan-

96Ja

n-97

Jan-

98Ja

n-99

Jan-

00Ja

n-01

Jan-

02Ja

n-03

Jan-

04Ja

n-05

Jan-

06Ja

n-07

Jan-

08Ja

n-09

Jan-

10Ja

n-11

Fiscal Rules•They anchor expectations for sustainable

public finances•In early 1990s only a few countries

adopted fiscal rules: 7 countries. Right now more than 80 countries had in place these rules: 21 advanced, 33 emerging markets, and 26 low income countries

•The use of fiscal rules is associated with improved fiscal performance: contribution to prudent fiscal policy

Fiscal Rules

•A rule has to be credible with regard its ability to help deliver the required adjustment and put debt on a sustainable path

•But it should also have adequate flexibility to respond to shocks

Fiscal stabilization: Chile’s fiscal policy framework

•Flow management: ▫The fiscal structural surplus rule

•Stock management: ▫Fiscal asset funds:

Pension Reserve Fund (PRF) Economic and Social Stabilization Fund

(ESSF)

10

Fiscal stabilization: the fiscal structural surplus rule• The fiscal rule aims to protect Government spending

from the effects of the economic and copper price cycles

• Structural (i.e. medium term or trend) government income is calculated for the following year

• This requires the input of three key parameters: the medium term price of copper, the economy’s long term output, and the returns of financial assets

• Yearly fiscal expenditure is then set so that Structural Revenue – Fiscal Expenditure = X% of GDP

11

Fiscal stabilization: the fiscal structural surplus rule

• The long-term copper price defines permanent income, contributing to have a countercyclical policy

Lon-term copper price

Copper Price

Savings

Use of savings

Example: All income comes from copper

Fiscal stabilization: fiscal balance and copper price

-3

-2

-1

0

1

2

3

4

5

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

(P)

Copp

er p

rice

(US$

per

pou

nd)

% o

f GD

P

effective structure copper price

Fiscal stabilization: the fiscal responsibility Law

• Complements Fiscal Rule by focusing on the management of the stocks of financial assets generated by the Rule

• Provides for the creation of two funds: ▫ the Pension Reserve Fund (Feb. 11: US$ 3.9 billion) and ▫ the Economic and Social Stabilization Fund (Feb. 11: US$

12.8 billion)

• These government funds are separate from Central Bank reserves, which are managed by the independent Central Bank

• Permits the re-capitalization of the Central Bank over 5 years

14

Fiscal stabilization: Funds’ objectives

•Pension Reserve Fund : supplement the financing of future contingent liabilities related to pensions

•Economic and Social Stability Fund: to finance potential fiscal deficits and to amortize public debt

15

Fiscal stabilization: virtues of the fiscal policy framework

Counter-cyclical effect on the business cycle: under the rule Government spending is counter-cyclical

Ensures the financial sustainability of government policies, allowing for long-term planning, reduced spending volatility, and secure financing of ambitious social agendas

Protects export competitiveness during copper price booms by avoiding unsustainable fiscal spending increases and the resulting transitory exchange rate appreciations

Boosts public saving, reducing the need for historically volatile external financing in times of crisis or recession, thus eliminating a source of macroeconomic risk

16

Source: Ministry of Finance

14.9

16

15.2

23

17.1

92

17.2

51

17.1

32

18.7

70

19.7

71

19.4

60

19.2

68

18.7

91

19.1

64

20.2

11

19.5

41

19.3

34

19.6

18

17.9

80

17.5

07

15.7

67

15.0

15

14.3

43

13.7

09

12.9

28

12.6

04

11.2

85

11.2

57

11.2

37

11.1

30

11.1

00

10.8

88

10.7

99

11.1

04

12.4

72

12.8

52

12.9

88

12.5

82

12.7

20

12.7

92

12.8

34

200

1.75

0

2.70

0

4.37

7

5.25

7

6.09

7

6.93

7

7.77

7

8.33

7

9.27

8

9.27

8

9.27

8

9.27

8

9.27

8

9.27

8

9.42

8

9.42

8 9.42

8

9.42

8

9.42

8

9.42

8

9.42

8

9.42

8

9.42

8

0

5000

10000

15000

20000

25000

Jan-

08

Feb-

08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-

08

Ago

-08

Sep-

08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

Apr

-09

May

-09

Jun-

09

Jul-

09

Ago

-09

Sep-

09

Oct

-09

Nov

-09

Dec

-09

Jan-

10

Feb-

10

Mar

-10

Apr

-10

May

-10

Jun-

10

Jul-

10

Ago

-10

Sep-

10

Oct

-10

Nov

-10

Dic

-10

Ene

-11

Feb-

11

Cumulative Withdrawals Fund Balance

US

Mill

on

Fiscal stabilization: Accumulation of assets - ESSF


1.50

6

1.53

7

1.57

4

1.54

3

1.52

5

2.45

2

2.45

2

2.41

4

2.39

0

2.33

1

2.37

6

2.50

7

2.42

3

2.39

8

2.45

8

2.44

8

2.51

5

2.50

3

3.36

7

3.40

7

3.45

7

3.47

2

3.53

6

3.42

1

3.41

3

3.40

6

3.37

4

3.36

5

3.30

0

3.31

9

3.75

9

3.76

3

3.87

7

3.91

8

3.79

5

3.83

7

3.85

9

3.87

1

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Jan-

08

Feb-

08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-

08

Ago

-08

Sep-

08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

Apr

-09

May

-09

Jun-

09

Jul-

09

Ago

-09

Sep-

09

Oct

-09

Nov

-09

Dec

-09

Jan-

10

Feb-

10

Mar

-10

Apr

-10

May

-10

Jun-

10

Jul-

10

Ago

-10

Sep-

10

Oct

-10

Nov

-10

Dic

-10

Ene

-11

Feb-

11

US

Mill

onFiscal stabilization: Accumulation of assets - PRF

Fiscal stabilization: Reduction of gross debt (% of GDP)

0%

5%

10%

15%

20%

25%

30%

35%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


Fiscal stabilization: the accumulation rule (% of GDP)

0

0.5

1

1.5

2

2.5

3

3.5

-0.5 -0.2 0.1 0.4 0.7 1 1.3 1.6 1.9 2.2 2.5 2.8

Effective fiscal balance

Cont

ribu

tion

s

ESSF CBC's capitalization PRF

Institutional arrangement

Minister of Finance

Financial Committee

Central Bank

Investment Policy definition

Execution

Custodian

Investment guidelines

Investment policy

66,5%

45%

30%

5%

3,5%

15%

20%

15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Initial Proposed

Sovereign and agency bonds Liquid assets

Inflation-linked bonds Corporate bonds

Equities

A commitment to transparency•The funds have operated in a very

transparent manner since their establishment in 2006

•To ensure that the public has access to the relevant information, the ministry of finance has created an exclusive website that holds all of the funds’ monthly, quarterly, and annual reports, the legislation pertaining to the funds, and the recommendations of the Financial Committee and its annual reports

A commitment to transparency•Chile has actively engaged in international

initiatives to foster the transparency of SWFs

• In particular, the SWFs of the world reached

its transparency landmark agreement in Santiago in 2008

•The so-called “Santiago Principles” reflect the commitment to enhance transparency with regard to the policies and activities of sovereign wealth funds

A commitment to transparency

•Chile gets the maximum ranking in international transparency index elaborated by Sovereign Wealth Funds Institute (first quarter 2011)

Some lessons that I learned regarding SWFs

•SWFs are mechanisms for attaining and retaining fiscal discipline

•They are a mechanism for self-insurance in a volatile and unfriendly world economy

Common and unique features of Mongolia FSL

•The current draft of the FSL includes these best international practice features:▫Structural revenue of major minerals▫Expenditure rule▫Fiscal consolidation:

Reduction of government deficits Sustainable debt accumulation

Structural revenue of major minerals

Long term price of copper

Price of copper

Savings

Use of savings

• Long term price of copper defines fiscal returns in the long term (permanent income hypothesis) and foster a countercyclical fiscal policy

Example: All fiscal revenues come from copper


•Alternatives:▫Council that estimates long-term price of

minerals ▫Formula that takes the possible subjectivity

out


•Formula option:▫ A combination of both historical data and

projections long-term trend•The estimation of long-term price of

minerals should consider credible data sources: ▫IMF Commodity Prices database (history)▫Bloomberg (projections)

Structural revenue of major minerals: Comparison

Long-term price of copper

0

1000

2000

3000

4000

5000

6000

7000

Current Price Formula Chile Council

US

$ pe

r to

n

Expenditure rule

•Alternative: “Total budget expenditure growth shall not be more than the GDP growth rate of a particular year”

•It sounds very prudent, but it has a problem when GDP growth is weak

•Key idea: keep fiscal expenditure despite the business cycle (countercyclical fiscal policy)

Expenditure rule

•The rule should tackle two issues:▫Having a sustainable fiscal expenditure▫Avoiding sudden jumps in the transition period

•Proposal: “Total budget expenditure growth of a particular year shall not be more than the maximum between non-mineral GDP growth and non-mineral GDP growth trend (average)

Expenditure rule

Non-mineral GDP growth

Non-mineral GDP growth trend

Rule: Expenditure should be less than the Max (actual GDP growth; GDP growth trend)

Expenditure rule

Non-mineral GDP growth

Non-mineral GDP growth trend

Rule: Expenditure should be less than the Max (actual GDP growth; GDP growth trend)

Maximum fiscal expenditure

Rate of growth

Years

Fiscal consolidation: fiscal deficits

•Reduction of government deficits▫2% or surplus later from 2013

Fiscal consolidation: debt accumulation•Sustainable debt accumulation•Alternative: Hump shaped debt

accumulation▫40% from 2013


• Keep it legitimate!▫Main risk of any fiscal discipline device:

political illegitimacy▫ Investment policy: shared decision, with

autonomous body playing lead role▫Government does not administer a penny!▫Financial insurance needs political

insurance!


• Keep it transparent!▫Everyone should know what is going

on, all the time▫Report a lot▫Obligatory, regular and external

audits


•Keep it simple!▫Boring but useful principle: one

instrument, one target▫If macro stabilization is the goal, then

must have simple, safe and relatively liquid portfolio

▫Invest everything outside the country: avoid Dutch disease


•Keep it fiscal!▫Avoid overload of tasks: social

programs, public infrastructure, socially-responsible investments are desirable goals: that is why they should be funded out of budgets

Concluding remarks

• The successful Chilean experience to manage commodity booms has contributed to reduce economic volatility and increase the resilience of the economy

• An important general lesson of this process is that governments should avoid short-term temptations to spend significant temporary surpluses

• Paradoxically, this policy gains legitimacy in the rainy days when governments need additional resources to support their economies

Concluding remarks

•If natural resource booms are well managed they must be a blessing for any country

•Today many nations have recently developed or are developing SWFs

•To them a simple message: ▫Keep it legitimate!▫Keep it transparent!▫Keep it simple!▫Keep it fiscal!

Natural Resource Booms and Fiscal ResponsibilityEric ParradoUniversidad Adolfo Ibáñez

Sovereign Wealth Management for Mongolia - A YPAD FocusMongolia YGL Learning Journey

Terelj Hotel, MongoliaSeptember 10, 2011

mongolia swf eric parrado

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