‘Hand to Mouth’ approach to Sovereign Wealth Fund will be as bad for Guyana as it was for T&T – Economist

Aug 20, 2018 News

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By Abena Rockcliffe-Campbell

The term “hand to mouth” is nothing new to the Guyanese vernacular. It is also used by economists. In fact, Dr. Roger Hosein, an economist from Trinidad and Tobago, used this term recently to describe the uses of its energy windfall that Guyana should stay far away from.
He said that this was the sort of model employed by his country and it did not bode well—at all.

Dr. Hosein is a well respected economist who also lectures at the University of West Indies (UWI).
During a recent interview, Dr. Hosein said that Guyana should clearly avoid the ‘Hand in Mouth’ approach which sees the fiscal revenue being utilized within the same period the oil and gas resource was extracted. Specifically, he noted that the government of TT collected TT$280.5bn in energy sector revenues from 1999 to 2018 but spent TT$328.2bn on transfers and subsidies in the same time period.
This compromised the capacity of the state to effectively widen its infrastructural base as well as triggered an overheating of the domestic economy.
Dr. Hosein noted that Guyana’s oil reserves is growing rapidly as no less than 300,000 barrels of oil will be produced daily by 2025. This is by ExxonMobil alone.
Dr. Hosein said, “To benchmark Guyana’s rapid acceleration in crude oil production, T&T at its peak crude oil production was 230,000 barrels of oil per day in 1978.”
The economist noted that Guyana has engaged Exxon with a formula that facilitates 75 percent of oil production initially assigned to cost recovery with the remaining 25 percent to be split equally between Government and ExxonMobil.
Included in the contract is an arrangement that allows two percent royalty on gross earnings; so that the government’s take increases to 14.5 percent of profit oil. “Of course, once the ‘cost recovery’ phase of the production horizon passes, there would then be a very rapid increase in the size of profit oil.”
Using data from the IMF 2018, Dr. Hosein noted that the growth rate of real aggregate GDP for the period 2014 to 2019 averages 3.5 percent.  He said that for the next four years however, real economic growth averages 22.9 percent.
Hosein said that of significance is that “non-oil real GDP growth in the time period 2020 to 2023 would average 4.7% as compared to an average annual real non-oil GDP in 2014-2019 of 3.5percent.
Dr. Hosein said that in total, between 2020 and 2023, the Guyanese government is expected to collect US$1.6B in oil revenues.  He posited that this as non-trivial and notes that it would escalate quickly after the “cost recovery phase” comes to an end.
Dr. Hosein said that based on the variables as mentioned above, the International Monetary Fund (IMF) recommends that Guyana follow Permanent Income Hypothesis (PIH) logic.
Dr. Hosein said that the PIH solves the problem of optimal consumption in the context of maximizing a social welfare function in an environment characterized by uncertainty.
Dr. Hosein noted that the literature on the revenue management of nonrenewable natural resources recommends that the State smoothes expenditure overtime.
“However, the challenge with smoothing is that the State will need to determine the long-run value of the resources from the commodity, which, in turn, involves forecasting both long-run extraction costs and long-term pricing.  This can be very difficult, as oil prices are subject to a multiplicity of influences and tend to fluctuate.”
He posited that a more conservative strategy is the Bird in Hand approach (BIH) approach. He said that with the BIH, all the resources are placed in a SWF and consumption is then conditioned by the interest earned on the asset.
The economist explained that once the revenues to be collected have been exhausted, the BIH collapses into the PIH. He said that although the BIH is more conservative up front, it allows a higher level of consumption in the future. “The major disadvantage of this approach is that consumption is displaced into the future.”
Dr. Hosein said that the BIH approach has several advantages over the PIH, including that it facilitates increasing expenditure overtime “and this may be politically appealing.”
He said that the BIH approach also provides more effective stabilization to expenditures in the economy, as it is based on predictable levels of revenue flows.
Dr. Hosein noted that because the growth rate of non-oil GDP in the medium term is “fairly strong,” the Guyanese authorities should commit more of their oil sector fiscal revenue to a sovereign wealth fund, “not exactly along the BIH approach of the Norwegians but along a similar trajectory as far as possible.”

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