Saving oil money, but borrowing more for development makes no sense - Sovereign Wealth Fund Expert

Saving oil money, but borrowing more for development makes no sense – Sovereign Wealth Fund Expert

Oct 30, 2018 News

– Many countries have paid the price for this

International Oil Expert, Andrew Bauer

“In both Ghana and Mongolia, the overall impact of savings is a net loss running into the many millions of dollars (especially to foreign creditors). Had the governments of these countries allocated their resource revenues to debt reduction rather than savings, they would have paid less interest and less money would have left the countries.”- Report

By Abena Rockcliffe-Campbell
Guyana proposes to save its oil proceeds in the Sovereign Wealth Fund that it plans to establish at some point. While some government advisors support this proposition, international Sovereign Wealth Fund (SWF) Expert Andrew Bauer thinks that this would be a huge mistake.
In fact, during a recent interview with Kaieteur News, Bauer, of the Natural Resource Governance Institute (NRGI), said that based on the developmental needs of Guyana, saving should not be the priority at this point.
Bauer said that Guyana should be putting its energy behind establishing a National Development Plan that can guide its spending.
He told Kaieteur News, “In my providence in Canada, Quebec, if we had the same oil that you guys have, I would say save a bunch of the money. We have no need to spend crazy amounts right now. But Guyana is not Quebec, Guyana has poverty. It needs to spend and it has the possibility to spend, providing we have a National Development plan that makes sense. So, I would not provide the same advice… but, how much to spend? I would have to spend three years here to tell you how much to spend. But I can tell you need to spend.”
Also, Bauer said that it would make no economic to save proceeds from oil and gain two to three percent interest, but then take loans that may attract higher interest than the one being gained on the savings. He said that this will cost Guyana more and can increase poverty.
The points Bauer made during the interview with this newspaper were also articulated in a report done by him and colleague, David Mihalyi titled “Premature Funds: How Overenthusiasm and Bad Advice can Leave Countries Poorer.”
The report stated that in many countries—especially those with fiscal revenues that are massive relative to their small populations or economies—it makes sense to set aside a portion of oil or mineral wealth. A government can earn interest on these savings and use that interest to finance crucial social services and public investments.
Bauer and Mihalyi noted, for example, the Texas government uses the earnings from its sovereign wealth fund to finance public university education; Alaska uses its fund to pay cash dividends to each resident; and Norway and Timor-Leste use their funds’ interest to finance their national budgets.
However, they said that this approach makes less sense where public debt levels are so high that the interest rate paid on borrowed money is higher than the interest earned from SWF savings.

The report stated, “The well-established, larger and more professionally managed SWFs have yielded financial returns in the range of 2 to 6 percent annually, but it is important to contrast this with the borrowing costs these countries face.
While many countries are borrowing at near-zero interest rates, emerging market sovereign bond yields are around 4.7 percent and the average African Eurobond requires borrowing states to return 6.2 percent to lenders. These yields can go much higher in case of shocks, and management fees in issuing bonds also add to the cost.”
It continued, “But countries with small savings, less experience investing in complex financial instruments and high debt levels should expect lower returns and higher interest rates on debt. For example, Ghana’s transparent and conservatively managed funds have yielded a net return of around 1 percent annually since they were established in 2011. However, over the same period, the country has borrowed over USD 3 billion in Eurobonds and is paying more than 9 percent interest on its latest Eurobond issuance.”
Similarly, the experts pointed out that Mongolia invested the money in its Fiscal Stability Fund in demand deposits in Mongolian commercial banks that generally pay seven to nine percent interest in domestic currency.
“In contrast, the government is paying nearly six percent on U.S. dollar-denominated debt and 14 percent on short-term domestic debt. Interest payments on Mongolian public debt alone were greater than USD 400 million in 2016, more than the government spent on health care for the whole country. Some funds do not publish the returns they earn, so we cannot assess their performance.”
However, both Ghana’s and Mongolia’s government borrowed extensively at high interest rates at the same time as they have been saving in their SWF and earning low returns.
In both Ghana and Mongolia, the overall impact of savings is a net loss running into the many millions of dollars (especially to foreign creditors).
Bauer and Mihalyi noted that had the governments of those two countries allocated their resource revenues to debt reduction rather than savings, they would have paid less interest and less money would have left the countries.
“As 2017 Nobel Prize laureate Richard Thaler has pointed out, there is a human tendency to place savings and borrowing into separate mental “buckets,” which may partly explain why governments make such ultimately irrational choices.
Mongolia—currently facing a debt crisis—has recently passed legislation requiring the government to save an additional 25 to 50 percent of its mineral revenues in any given year. Guyana and Lebanon, both highly indebted countries, are also in advanced stages of establishing oil and gas funds,” the report stated.