At the recently held 2021 Petersberg Climate Dialogue in preparation for the Conference of Parties (COP) meeting at the end of the year, the United Nations Secretary-General Antonio Gutteres gave a stark assessment of where the world stands on climate change. He stated that 2020 was another unprecedented period of extreme weather and climate disasters. Carbon dioxide concentrations again rose to a new high – 148 per cent above pre-industrial levels, the highest level for three million years. Temperature rise is already 1.2 degrees Celsius higher than in pre-industrial times which is dangerously close to the 1.5 degrees set by the Paris Agreement on Climate Change.
The Secretary-General summed up the state of affairs as follows:
Under current commitments, including the recent ones, we are still heading for a disastrous temperature rise of 2.4 degrees by the end of the century. We stand indeed at the edge of the abyss. But if we work together, we can avert the worst impacts of climate disruption and use the recovery from the COVID-19 pandemic to steer us on a cleaner, greener path.
We can no longer afford big fossil fuel infrastructure anywhere. Such investments simply deepen our predicament. They are not even cost-effective. Fossil fuels are now more expensive than renewables.
We have a small and narrow window of opportunity to do the right thing. But our future is in our hands, and in your hands, dear friends. Let us use the pandemic recovery and COP26 to promote a safe and sustainable future for all nations and people.
In today’s article, we conclude our discussion on the recently released Inter-American Development Bank (IDB) report entitled “ECONOMIC INSTITUTIONS FOR A RESILIENT CARIBBEAN” as it relates to public financial management.
Debt management (cont’d)
Debt management is about developing and executing a strategy to manage the country’s portfolio of public debt and publicly guaranteed debts as well as the framework and procedures for entering into new debt obligations. An effective debt management framework assists in avoiding excessive risk accumulation while supporting growth and stability of the economy.
Fiscal responsibility frameworks: These are ‘institutional and legal structures that help to guide fiscal policymaking over time with the aim of increasing transparency, discipline, and accountability on the part of policymakers and executing agencies’. The frameworks normally include setting quantitative targets relating to outcomes and are based on legal instruments, such as, budget and fiscal responsibility laws. They cannot, however, be viewed in isolation, and must rely on capable institutions and personnel, as well as important inputs from those provided by sound and effective debt management institutions, among others.
The report noted that in terms of fiscal institutions, all six Caribbean countries surveyed (The Bahamas, Barbados, Jamaica, Trinidad and Tobago, Guyana and Suriname) suffer in varying degrees from significant institutional and capacity weaknesses. It offers the suggestion that countries in the region that do not currently have fiscal responsibility frameworks, could benefit from the experience of Jamaica. Implemented in 2014, the Jamaican model has helped to guide fiscal policy towards successful debt reduction. The framework includes quantitative rules for debt reduction, public wages and fiscal outcomes. It is also flexible enough to help the government adjust to the COVID-19 pandemic by delaying target dates for medium-term debt reduction.
Independent fiscal councils: These are independent institutions established to: (i) strengthen commitments to sustainable policies and finances through mainly public assessments of fiscal plans and performance; (ii) evaluate or provide macroeconomic and budgetary forecasts; and (iii) involve independent stakeholders in the policy development and review process. These councils have some degree of independence from agencies that are normally charged with budgetary functions relating to planning, forecasting revenues and expenditures, and budget execution. Fiscal councils have increased considerably over the years, especially since the global financial crisis in 2008. Sound fiscal institutions assist debt management institutions in the monitoring of the public debt.
In Guyana, which was the most indebted country in the world from 1970 through the mid-1990s as measured by the ratio of nominal public debt to GDP, there have been significant reductions in the public debt, due mainly to debt relief initiatives such as the Heavily Indebted Poor Countries (HIPC) Initiative as well as debt write-offs by multilateral and bilateral agencies. In some cases, there was a rescheduling of the repayments of the debts. As 31 December 2020, Guyana’s debt-to-GDP ratio was 47.4 percent, inclusive of the publicly guaranteed debts as well as the overdraft on the Consolidated Fund which previously were not reflected in the ratio.
Guyana’s Debt Management Office (DMO) is located centrally at the Ministry of Finance. However, according to the report, there is no clear separation between front, middle, and back office functions. Front office functions generally involve leading issuances in primary and secondary market operations, while the middle office is responsible for policy and portfolio strategy development and accountability reporting. Back offices focus on transaction recording, reconciliation, confirmation and settlement. A lack of functional separation within the DMO does not allow for proper specialization, creates inefficiencies in the form of duplications, and produces less functional clarity and accountability within the DMO. There is also no Debt Management Committee for ensuring that debt management is consistent with the macro framework, including debt sustainability and macro-financial stability.
In the final analysis, reducing public debt to more sustainable levels requires significant fiscal consolidation. To ensure that the adjustment is sustained over the medium-term, it is critical to strengthen the institutional fiscal frameworks, including fiscal rules, medium-term fiscal frameworks, transparency and accountability, independent fiscal councils, and revenue and expenditure management system. It is to be noted that Guyana’s budget formulation focuses mainly on annual budgets. There is no published medium-term fiscal framework, and although the budget documents include indicative figures for the following three years, fiscal policy is not guided by formal medium-term objectives.
Dependence on revenue from non-renewable natural resources
Fiscal management is significantly more complex where there is dependence on revenues from non-renewable natural resources. This is due mainly to:
(a) High degree of uncertainty of revenues because of volatility and unpredictability of prices;
(b) Difficulty in estimating the size of the resources, and forecasting production volumes and their associated costs;
(c) Exhaustibility of such resources as well as the risk of technological obsolescence; and
(d) Impact on the exchange rate, including that relating to the “Dutch disease”.
In order to mitigate these risks, there is a need to: (i) build adequate buffers by maintaining relatively low public debt levels; (ii) appropriately designing sovereign wealth funds to finance temporary deficits during price downswings; (iii) accessing contingent credit lines; and/or (iv) hedging against significant fall in prices.
The report noted that Guyana’s macroeconomic and fiscal prospects over the medium- to long-term have significantly changed since the discovery of substantial offshore oil reserves. These discoveries are likely to improve Guyana’s fiscal performance if prudent policies are pursued. However, Guyana’s public finances over the years have suffered from significant long-standing institutional weaknesses such as the absence of: (i) a formal medium-term budget framework (MTBF); (ii) national and sectoral planning; (iii) standardized systems for the preparation, selection, monitoring, and evaluation of public investment projects; (iv) adequate procurement regulations; (v) sound legal framework and capacity for management of public-private partnerships (PPPs); and (vi) comprehensive and timely monitoring as well as transparency of the finances of State-owned enterprises (SOEs). These areas received relatively low scores in Guyana’s 2019 Public Expenditure and Financial Accountability (PEFA) Performance Assessment.
The report commented that excessive spending in the wake of oil discoveries leads to inflationary pressures, future rigidities in the budget, and/or wasteful investment projects, especially when institutions for management of the budget and public investments are weak. To counteract such pressures, Guyana should quickly adopt an expenditure rule by capping the growth of primary expenditures at a level somewhat lower than the GDP. The rule should be calibrated to ensure that fiscal deficits are eliminated rapidly and replaced by growing surpluses; and spending does not exceed the country’s macroeconomic and public financial management absorption capacity.
Sovereign wealth funds
Sovereign wealth funds (SWFs) are special purpose investment funds or arrangements, created and owned by the government for macroeconomic purposes. They hold, manage, or administer assets to achieve financial objectives and employ a set of investment strategies that include investing in foreign assets. SWFs are commonly established from balance of payments surpluses, official foreign currency operations, proceeds from privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. The main objectives for the establishment of SWFs are to assist in ensuring:
(a) Fiscal and macroeconomic stabilisation in the face of highly volatile and uncertain resource revenues;
(b) Long-term savings since natural resources are exhaustible and may become obsolete;
(c) Adequacy of funds to finance the budget, especially when there are budget deficits;
(d) Provision for pension liabilities, especially in the light of aging population;
(e) Effective foreign exchange management, especially where there are sustained external current account surpluses and/or where large capital inflows from abroad have accumulated in the international reserves; and
(f) Provision for financing for national development projects based on public policy objectives.
Well-designed SWFs can provide support in reducing fluctuations and volatility of public expenditures as well as in fostering public savings in countries with high institutional quality and sound overall fiscal framework.
Guyana’s SWF is the Natural Resource Fund (NRF) for which legislation was passed in January 2019. The NRF Act provides for the transparency and proper accountability for oil revenues in order to ensure that such revenues are managed for the benefit of both present and future generations, and in a sustainable manner. The key provisions include:
(a) The Minister of Finance having overall responsibility for the management of the Fund, including the preparation of an Investment Mandate. He is assisted by a Senior Investment Advisor and Analyst, and Investment Committee comprising six members having experience and expertise in financial investments and portfolio management;
(b) A Public Oversight and Accountability Committee (POAC) to be established, comprising 22 members drawn from mainly civil society organisations, to monitor compliance with the Act as well as independent assessment of the management of the Fund and the utilization of withdrawals;
(c) The Bank of Guyana to be responsible for the operational management of the Fund, including maintaining proper books of account and preparing monthly and quarterly reports;
(d) A Macroeconomic Committee to be established to advise the Minister on the Economically Sustainable Amount. This is the maximum amount that can be withdrawn from the NRF in a fiscal year while ensuring the long-term financial sustainability of the Fund, a fair intergenerational distribution of natural resource wealth, and maintaining stability in the annual withdrawals from the Fund;
(e) The Bank’s Internal Audit to be responsible the internal audit of the Fund;
(f) The Auditor General to perform the external audit of the Fund and report the results not later than 30 April of the following year; and
(g) The Minister to table an annual report, including audited accounts, in the National Assembly.
As of April 2021, amounts totalling US$267.7 million have been deposited in the NRF account at the Federal Reserve Bank in New York representing royalties and Guyana’s share of profits based on the ExxonMobil Petroleum Agreement of October 2016. There have been no withdrawals. However, the Investment Committee, the POAC and the Macroeconomic Committee are yet to be established. The POAC is responsible for monitoring and evaluating compliance with the Act and for providing independent assessment of the management of the NRF and the utilization of withdrawals, among others.
In December 2019, the Ministry of Finance and the Bank of Guyana signed a Memorandum of Understanding outlining the responsibilities of the Bank in relation to the NRF. These include: (i) receiving and accounting for all deposits into the NRF; (ii) investing the NRF in eligible asset classes; (iii) appointing private managers and custodians; (iv) reporting on the performance of the NRF on a monthly, quarterly and annual basis; (v) implementing management systems, procedures and risk management arrangements in accordance with international standards; and (vi) providing the public with information on the NRF, as required by law.
The report concluded that for Guyana, the moderate scenario based on a simulation exercise carried out, shows that with relatively high expenditure growth, fiscal balances would grow, leading to higher levels of debt and an erosion of the savings accumulating in the NRF. It is therefore important for the government to not only strengthen its fiscal framework to avoid the above outcome, but also strengthen other institutions both in oil and gas governance as well as the public financial management framework in order to bolster the quality and efficiency of future public expenditure.