IMF recommends precautionary stabilization fund

-sees need for analysis of absorptive and institutional capacity constraints

While it noted that the economy has tripled in size since the start of oil production, fundamentals remain sound and there are no signs of inflationary pressures, the IMF has advised the government to establish a precautionary stabilization fund in the medium to long term as a hedge against shocks.

The recommendation contained in one of the annexes to its recent country report following its Article IV Consultation with Guyana earlier this year will be seen as a criticism of the manner in which the current Natural Resource Fund (NRF) has been structured.

This recommendation came just days after the Inter-American Development Bank’s 2023 to 2026 country strategy for Guyana raised doubts about the frontloading of proceeds from the NRF.

Stating that fiscal policy can play a critical role in ensuring that Guyana’s oil wealth is managed effectively and equitably, the IMF country report said that issues of long-term fiscal and debt sustainability, while not of pressing concern, cannot be ignored as oil is an exhaustible resource.

It asserted that favourable debt dynamics signal that issues of overheating, absorptive and institutional capacity constraints, and inflationary and real exchange rate pressures are likely to be more pressing policy challenges over the near- and medium-term. It pointed out that savings accumulated in the NRF, consistent with a zero overall fiscal balance by 2028 and thereafter, are projected to rise substantially to around 36.5 percent of GDP by 2028.

“These considerations, together with the limitations of the current fiscal policy practices and practical challenges involved in calibrating a floor for the non-resource primary balance, usually recommended in resource rich countries, suggest adoption of a comprehensive fiscal policy framework that guides spending decisions based on a medium-term fiscal framework (MTFF) and updated public financial management (PFM) and public investment management frameworks”, the country report said.

This, it said, should be combined with an effective medium-term fiscal anchor, which staff suggests to be zero overall fiscal balance by 2028 following a transition path with higher public spending to meet urgent human capital and physical infrastructure needs.

It said that the authorities are encouraged to carry out an in-depth analysis, by an independent consultant, of existing absorptive and institutional capacity constraints on scaling up of public spending. This, it said, could be a crucial input in the setting of expenditure limits in the context of the MTFF.

It pointed out that fiscal policy in resource rich countries usually has to balance competing, policy objectives. It said that fiscal policy has a vital role to play, to (i) promote and maintain macroeconomic stability, (ii) protect the sustainability of public finances,(iii) ensure an equitable intertemporal distribution of oil wealth across generations, and (iv) meet the economy’s infrastructure and human capital needs while cognisant of absorptive and institutional capacity constraints.

The key fiscal policy challenges for Guyana over the short- and medium-term will likely focus on containing absorptive capacity constraints, overheating, inflationary pressures beyond what is expected from a balanced growth path, and the associated loss of competitiveness. Stress tests carried out using the Low-income Countries Debt Sustainability Framework (LIC-DSF) suggest that long-term fiscal and debt sustainability could come under risk if there are adverse shocks to real GDP growth, exports, and/or commodity prices. However, it noted that accumulation of savings under Guyana’s Sovereign Wealth Fund, the NRF, are projected to rise rapidly and are providing a very substantial buffer against a major natural disaster. Considerations regarding overheating and macroeconomic stability, it said, will be much more important than fiscal sustainability over the near and medium-term. Moreover, it said that the authorities are well aware of the dangers of ‘Dutch disease’ through inflationary and real exchange rate pressures.

Pointing out that many Resource Rich Countries have adopted the non-resource primary balance (NRPB) as their fiscal policy anchor, with calibration of the nonresource overall balance based on simulations of a modified Permanent Income Hypothesis (PIH) model, the IMF said that this is particularly useful for countries with relatively short reserve horizons (typically 30 years or less) and where fiscal and debt sustainability are pressing fiscal policy concerns.

The study said that staff recommend adoption of a comprehensive fiscal policy framework to guide spending decisions based on a medium-term fiscal framework and updated public financial management and public investment management frameworks.

Based on existing literature and international experience, staff also recommend using the non-oil primary balance as a percent of non-oil GDP as an operational target and assessing the speed with which urgent development needs can be addressed without creating macroeconomic imbalances or jeopardizing fiscal sustainability through an expenditure review.

Integral part

It asserted that an integral part of such a comprehensive framework should be that annual budgetary withdrawals from the NRF would be consistent with the medium-term expenditure and fiscal frameworks. The MTFF also needs to ensure that the medium-term fiscal targets are consistent with intergenerational equity and fiscal sustainability.

The study said that the “Bird-in-Hand” approach (BIH) provides an alternative, very conservative fiscal policy anchor for use of an economy’s natural resource revenues. Under this approach all resource revenues are invested in financial assets and consumption out of resource wealth is equal to the interest earned on accumulated financial wealth (i.e., not based on permanent income concepts).

“However, this approach benefits future generations more than the current (likely less well-off) generation and allows policy makers no flexibility on borrowing to finance productive investment opportunities. Hence it is less suitable for countries like Guyana with urgent public expenditure needs”, the IMF country report said.

Over the medium- to long-term the study said that the establishment of a precautionary stabilization fund could enhance the effectiveness of the MTFF.

“Currently, withdrawals from the NRF are not integrated with the budgetary financing needs and cannot be drawn upon readily when shocks materialize, except in the case of a major natural disaster. Establishment of a precautionary stabilization fund in the medium- to longterm, as part of the MTFF, would help avoid a procyclical fiscal policy (a sudden adjustment in capital spending or increase in non-oil tax revenues), or borrowing at highly unfavorable terms, in case of an adverse shock, the study said. It added that the Debt Sustainability Analysis shows that external and public debt are susceptible to export shocks, and in the case of Guyana, 80 percent of exports are constituted by oil.

“The NRF rules protect against some procyclicality as the annual withdrawal from the NRF is a step function of the preceding year inflows into the NRF. However, in a scenario of two-three years of depressed prices with low oil production, oil revenues and hence NRF transfers will be low”, the country report cautioned. Moreover, it said there is uncertainty about the world’s transition to net zero emissions and what impact this will have on oil demand and on prices.

“If a sizeable adverse shock materializes a precautionary stabilization fund would help smooth the fiscal adjustment while giving the authorities time to ascertain the permanence or otherwise of the shock”, the study said. The fund should include only liquid assets of the government that can be used to respond to shocks.

The IDB country strategy for 2023 to 2026 had pointed out that the risk of macroeconomic imbalances from an overvaluation of the real exchange rate is mitigated by the existence of the NRF.

“However, the recent amendment to the NRF in 2020 frontloads transfers from the NRF to the budget, which reduces its mitigation effect. Significantly higher government spending levels could contribute to higher inflation and real exchange rate appreciation. Macroeconomic risks will be mitigated and monitored by close supervision of economic performance and policies to continue supporting corrective measures”, the strategy said.