Commodity Endowment Funds

Transcription

1 Commodity Endowment Funds Moscow March 9-10 Roberts L. Grava Jennifer Johnson-Calari World Bank

2 Challenges of managing commodity revenues Macro issues Smoothing of government revenues Preventing boom/bust cycles Avoiding real appreciation of exchange rate Preserving capital and transforming of depleting resources into permanent income Coming to political consensus on use of revenues Domestic versus overseas investment Spending today versus spending tomorrow Micro issues Setting up governance structure and investment strategy so that risk/returns meet fund objectives Building institutional capacity to manage complex investment program

3 Budget focus DUAL FOCUS Savings and investment focus Stabilization Fund Commodity Endowment Fund Fund Fund for the Future Endowment funds--meet both current spending and capital preservation objectives

4 Stabilization fund Shifts money from one budget period to another Sterilizes foreign exchange inflows prevent appreciation of real exchange rate and protect tradable economic sectors Problems Funds subject to political raids Spending rules based on threshold prices-- not sustainable in non cycular markets No relationship between spending and total wealth Foregone income due to investment in low return investments

5 Fund for the future Transfers wealth to future generations Generates significant investment income Sterilizes excessive foreign currency inflows Problems Lock-box approach and lack of attention to current income needs Difficulty in garnering political support Small relative allocations (historically 90%/10% rule)

6 Commodity endowment fund Preserves capital while meeting minimum government revenue requirements for budgetary finance Generates significant investment income Smoothes revenue volatility (oil taxes plus investment income) through investment assets negatively correlated to oil and gas Sterilizes foreign currency inflows Provides an upper bound on annual spending based on total wealth Problems/challenges: Achieving political consensus on spending rules/guidelines Simulation modeling required to ensure spending rules/guidelines meet objectives Simulation is non water-tight and future market developments could still produce surprises

7 Commodity fund design: Form follows function Trade-off Capital preservation for future spending Meet current income needs Generating independent source of f/x income Smoothing of f/x revenues Sterilizing foreign currency (f/x) inflows Saving rule or guideline based on total wealth that assures minimum annual income to government and meets future spending needs Investment in diversified portfolio of risk assets for return Investment in financial assets with low or negative correlation to commodities Investment only in overseas assets Domestic investments flow through budget process

8 Commodity fund: balances capital preservation and spending requirements 160, , , ,000 80,000 Oil Production (bbl/day) Net Oil Revenues (Million USD) 60, ,000 20, Capital preservation: Size of Permanent Fund (Million USD) Annual spending: Available for Spending (Million USD) , From Oil Revenues From Capital Market Returns 8, , , , The values expressed in these and subsequent figures are expressed in real terms (i.e dollars). Example for region with 500 million barrels of oil expected to last from 2006 to 2024

9 Rules balance current and future spending: trade-off Real Oil Revenues Average Spending (3.5%) Real Oil Revenues Average Spending (10%) Average Spending (20%) Real Annual Spending For permanent income, spending rate should not exceed long term average rate of return on investments (guideline for Norway, Alaska) nassumed real rate of return on assets is 3.5% Example for region with 500 million barrels of oil expected to last from 2006 to 2024

10 Guidelines balance current vs future spending base on fund objectives Available for Spending (Million USD) Total Wealth Approach Bird in Hand Approach

11 Savings guidelines limit spending as percentage of wealth Nigeria Venezuela Azerbaijan Kazakhstan Trinidad Norway Alaska Sao Tome No limits or guidelines Spending guideline: Amount available for spending should not exceed earnings on fund Amount available for spending should not exceed agreed percentage of total wealth in any one year Spending ceiling: Amount available for annual spending capped as a percentage of total wealth

12 Generating investment income: US Treasury bill returns versus portfolio of equities/bonds 30.00% % 14.0 Annual Real Return 10.00% 0.00% % % Cumulative Real Return % Real Return on 3-mo T-Bills Real Return on 50% Stocks/50% Bonds Cumulative Real Return on 3-mo T-Bills Cumulative Real Return on 50% Stocks/50% Bonds

13 Value of investment portfolios

14 Smoothing of f/x revenues through investment in financial assets with negative correlation to oil/gas Oil Price Changes Real Return on 50% Stocks/50% Bonds

15 Financial assets have low or negative correlation with oil and gas Diversifying Oil and Natural Gas Resources Oil Natural Gas TIPS Govt. Bonds Corp. Bonds Stocks Real Estate Correlations based on annual return series from , except TIPS and Real Estate ( ). Real Estate is US REITs, TIPS return series are hypothetical before 1997 and actual after 1997

16 Sterilizing foreign currency inflows Investment Income Income FUND Commodity revenues Liquidity (ruble) Investments Finance Budget: domestic investments (forex)

17 Simulation Model

18 Model objective: test robustness of fund design under uncertainty OBJECTIVES Fiscal budget requirements Fiscal smoothing TEST KEY DESIGN FEATURES SPENDING GUIDELINES RISK SCENARIOS OIL PRICE stochastic mean reverting OUTCOMES Assess distribution of outcomes versus objectives Capital preservation Future spending needs STRATEGIC ASSET ALLOCATION INVESTMENT RETURNS COVARIANCE MATRIX Adjust rules if necessary Retest Model is also a fiscal planning tool for medium term planning

19 Oil price scenarios

20 Total real revenues from extraction taxes & export Duties, RUB thsd.

21 Value of investment portfolios

22 Russia: Oil prices influence sustained spending % of Real GDP 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Real Oil Price Remains Steady at 55 USD/bbl Spending From Oil Spending From Fund Spending Shortfall % of Real GDP 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Real Oil Price Declines to 30 USD/bbl Spending From Oil Spending From Fund Spending Shortfall

23 Russia: Financial asset returns influence sustained spending Fund Invested in "Risk-Free" Assets % of Real GDP 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Spending From Oil Spending From Fund Spending Shortfall % of Real GDP 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Fund Invested in Balanced Portfolio Spending From Oil Spending From Fund Spending Shortfall

24 Russia: Saving vs. spending windfall % of Real GDP 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Excess Income Saved to Fund Spending From Oil Spending From Fund Spending Shortfall 12.0% Spend Excess Windfall Income 10.0% % of Real GDP 8.0% 6.0% 4.0% 2.0% 0.0% Spending From Oil Spending From Fund Spending Shortfall Windfall Spending

25 Governance Structure

26 Delegation of authority ensues from fund owners to trustees to managers Government Legislation Financial Advisory Custodian Contract Trustees (Investment Committee) Central Bank (Agent) Investment policy and strategic asset allocation MOF-Central Bank Contract Investment Management Agreement (IMA) Global Custodian Asset Manager(s)

27 Summing up Commodity endowment fund can meet multiple objectives through careful design Development of spending guidelines based on total wealth important for capital preservation and to meet future spending needs Strategic asset allocation should seek to maximize foreign currency income while diversifying away from oil and gas Simulation and risk models are crucial for the design of spending guidelines and strategic asset allocation We live in a world of risk. No decision is a decision. Important to design solutions that encompass risk parameters rather than ignoring it.

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29 Oil price scenarios

30 Total real revenues from extraction taxes & export Duties, RUB thsd.

31 Value of investment portfolios