EI Sourcebook | 8.8 Fiscal Discipline and Sustainability

8.8 Fiscal Discipline and Sustainability

Fiscal Responses to Revenue Volatility. Good practice in resource revenue management is increasingly recognized, yet the experience of most resource-rich developing states has not been especially encouraging. This suggests that there are continuing problems in the implementation of resource revenue management good practice. A series of studies by the IMF on the response of petroleum-rich developing states to the oil booms of the past decade shows the following: while the prospect of long-term fiscal sustainability was improving in many states, that prospect is being seriously jeopardized by-short term policies and behavior that sharply increased non-oil fiscal deficits through tax cuts or dramatic escalation of expenditures. This is resulting in significantly increased vulnerability to future revenue shocks from price collapses or resource exhaustion.^[13] Two macroeconomic management tools can be particularly valuable in avoiding these risks: (1) medium-term frameworks (MTFs) and (2) revenue forecasting.

Medium-Term Frameworks. MTFs for fiscal and expenditure policy are planning tools that help connect the annual budget to longer term policies and sustainability objectives. The budgets of many governments in resource-rich states continue to be too dependent on volatile and exhaustible resource revenues in the short-term, and would benefit considerably from introducing a medium-term to longer term perspective. MTFs for these states should incorporate estimates of future resource revenue earnings, giving important weight to uncertainty through evaluation of a range of possible future external scenarios and their impact on revenues. Additional relevant considerations should include macroeconomic stabilization, medium-term expenditure priorities, and absorptive capacity.

Revenue Forecasting. Realistic resource revenue forecasting is the starting point for good practice in revenue and budgetary management. Ideally, forecasts should be prepared on a project-by-project basis, applying simple fiscal models and aggregating them to the economy-wide level. Data required from EI sector investors should include expected volumes and expenditures. Price projections should be consistent with EI sector-wide forecasts, but recognizing the volatility of prices and the notorious inaccuracy of price forecasts (see Figure 8.1 below), a range of projections should be considered rather than relying on a single projection. Prudent resource revenue management should also argue for cautious assumptions and scenarios.

Source: US Department of Energy. Annual Energy Outlook (1982, 1985, 1991, 1995, 2000, and 2004).

Institutional Strengthening. The quality of government institutions and public financial management is critical to the fiscal discipline (and focus on sustainability) needed for successful resource revenue management.^[14] The issue has some urgency since many resource-rich developing states are characterized by low indices of institutional effectiveness. Clearly, technical assistance can make an important contribution in this area, but political will may prove equally or more important, especially where political economy factors place great emphasis on short-term horizons and early spending of resource revenues.