Some thoughts on the Green Paper

I hope the Green Paper on the proposed Sovereign Wealth Fund (SWF) is a work in progress. The paper outlines a fiscal rule for withdrawals and the passive investment strategies for the foreign assets that will make up the Natural Resource Fund (NRF). It is quite intuitive why a NRF is necessary. It’s like a person’s bank savings account, with monies put away for financing income shortfall. The “rational” person is probably going to have some long-term or permanent spending profile. Once income rises above the long-term spending habit, the person saves for when hard times come. The Green Paper is proposing a set of rules and new systems that it hopes will make the Guyanese government behave like a rational person. In addition, the idea of having a single NRF makes sense.

The public has expressed several objections regarding who will be the caretaker of the people’s oil and gas bank account. For example, many people have rightly objected to the strong control the Green Paper gives to the Minister of Finance over the NRF. It is clear from the document that the Minister has significant leverage over the proposed Macroeconomic Committee, as well as the Sovereign Investment Committee. The control over the future Macroeconomic Committee is more important from the perspective of best use of the oil revenues.

It is no secret that no one can be independent in Guyana. No one is exempted from the politicians’ grip or private special interests. There is no way on this planet a Guyanese Minister of Finance will place a truly competent and fiercely independent macroeconomic expert to Chair the committee responsible for determining the sustainable amount of annual withdrawal for the National Budget. Ultimately, the President and Minister will select people from their political and ethnic networks. As noted in the paper, Cabinet also gets to vet another member of the committee. Since Guyana does not have an independent central bank, the government of the day gets indirect control over the person representing the Bank of Guyana (BoG).

Let us try to understand the role of the Macroeconomic Committee as outlined in the Green Paper. The committee will determine the “fiscally” sustainable amount of money that can be withdrawn in any given year to fund the National Budget. As everyone is aware, the annual Budget reflects a messy political process, where consensus is deemphasized and sabotage is the dominant strategy, to use a term from game theory. Imagine the election is a year or two away and government wants to make a big infrastructure splash, which Chairperson living inside Guyana and is a representative of the Ministry of Finance can tell him that his request is above the amount that can be withdrawn?

The Minister of Finance still has to provide annual budgets of taxing and spending. The oil revenues become a supplement to – or in the likely worst case a replacement for – the traditional taxes the government collects. The contentious political process, built on ethnic rivalry and patronage, determines government spending; not the Macroeconomic Committee overseeing withdrawals from the NRF or SWF. This implies that a SWF is a necessary but not sufficient institutional mechanism to make sure Guyana escapes the natural resource curse.

This is the reason why I find it difficult to take the following statement on page 16 seriously: “countries rich in natural resources have the opportunity to achieve inclusive growth while ensuring that excessive debt is not incurred.” Inclusive growth depends on legal and constitutional systems that minimize the harmful effects of strategic ethnic voting. It does not depend on the goodness and benevolence of one man, woman or a selected group. It also depends on laws, a suitable constitution and other systems that make the public service and army more reflective of the country. It depends on an independent elections commission and an electoral system that allows for regular democratic turnover. The latter is the only disciplining mechanism for political parties.

Another major concern I have is the interplay between the SWF and the international reserves of the Bank of Guyana. I agree that the central bank has obvious comparative advantage as operational manager of the NRF. The Bank of Guyana already pursues a passive investment strategy when maintaining the country’s foreign exchange reserves. By definition no central bank, including the BoG, is allowed to speculate in foreign financial markets with the international reserves.

The Green Paper notes that a professional investment manager will be employed to oversee the passive investment strategy of the saved-up oil revenues. The paper makes it clear the manager cannot pursue an active or aggressive portfolio strategy. Perhaps this investment manager might be housed at the central bank. This is not clear in the Green Paper.

Furthermore, the Green Paper is not clear how the nominal anchor the central bank targets for the purpose of monetary policy is related to the sustainable withdrawals from the SWF. In the past, the BoG was able to replenish its foreign reserves by purchasing from state-owned enterprises such as GuySuCo and others. Suppose the BoG decides to target the exchange rate as its nominal anchor, from where will the foreign exchange come if the SWF is going to sequester all oil revenues overseas? The traditional sectors are in decline and gold production appears to have plateaued. So, the opportunities for buying foreign exchange from existing exporters are narrowing.

The organizations writing the Green Paper and advising the government have always expressed a bias for inflation targeting, flexible exchange rates and open capital account. No doubt the Common-wealth economists have been trained to think in this tradition. Nevertheless, Guyanese and their government will get the hang of it in a few years when there are rapid swings in the exchange rate. Moreover, if you don’t have a command of your national currency and its internal and external value, and outsource your financial system to forward speculators (they call them bond vigilantes), then you expose yourself to externally-induced economic sabotage of the type that Turkey experienced a few weeks ago, becoming a classic testing ground of textbook trade models, one of which predicts devaluation in the small country if a large country levies a tariff against it.

That the authors did not address this delicate detail of the interplay between the Bank of Guyana’s international reserves and the SWF indicates Guyana is on the path of moving away from exchange rate targeting. Of course, the Minister of Finance has other concerns such as making sure the committees are going to be in favour of his and his party’s interests. No doubt, the main opposition party is also looking forward to the day when it can have a compliant Macroeconomic Committee.  

Finally, the idea of a fiscal rule makes sense. The rule they propose has a 3 percent sustainable income. This implies that if the government draws down 3 percent income from the fund each year, the NRF will not run out of money. Whether this 3 percent is necessary for the first 10 years of oil production is debatable. There are significant demands for infrastructure, pre-tertiary education, university-level training, healthcare, industrial diversification, etc, and perhaps some conditional cash transfers. Also, with a 2 to 3 degree warming of the planet, a lot of the floods will occur in places close to the equator. However, after the first decade, a 3 percent rule seems reasonable.