RESEARCH AND ANALYSIS

A Public Financial Management Framework for Resources-Producing Countries(1)

Teresa Dabán (The Western Hemisphere Department) and Jean Luc Hélis (The Fiscal Affairs Department), the International Monetary Fund (IMF)

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If well-managed, resource revenues, that is the revenues that resource-rich countries may obtain from their natural resources, could represent a big economic opportunity, especially given the advantages they present with respect to other government sources of financing. The most salient advantage is that resource revenues could be considered as a "gift from nature”, in some cases generated by the discovery of a sub-soil asset, which automatically translates into an expansion in the country’s gross domestic product and the government’s financial envelope. Another advantage is that resource revenues are not subject to the conditions that donors and lenders usually impose on recipient countries. A third advantage resides in the “enclave” nature of resource revenues, which makes it possible that resource revenues could be generated in extremely challenging circumstances, including in some cases internal armed conflict. This contrasts with the collection of non-resource revenues and borrowing, which are affected by domestic demand conditions and countries’ credit rating.

However, resource revenues also pose significant challenges, mainly in the form of the so-called “resource curse”—a complex phenomenon through which an abundance of resource revenues can translate into stagnation, waste, corruption and conflict. The resource curse could derive from the macroeconomic and budgetary difficulties of managing resource-related funds, which usually are large and extremely volatile. In particular, the most common story of resource-producing countries responds to a cycle of high revenue/high expectations/high expenditure followed by a resource price slump, a decline in resource revenues, and social unrest caused by fiscal and budgetary adjustments. As a result, most resource-producing countries tend to fall behind non-resource producing economies in economic development, rate of growth, income per capita and human development. In addition, the resource curse could derive from the way in which resource revenues are generated. Because in most cases they derive from depleting an exhaustible asset and can be generated without the direct scrutiny of taxpayers, donors, and lenders, resource revenues usually pose important intergenerational, political economy and governance challenges. In particular, resource-producing countries are relatively prone to develop a “rentier” mentality and experience armed civil conflict.

But the resource curse is not an “iron law” (Auty, 1994), but a disease that can be prevented with the implementation of the right policy prescriptions. These policy prescriptions include the implementation of prudent macroeconomic policies, the adoption of a sound strategy to promote development and economic diversification, and the enhancement of the country’s institutional framework, including the public financial management (PFM) system. Moreover, country experience shows that the success on preventing the resource curse depends on countries’ pre-existing conditions and institutions before that resource revenues came into stream. In fact, most developed resource-producing countries (such as Norway, Chile, Australia, or Canada among other) usually had a sound governance system prior to the resource era, and therefore were better equipped to implement the policy prescriptions to prevent the resource curse. However, low-income resource-producing countries, which usually have adverse pre-existing institutional conditions, are more prone to fail in adopting the right policies and preventing the resource curse

Cross-country experience also shows that some resource-producing countries have resorted to special mechanisms to manage their resource revenues, with a view to bypassing their ill-functioning PFM systems. The most used mechanisms include special arrangements for the allocation and use of resource revenues, the creation of resource funds, the adoption of “parallel” budgetary and treasury procedures, the creation of separate investment committees and oversight institutions, and the enactment of special legal frameworks. Three rationales are usually put forward to justify the adoption of these special mechanisms: (i) the convenience of mobilizing public support for managing resource revenues in a special and reinforced way, even in countries with acceptable institutional frameworks; (ii) the need to overcome the weaknesses of the existing PFM systems, by implementing quickly certain parallel mechanisms, given that reforms are likely to take time; and, (iii) the expediency of carving out a space within the public sector in which the appropriate budgetary mechanisms and transparency standards can be put to work in a highly visible.

In a few cases, such as Chile and Norway, the adoption of these special mechanisms has been successful. However, country experience shows that the design and implementation of these mechanisms have in general posed significant challenges, especially to less-developed countries. In fact, when designed in a non-transparent and rigid way, these mechanisms may have contributed to the failure of some resource-producing countries in preventing the resource curse. The parallel mechanisms have in some cases: (i) increased opportunities for misappropriation and mismanagement, especially in countries with a high concentration of power; (ii) led to the fragmentation and delay of the budget process, especially in countries with poor sharing-information practices; (iii) resulted in high administrative costs, reflecting the differentiated, expensive, and sometime privileged bureaucracy of the parallel bodies; and (iv) discouraged the incentive for reforming existing budgetary institutions and building an efficient and merit-based civil service.

Against this background, resource-producing countries should adopt a PFM framework that enhances, instead of replacing, existing budgetary institutions and preserve the integrity of the budget process. A PFM for resource-producing countries should include: (i) a transparent and comprehensive presentation of resource revenue in the budget—emphasizing the role of the non-resource deficit; (ii) a set of sound long-term projections, a sustainable long-term fiscal strategy, and realistic medium-term fiscal frameworks; (iii) a set of well-defined budget classifications to track budget execution; (iv) a system of flexible and transparent transfers from the treasury accounts to finance the non-resource budget deficit; (v) the development of an unified budget execution process, avoiding rigid and non-transparent earmarking mechanisms; (vi) sound cash flow and asset-liability management, based on a simple and integrated banking circuit and integrated treasury accounts; and (vii) enhanced accountability and transparency mechanisms. The adoption of such a PFM framework should be supported by a reform path that take into account the institutional diversity of resource-producing countries and allow for the adoption of PFM choices that are tailored to the institutional reality of low-income countries. In the short term, reforms should focus on adopting basic PFM tools, while, over the medium term, reforms should aim at making the PFM systems of low-income resource-producing countries converge with best international practices.

References

Auty, R., 1994, “Industrial Policy Reform in Six Newly Industrializing Countries: the Resource Curse Thesis”, World Development, Vol. 22, No1.

Dabán, T and J.L. Helis 2010, “A Public Financial Management Framework for Resource-Producing Countries”, WP/10/72, Washington: International Monetary Fund.

 

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Note:
1.
This article draws on Dabán, and Hélis (2010). This article should not be reported as representing the views of the IMF. The views expressed in this article are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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