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Natural resource funds: the good, the bad, the ugly -report

Source: Tue, 8 Apr 2014 16:49 GMT
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Oil rig pumpjacks, also known as thirsty birds, extract crude oil in this archive photo. REUTERS/David McNew
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LONDON (Thomson Reuters Foundation) – Sovereign wealth funds backed by oil, gas and mineral revenues are not the embodiment of good governance that their supporters claim and, without suitable safeguards, they may end up as slush funds for corrupt officials, a report published on Tuesday by two think tanks said.

The report by the New York-based Revenue Watch Institute (RWI) and the Vale Columbia Center (VCC) analysed 22 natural resource funds at both the national and subnational level.  Almost half of the natural resource funds studied were too opaque to study comprehensively, the report said.

The natural resource funds of Botswana, Equatorial Guinea, Iran, Kuwait, Mexico, Russia and Qatar were criticised in the report for not providing enough information on how their  revenues are invested and overseen, despite the fact that all seven countries have signed up to voluntary good governance guidelines for sovereign wealth funds.

About 3.5 billion people live in countries with extensive oil, gas or mineral reserves, but poor governance and corruption mean many of them do not benefit from the wealth created by their extraction.

Natural resource funds can provide huge benefits to resource-dependent countries, Andrew Bauer, an economic analyst at RWI and a co-author of ‘Managing the public trust: How to make natural resource funds work for citizens’, told Thomson Reuters Foundation.

“Where they are useful is where these resource revenues are going to overwhelm your budget,” Bauer said.

Large increases in a country’s budget can cause massive expenditure volatility and create incentives to spend money poorly, he added.

Another benefit of natural resource funds is that they can provide a safeguard against the risk of ‘Dutch disease’, Bauer said.

‘Dutch disease’ is an economic phenomenon in which a significant increase in natural resource revenues can strengthen a country’s currency to the extent that it hurts manufacturing exports. A vicious cycle can occur: as manufacturing declines, the resource-rich country becomes increasingly dependent on its natural resources.

There are currently 54 natural resource funds active in the world, holding about $3.5 trillion in assets, the report said.

CLEAR RULES ARE VITAL

“If you have the right deposit and withdrawal rules, the right investment risk limitation and if you have transparency and effective independent oversight... then these funds can work perfectly well in low capacity or developing countries as well,” Bauer said.

“And those standards are being met in certain countries, in a place like Ghana, for example. The funds have only been around for a few years now but so far they’re managing to work the way they’re supposed to have worked,” he added.

But, the report said, many of the natural resource funds analysed did not have the correct rules in place.

“For instance, due to excessive risk-taking and lack of oversight, the Libyan Investment Authority lost much of a $1.2 billion investment  in equity and currency derivatives following the 2008 financial crisis,” the report said.

In addition, the natural resource funds of Azerbaijan, Kazakhstan, Trinidad and Tobago and Venezuela were all established with the expressed aim of providing a stabilizing mechanism for the countries’ resource-dependent economies, but in every case they failed to do this, it said.  

The natural resource funds of Angola, Iran and Russia bypass normal budgetary procedures and have been used as vehicles for political patronage, the report said.

Of the 54 natural resource funds, 30 were established after 2000, the report said.

While this growth is due in part to new technologies which have allowed the extraction of natural resources that were previously inaccessible or were not cost-effective, natural resource funds have also become a popular stipulation of international institutions and advisers.

“International advisers should recognise that the establishment of a fund by itself will not improve resource governance,” the report said.

“Rather, natural resources funds ought to be products of fiscal rules or macroeconomic frameworks that call for savings of oil, gas or mineral revenues,” the report added.

“Minimum conditions (e.g. clear objectives, operational rules, investment risk limitations, effective oversight, transparency) must be present in order to improve natural resource governance,” the report said.

The report analysed the natural resource funds of Abu Dhabi, Azerbaijan, Botswana, Chile,  Ghana, Iran, Kazakhstan, Kuwait, Norway, Russia, Timor-Leste, Trinidad and Tobago, the U.S. states of Alabama, Alaska, North Dakota, Texas and Wyoming and the Canadian province of Alberta. 

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