Oil funds to be invested overseas

Finance Minister Winston Jordan

…Central Bank proposed as operational manager for Sovereign Wealth Fund
…broad-based investment committee to be set up

IN order to become sustainable and achieve all of its objectives, the National Resources Fund (NRF) must also invest in overseas financial instruments. This is according to government’s ‘green’ paper managing future petroleum revenues and the establishment of a fiscal rule and a sovereign wealth fund.

The green paper was on Wednesday laid in the National Assembly by Finance Minister Winston Jordan. It says that the Economically and Fiscally Stable Account (EFSA) would determine how much is transferred to the national budget and the balance would be invested in overseas markets in order to minimize the risk of creating economic instability locally.

“It is the investment in overseas assets that would serve to ensure that the country has a long-term stable source of income which would allow for the Fund to meet its stabilization and inter-generational savings objectives. Very safe investments would be mandatory so that the first US$500M and at least three times the expected annual withdrawal would be invested in very safe investments. “This would ensure that the Fund meets short term stabilization and cash management,” the paper noted.

“Investments by the Fund would be made following a passive investment management strategy to maximize returns over the long run,” the green paper noted.

Meanwhile, Jordan, in describing the paper as “revolutionary” noted that it captures key issues and mechanisms that will ensure the sustainable use of the country’s petroleum revenues to achieve a diversified and green economy. The paper seeks to ensure that the mismanagement of the country’s natural patrimony is avoided and ensure that all Guyanese, especially the youth, are able to benefit from the revenues to be derived, thereby enabling them to live in security and comfort.

The paper speaks to the pre-source curse, resource curse and the Dutch Disease and why a sovereign wealth fund is necessary. The establishment of a sovereign wealth fund can help to protect Guyana against the Dutch Disease by “sterilizing boom revenues and ensuring that export earnings from petroleum only enter the economy at a rate which the economy can absorb these additional resources.”

As such, the National Resource Fund Act (NRFA) will mandate the formation of a macro-economic committee, comprising leading experts from the public and private sectors, as well as academia who will have responsibility for assessing the economy’s ability to absorb additional expenditures from petroleum revenues.

Concerns of overheating in the economy were also addressed in the ‘green’ paper. Overheating in the economy occurs when unsustainable growth driven by excess aggregate demand, in the short run, is unable to be met by the economy’s productive capacity and which inevitably leads to increased inflation. “One way of preventing overheating is to scale the investment expansion, for example, developing infrastructure in a constant pace, to increase the economy’s productive capacity and sustainability. But if the government expenditure resulted in the construction of high quality assets, then there is a possibility Guyana could still suffer from the Dutch Disease in the short term.

Separate funds
Additionally, the ‘green’ paper assesses whether separate funds are required to meet the multiple objectives of intergenerational savings, stabilisation and investing in development priorities. Government is of the opinion that a single fund, that is, the NRFA will be the most effective, efficient and transparent mechanism for achieving the aforementioned objectives. “A single fund can achieve multiple objectives with a robust fiscal rule,” the government said, noting that if any given year, government deposits all oil revenues into a single fund, which exceeds $100 million annually and then withdraws a portion of the balance of the fund, based on a fiscal rule, amounting to $100 million annually, towards the domestic investment objective.

“Simultaneously, the remainder is invested in financial assets that generate returns. In the very long-term (once oil production had ceased) the long-term rate of return on the Fund’s investments would exceed $100 million per annum, as the saved and invested balance increases, thereby achieving the savings objective. The fund would be achieving a stabilisation objective as the withdrawal of $100 million a year would be maintained in spite of short-term changes in oil revenues.”

As such, the establishment of the sovereign wealth fund is “relatively complex” and according to the ‘green’ paper, there can be substantial administrative costs. “If two completely separate funds are established, then this implies that there are two governance structures, two investment policies/investment mandates, two sets of accounts and two external audits. There would also need to be detailed rules for transferring money between the two funds and the National Budget.”

Moreover, it is felt that it would not be prudent to spread the limited expertise and experience in fund management in Guyana across two separate funds. The costs of managing two funds would be much higher than those of managing a single fund, the ‘green’ paper notes. “Overall, the Government considers that it is most efficient to have a single fund (the Natural Resource Fund). Both economic theory and case studies of Botswana, Norway and Timor-Leste demonstrate that a single fund can effectively achieve multiple objectives.”

The NRFA was established to effectively and efficiently and wisely manage natural resource wealth for the benefit of current and future generations by contributing to economic stabilisation, ensuring that volatility in natural resource revenues does not lead to volatile public spending and ensuring that natural resource revenues do not lead to a loss of economic competitiveness.

The withdrawals from the NRF will be deposited into the Consolidated Fund to form part of the financing streams for the annual budget, along with loans and tax and non-tax revenues. Government will then determine its development priorities, based on the costed Green State Development Strategy (GSDS), and the available income envelope which, from 2020, will consist of petroleum revenues, loans, grants, tax and non-tax revenues. Priority will be placed on catalytic investments to transform communities, regions and the country as a whole, within the context of the measureable targets, identified within the GSDS.
It should be noted that notwithstanding the aforementioned, withdrawals from the Natural Resource Fund cannot exceed the amount approved by Parliament. In addition to withdrawals from the NRF being deposited into the Consolidated Fund to finance development priorities, the only further drawdowns that can be made would be for Petroleum Tax Refunds, when necessary.

Revenues deposited into the NRF will include royalties due and payable by the holder of a Petroleum Licence; the Government’s share of profit oil; the Government’s share of profit gas; any petroleum income tax, additional profits tax or any other future tax levied on the profits of companies or individuals undertaking Petroleum Activities; any signature bonus, discovery bonus, production bonus or other bonus related to Petroleum Activities or the award of a Petroleum Licence; any other current or future fiscal instrument levied solely or mainly on companies or individuals involved in Petroleum Activities; and any revenue or profits from a National Oil Company.

Petroleum Revenues would exclude the value added tax collected on inputs or outputs from Petroleum Activities; customs duties collected on inputs into Petroleum Activities; fees collected by the Petroleum Commission; withholding tax on payments made to contractors by companies or individuals undertaking Petroleum Activities and the total return from investments of the NRF which would be retained by the Fund.

Management of the Natural Resource Fund falls directly under the Ministry of Finance. According to the ‘green’ paper, Parliament will pass the NRFA, thereby approving the budget which would include the annual withdrawal from the Annual Report. “The Ministry of Finance would be responsible for overall management of the NRF, including requested withdrawal in the Annual Budget Proposal; calculating the Fiscally Sustainable Amount; drafting the Investment Mandate; entering into the Operational Agreement with the Bank of Guyana and drafting the Annual Report and reporting on the NRF through the Annual Budget.”

Additionally, a Sovereign Investment Committee would be responsible for advising the Minister of Finance on the Investment Mandate and would consist of the following seven members appointed by the minister: A representative of the Minister of Finance; an ex-officio representative nominated by the Minister of Natural Resources; an ex-officio representative nominated by the Governor of the Bank of Guyana; a representative nominated by the Institute of Chartered Accountants of Guyana; a representative nominated by the Guyana Association of Bankers; a representative nominated by the Leader of the Opposition; and the Senior Investment Adviser and Analyst.

Members of the Committee would be persons with substantial experience, training and expertise in financial investments and financial portfolio management; and a minimum of a post graduate degree from a reputable university in the discipline of finance or economics, or an equivalent professional qualification, the ‘green’ paper states.

The Senior Investment Adviser and Analyst would be recruited via international open tender and would be responsible for assisting the minister to draft the Investment Mandate; assisting the Minister report and monitor the financial performance of the Natural Resource Fund; supporting the Sovereign Investment Committee undertake its functions; and undertaking financial modeling showing the expected total return and risk of different allocations of the Natural Resource Fund across different Eligible Asset Classes.

The Bank of Guyana (BOG) would serve as the operational manager of the fund and is expected to manage it in accordance with the operational agreement and investment mandate. As such, the BOG is required to draft quarterly reports and annual accounts, procure private managers, and draft management agreements and investment instructions. Those private managers are expected to manage the overall investment portfolio in accordance with the management agreement and investment instructions.

The Ministry of Finance will be required to lay an annual report in the Parliament each fiscal year and provide further reporting through the annual budget process which will include additional documentation. This process seeks to ensure that all petroleum revenues are accounted for. It is expected that the NRF would be operated in a transparent manner and fully conform to the Santiago Principles.