1. Do’s and Don’ts of Natural Wealth Management Leonor Coutinho Europrism Research Saturday, 26 November 2011
Presentation for the Conference “The Hydrocarbon Wealth of Cyprus: Equitable Distribution and Regional Politics”, organized by the Friedrich Ebert Foundation (FES) and the PRIO Cyprus Centre (PCC), Nicosia Buffer Zone, Chateau Status, Cyprus.

2. Outline of the Presentation
Risks of Natural Resource Exploitation
Optimal Natural Resource Management Principles
The Don’ts
Some Examples (Don’ts)
Nigeria
Saudi Arabia
Mexico
Selected Success Stories
Botswana
Indonesia
Chile

3. The Risks of Natural Resource Exploitation
Problems of associated with hydrocarbon wealth are shared by other types of natural resource wealth.
Malaises associated with natural resource exploitation:
The Dutch Disease: contraction of other tradable sectors of the economy
Deterioration of governance: the “Voracity Effect”
Poor investment decisions (e.g. overcapacity in infrastructure)
Under investment in human capital
Underdeveloped financial markets: too much government weight
Macroeconomic instability: output volatility correlated with ups and downs of resource prices; amplified economic cycles

4. Optimal Natural Resource Management Principles
Consumption smoothing and inter-generational equity: take into account the volatility of prices and the resource exhaustibility => base expenditures on measures of permanent income
National revenue funds as vehicles for savings
Fiscal rules to control government expenditures
The optimal amount of savings and the control of government budget deficits requires measures of permanent income:
Independent forecasts
Use of hedging instruments to reduce risks
Optimal investment strategies: maximize returns
Government vs private decisions (distribute dividends) or a combination of both
Independent investment council

5. The Don’ts
Allow expenditures to be highly correlated to resource prices
real exchange rate appreciation and exchange rate volatility
amplification of business cycles
sudden cuts in investment
Borrow on natural resource collateral: Debt Overhang
macroeconomic instability
nominal devaluations undermined by price inflation
Large governments: crowding out of the private sector
Lack of economic diversification
Short sighted investment decisions

6. Some examples… Nigeria (oil)
Collapse of agriculture and failure to industrialize
Migration to urban areas: desertification and inequality
Accumulation of unsustainable debt
Saudi Arabia (oil)
Poor diversification: real exchange rate overvaluation
Public sector expansion as the main mechanism for job creation
Overinvestment in infrastructure
Mexico (oil)
Public overinvestment in infrastructure: crowding out of private sector
Large current account imbalances; accumulation of government debt
Nominal devaluation undermined by inflation
Currency crisis

7. Selected Success Stories of Natural Resource Exploitation
Botswana (diamonds)
Revenue Stabilization Fund
Medium term expenditure plans based on long-term projections
Mineral revenues used mostly for planned investment and the rest saved
Currency peg to South African rand has worked as an anchor for inflation
Relatively open trade policy
Some diversification achieved through manufacturing, but limited
Still risks are always looming:
Investment policy did not prevent unproductive public investment
Social tensions and inequality
HIV prevalence

8. Selected Success Stories
Indonesia (oil)
Accumulation of de-facto government surpluses (although formally there is a balanced-budget rule that could have meant high volatility of expenditure)
Control over the borrowing of state-owned oil companies
Expenditure focusing on non-oil exporting sector, specially agriculture (R&D, and infrastructure), and health and education
Private investment and development of labour-intensive industry
Reduction of poverty and inequality
Nominal devaluations
Special conditions:
Role of technocrats
Strong non-oil interest groups

9. Selected Success Stories
Chile (copper)
Copper Stabilization Fund
Fiscal Policy Rules: target for structural budget balance; independent forecasts for the trend price of copper and trend output
Mixed of public and private ownership in copper sector guarantees that some profits are re-invested in the country but also attracts FDI with positive spillovers
Contained inflation and relatively good business climate allowed for diversification: fisheries, wine, tourism
Special conditions:
Role of technocrats
Competitive RER policy via a PPP crawling band-rule (and occasionally through significant discrete nominal devaluations) and capital controls from some time; recently inflation targeting and floating with possibility of intervention