The Natural Resource Fund Act of December 2021 is a clear and concise document outlining the purpose of the Fund, as well as the sources of oil revenue deposit and method of withdrawal. The Act is quite clear on the kinds of assets in which the people’s oil monies are to be invested. It was admirable in outlining clearly some parameters surrounding a very passive investment strategy. For example, if the Fund has less than US$500 million, then only safe assets such as eligible treasury bills and bank deposits can be held. Beyond the said US dollar threshold, the managers of the Fund are expected to switch to a passive investment strategy of a well-diversified investment portfolio. The Act makes it clear that the government cannot borrow against the Fund or lend from the Fund.

There are however some serious doubts, at least from where I stand. The first one pertains to the issue of independence of the Board. The degree of perceived independence from or control by a politician is not significantly different from the APNU+AFC’s version of the Act. The latter gave substantial power to the Minister of Finance, while the PPP/C’s version hands significant power to the President and subsidiary power to the Minister of Finance. While the President gets to determine the majority of members who will serve on the Board, the Minister of Finance has significant authority over the Investment Committee.

I find the desire of careered politicians to exercise complete control to be curious since the Board, the Investment Committee, and the proposed Public Accountability and Oversight Committee (PAOC) cannot dictate fiscal policy (annual budgets). The task of spending and taxing rests solely in the power of the elected administration. An astute government will always yield something to the parliamentary opposition, but that’s another discussion for another day (Mr. Ramotar would have been elected President in 2015 had he offered AFC some wins in Parliament). We can debate whether various proposed budgets express optimal project choice or timing – they often don’t – but career professionals cannot take away that power from elected politicians. In any case, most professionals will be hard-pressed to be independent in a place like Guyana. Most will likely be in some form of transactional relationship – explicitly or implicitly – with the government, or its proxies, as it assumes an ever-greater role – for better or worse – in the Guyanese economy. Therefore, why are politicians so insecure that their first-order instinct is to stamp out all checks and balances on good governance?

Perhaps nothing so expresses this insecurity as the abandonment of the macroeconomic committee, which could have played a crucial role in not only suggesting the best amount of annual withdrawal, but also providing detailed insight into the potential risks of drawing down large amounts of US dollars and depositing them into the Consolidated Fund. The Act (see 20.1) also requires that the Minister of Finance provides three-year projections of oil revenues as he prepares budget proposals. The committee could have helped in this regard and prevented the need for ad hoc number plucking.

Moreover, the macro committee was meant for providing a data-driven approach for the management of the Fund. Investment management of large funds, whether active or passive, often rely on this kind of approach to decision making. We cannot invest without data and information. Converting data into useful information would have been a very helpful input for not only the government, but also the Board, the PAOC and civil society.

However, I concede that the macroeconomic committee could only be as effective as the competence of its members. If these individuals are selected because of their political servility, then we have another ineffective body – a situation that would have likely occurred under APNU+AFC. Nevertheless, a macroeconomic committee similar in spirit to the independent economists of the Congressional Budget Office could be a very good institution as Guyana considers spending its oil rents in the best possible manner.

Before the Bill was passed with only PPP/C votes, Mr. Jagdeo criticised the previous government’s NRF Act as reading like an academic paper. I find this to be curious because as I read their version, I am seeing all kinds of academic theories underpinning the investment mandate of the Act. Take for example the idea of index fund investing, which the Act rightly demands as the method of investment for the people’s oil monies. Well, it turns out that when Messrs McQuown and Bogle created the first index funds in the 1970s, they were well aware of the emerging academic research into random walks and efficient markets.

In addition, the new NRF Act spells out nicely the one condition when the investment manager of the Fund could purchase derivatives – a form of risky security whose price is derived from some underlying asset. But guess what? It was the academics who invented back in 1973 the formula for objectively pricing the kind of derivatives implied by the PPP/C’s NRF Act. I am therefore reminded of Mr. J. M. Keynes’ dictum relating to “practical men” and the “academic scribblers” that come to bear on their actions.

I also find another troubling aspect of the Act as it relates to opening the door for procuring unnecessary financial advisory services. First, the Board, which will have up to five members, is empowered to acquire investment advice from financial advisory companies (12.1). My distrust stems from the fact that the Act already demands that there be a seven-person Investment Committee (IC). I do not see why the people’s monies must be used for paying consultancy fees when there are a five-member Board and a seven-member IC. This implies to me that the members of the Board and IC, who will be selected and appointed by politicians, will not be competent in the area of finance and investment. We also should bear in mind that the oil funds will be invested in eligible risk-free treasuries, bank deposits (which are not 100% risk-free), and various diversified index funds that are typically of lower risk. I would see the need for the Board to acquire financial consulting services if the Fund was involved in active management, which is forbidden by the NRF Act of 2021. Eventually this opportunity for procuring financial advice will result in rent seeking by the politically loyal boys and girls.

Second, I find it interesting that the Bank of Guyana is also empowered to procure the financial advice of private firms (13.1). Now, there is much confusion here. The Act says that the oil funds must be managed separately from the foreign reserves of the BoG (5). Therefore, I do not understand why the BoG should be procuring investment consultancy services when the Board – which is directly tied to the Fund – also is given that unnecessary mandate. Again, my concern stems from the fact that the Act only stipulates passive investments. The BoG, furthermore, already has decades of in-house experience in passive investment management as it is required to safely invest its foreign reserves. That the BoG is the custodian of the Fund does not and must not give it the right to manage the investment decisions.

If anything, a nation’s central bank ought to be the centre of financial and macroeconomic intelligence, given the jettisoning of the macroeconomic committee, instead of only writing quarterly and annual reports describing upward and downward percentage movements – as important as those are, too. Instead of paying fees to private consultancies, the central bank ought to be a source of free in-house intelligence for the NRF Board, the IC, the PAOC and the Ministry of Finance.

In the next column, I will discuss the large upfront draw-down rule enshrined in the new Act and its potential macroeconomic implications, as well as the risk of mixing of the oil funds with the BoG’s international reserves.

Comments: tkhemraj@ncf.edu  

In the previous column, I noted several positive features of the Natural Resource Fund (NRF) Act of 2021. I also outlined several potential downsides such as the possibility for employing unnecessary financial consulting in the face of a legally-mandated passive investment strategy, the power relations between the officers of the Fund and government given the degree of control in the Guyanese society, and the abandonment of the macroeconomic committee that could have served the wider society by providing relevant information. One point I did not make, but is worth mentioning, is consulting and advising fees could eat way a large share of the annual rate of return on the Fund.

Before we move into the task for today’s column, I must mention that there are substantial similarities between the APNU+AFC’s NRF Act of 2019 and the recent one. The 2019 Act established the sensible investment mandate. However, it also opened the door for the said unnecessary consulting fees – a situation that was carried forward into the recent Act.

In spite of the numerous similarities, it is the withdrawal rule from the Fund that really separates these two Acts. Like the one in 2019, the recent NRF clearly establishes that Parliament must debate and vote on the annual withdrawals. It also determines that withdrawals must be deposited into the black box otherwise known as the Consolidated Fund. As we discuss the withdrawal rule, it is important to note that the NRF must be held in foreign currency, namely the world’s dominant currency: the US dollar. The Consolidated Fund, however, is held in Guyana dollars – thus presenting an interesting mismatch that the policy makers will need to navigate.

One of the criticisms coming from the PPP/C claims that the withdrawal rule of the 2019 Act was nebulous as there was no clear number attached. There is some merit to this argument, I think. The previous Act tasked the then proposed macroeconomic committee (MC) in advising the Minister on the “economically sustainable amount” (ESA) and the Minister is expected to formulate budgets bearing in mind the best withdrawal in a given year. On the surface, this sounds like a very good idea, but the MC could not have fully settled on an ESA unless there is general agreement – even better if it could come from broad political consensus – on what should be the aggregate savings in the Fund over a given time horizon, say a three-year or a five-year average.

Think of the agreed aggregate saving as the ideal level of water in a bathtub, say two feet. If the leakage from the bathtub is greater than the inflow from the faucet, then the ideal level of water is unsustainable. Therefore, the MC cannot determine an ESA unless there is an agreement on how much will be saved over a given horizon. The subsequent sustainable withdrawals have to be consistent with the aggregate agreed saving. For professional macroeconomists, the technical term of the ideal aggregate saving (or water in the bathtub) is a stationary state.

Sustainability, for our purpose, means that the stationary state is not changing over some time horizon. And that stationary state could be updated as more barrels of oil are pumped and there is consensus for altering the amount saved in the Fund. As a result, we would have had a MC that really cannot say what’s the real ESA with the exception of one rule: that interest earnings plus new deposits outpace annual withdrawals. The question is, would politicians, facing an imminent election and demanding base voters allow money inflows to exceed money outflows, especially if the group of politicians has a majority in Parliament?

The notion of making annual economically sustainable withdrawals has been expunged from the 2021 Act. Instead, sustainability has been replaced with a “first schedule” and supplementary emergency withdrawals. The first schedule means that the entire amount of US$607.5 million (or G$127.5 billion) can be withdrawn from the NRF and deposited into the Consolidated Fund (CF) in order to support spending in the 2022 budget. For context, the 2021 Budget projected G$383.1 billion. Therefore, the first-schedule withdrawal would amount to 33.3% of the 2021 budget.

I am somewhat sympathetic to Vice President Jagdeo’s recent lamentation that he cannot stand by and save for future generations when there are many who are poor in the present generation. However, I thought that a few large early withdrawals would be directly linked to a few earmarked capital projects that can improve people’s quality of life. Since capital projects like roads or the proposed bridge take more than one year to complete, I expected to see the secured withdrawals linked to said projects, an outcome that would imply several withdrawals, not a single one. Withdrawing everything and depositing into the CF means the country is losing interest income and capital gains.

Nevertheless, we must discuss the implications of the first-schedule withdrawal. The first consequence would be to further boost the government’s balance at the Bank of Guyana (BoG). The much-discussed overdraft on this account was securitised after Parliament increased the domestic debt ceiling early last year. The account is now in a surplus of G$50.3 billion as at November 2021. Money is fungible and once deposited in the CF, it is available for any use as the government sees fit given its parliamentary majority. Except for those of us who are into Neo-Chartalist academic literature, the CF and the extended BoG balance are like a black box. This is why it might have been better to sterilise the injected funds in a sub-account of the CF and earmark them for nationally-agreed capital projects (I know, I am a dreamer!). Moreover, funds deposited this year could be used in subsequent years for political advantage.

The CF is important for another reason. Only when payments are emitted from this account they enter the monetary system and produce favourable multiplier effects or unfavourable pressure on the demand for foreign exchange. Given that Guyana largely imports all its machinery and fuel, as well as most of what it consumes, we can expect the large expenses to stimulate the demand for hard currencies. Hope-fully, the private oil economy will continue to bring in hard currencies at an amount that exceeds the import leakages.

How does the US dollar balance in the NRF end up into the CF in terms of Guyana dollars? The managers of the Fund will need to sell the US dollars to an entity or entities in Guyana. They can sell to the private sector, thereby swapping out Guyana dollars for US dollars. More likely, the managers will sell to the government, or more accurately the government’s bank – the Bank of Guyana. The BoG will create reserves out of thin air (one of the privileges of not completely dollarizing the economy and why I oppose dollarization) and credit these into the government’s CF. Therefore, the US dollars merely switch from the NRF to BoG international reserves. However, sales of foreign currency to the private sector will result in a different, and less desirable, chain of events. It is important to note that neither the 2019 nor 2021 Act has legal provisions for distinguishing these mechanisms.

The latter scenario is one of the main reasons why I was adamant in my previous column (and in this May 2020 essay (“Oil, ethnic conflict, and necessary and sufficient reforms”) that the BoG should not be mixing its management of the foreign reserves with the NRF. The BoG’s foreign reserves and the NRF are meant for different purposes; therefore, they must be managed separately. Readers will point out an obvious conflict of interest here if the Act is not clear in separating them, which I believe is the case. Therefore, I still do not understand why the Act empowers the BoG to seek financial consulting services to invest a percentage of the NRF. The central bank has been reliably investing the people’s foreign reserves for over 50 years.

Comments: tkhemraj@ncf.edu