Governments dependent on revenues from commodities like oil, gas, copper, bauxite, zinc and cobalt are suffering serious budget crises.
While many have sought support from the international financial institutions, made drastic spending cuts, or borrowed heavily—sometimes at high interest rates—a few are blessed with large sovereign wealth funds (SWFs) or entered the crisis with low debt levels.
This “fiscal space” means that these governments are able to borrow quickly and cheaply or have money in the bank. They can increase spending during the crisis, respond to emergencies and lower taxes when necessary. They are also less dependent on bilateral donors, international financial institutions and private creditors, whether foreign or domestic. In short, these governments have the freedom to help their people when it matters most, without being beholden to others’ interests.
Among resource-dependent countries, Azerbaijan, Botswana, Chile, Peru, Kazakhstan, Kuwait, Myanmar, Namibia, Norway, Qatar, Russia, Saudi Arabia, Tanzania, Timor-Leste, Trinidad and Tobago, and the United Arab Emirates are among those that entered the crisis with enough fiscal space to cushion the impact of the coronavirus pandemic. The American resource-dependent states of New Mexico, North Dakota and Wyoming were also well prepared. Debt levels are relatively low in each. Most have relatively large and liquid SWFs.
Having sufficient fiscal space directly impacts on people’s lives. Botswana, for instance, has used its fiscal space to subsidize salaries at affected firms, build fuel and grain reserves, purchase medical equipment, and increase loans to tax-compliant businesses. Timor-Leste is providing USD 300 in cash to more than 214,000 households, subsidizing wages for formal sector workers, purchasing emergency rice, paying overseas student stipends and deferring utility bills.
Four remarkable sovereign wealth fund trends
One might expect these measures to be financed by SWF savings, causing a large drawdown in SWF assets under management. Yet out of the approximately USD 3.7 trillion in assets held in primarily resource-financed sovereign wealth funds (“natural resource funds”), governments have only announced withdrawals of about USD 100 billion more than they had expected last year, with withdrawals led by Russia, Norway and Peru. (See table below.) Some of the world’s largest natural resource funds, such as the Abu Dhabi Investment Authority, Brunei Investment Agency and Investment Corporation of Dubai, do not publish withdrawal data. But the USD 100 billion in withdrawals represents a mere 3 percent of assets under management belonging to those funds that do disclose. The percentage is likely to grow as governments make more announcements or the crisis persists.
Part of the reason for the dearth of withdrawals is that, for some governments, especially those with the largest SWFs, it makes more sense to borrow than to draw down their SWF savings. Interest rates on sovereign debt are at an all-time low, sometimes near zero for countries with good credit ratings, while expected returns on SWFs with long-term investment horizons are usually between 4 to 6 percent in real terms. Investors are betting that these countries will emerge from the crisis at a competitive advantage. Therefore, a government can make money by borrowing cheaply and investing that money for the future.
For example, Qatar has chosen to borrow USD 7.6 billion to finance its budget deficit despite holding about USD 300 billion in assets in its sovereign wealth fund. Kuwait has not tapped its USD 530 billion Future Generations Fund due to legal restrictions, and has covered its budget shortfall through normal revenue collection and other precautionary savings; it may have to consider modifying its fiscal rules next year once it depletes its General Reserve Fund.
Countries with poor credit ratings do not have this option. Sovereign spreads have actually increased for countries with weak credit ratings, indicating that investors suspect hard times ahead and sovereign defaults among many highly indebted nations.
In fact, credit is more expensive for the likes of Ghana, Mongolia, and Nigeria than before the crisis, even though each has at least one SWF. This shows that having a SWF does not itself improve investor confidence that a government will be able to repay its debts. Sovereign debt investors look at future fiscal needs and revenue generation potential, then compare them to the government’s assets (including SWF savings) and liabilities (including debt) to determine the probability of default. This is what determines interest rates on sovereign debt. The market treats SWF savings as just one government asset among many and, in countries with small funds relative to the size of the economy, not necessarily an important one.
Table. Significant withdrawals from sovereign wealth funds due to commodity price crash and the coronvirus crisis
|Country and SWF(s)||Action||Assets under management (latest figure)||SWF assets as a percentage of 2019 GDP|
|Azerbaijan – SOFAZ||Government withdrew USD 2.7 billion more than expected in the first quarter of 2020||USD 41.3 billion||86%|
|Botswana – Pula Fund||Government has withdrawn approximately USD 300 million from the Pula Fund (Government Account) and Liquidity Portfolio since the crisis began||USD 1.3 billion||7%|
|Chile – ESSF and PRF||Government withdrew USD 2 billion from its Economic and Social Stabilization Fund (ESSF) in April, but has not touched its Pension Reserve Fund (PRF)||ESSF – USD 10.5 billion
PRF – USD 10.4 billion
|Ghana – GSF||Government has withdrawn USD 200 million from the Ghana Stabilization Fund (GSF), one of the Ghana Petroleum Funds; the Ghana Heritage Fund (GHF) has not been touched||GSF – USD 334 million
GHF – USD 539 million
|Kazakhstan – National Fund||Government liquidated USD 1.1 billion in assets||USD 60 billion||33%|
|Nigeria – NSIA and ECA||Government to withdraw USD 150 million from the Stabilization Fund of the Nigeria Sovereign Investment Authority (NSIA); this is in addition to the approximately USD 250 million withdrawn from the Excess Crude Account (ECA) this year||NSIA – USD 1.75 billion
ECA – USD 72 million
|Norway – Government Pension Fund Global||Government plans to withdraw USD 37 billion from its SWF this year, in line with the government’s structural balanced budget rule||USD 1 trillion||248%|
|Peru – Fiscal Stabilization Fund||Government is likely to empty its USD 5.4 billion fund in addition to borrowing more than USD 13 billion||USD 5.4 billion||2%|
|Russia – National Welfare Fund||Federal government could draw down on as much as one third of its fund this year alone||USD 130 billion||7.5%|
|Timor-Leste – Petroleum Fund||Government withdrew an extra USD 250 million for 2020||USD 18.1 billion||1065%|
|Trinidad and Tobago – Heritage and Stabilization Fund||Government plans to withdraw up to USD 1.5 billion from the fund this year||USD 6.3 billion||26%|
A second trend is that those governments that have made unexpectedly large withdrawals from their SWFs have not liquidated many SWFs assets, such as stocks or real estate. That is because they had adequate cash reserves before March 2020. Norway, for instance, has not had to liquidate assets to pay for the government’s USD 37 billion SWF withdrawal. Sovereign wealth funds generate cash from natural resource sales and maturing bonds. This cash is needed to pay for capital calls and expenses. However, since the end of 2019 they have held excess cash because stocks were viewed as overvalued, meaning a market downturn was expected. The funds with adequate cash reserves were each following strict asset allocation and portfolio rebalancing rules that forced them to hold excess cash. SWFs have been well served by implementing clear investment guidelines prior to the crisis.
A third surprise is that some governments that have fiscal savings or fiscal space are not using them. Part of the reason is that fiscal rules in some jurisdictions are unable to adjust to boom-bust cycles. For instance, while the Canadian province of Alberta and many U.S. states such as Alaska, New Mexico and North Dakota have large resource-financed SWFs, most have strict rules preventing the government from accessing the principal, even in case of emergency. At the national level, Ghana and Nigeria could empty their SWFs by modifying legislation or using escape clauses to maintain spending and/or curb debt accumulation, as Peru is doing. Instead, some governments are borrowing or making drastic spending cuts, including to key areas such as healthcare and education. Others, like Myanmar and Tanzania, have thus far muted their fiscal responses to the crisis, despite ample fiscal space and no legal constraints on spending. The reasons are unclear, though they may be linked to domestic politics or bureaucratic culture.
Finally, some interesting trends in asset management have emerged. Some SWFs have scooped up big-name stocks cheaply. For instance, since the crisis began, Saudi Arabia’s USD 325 billion Public Investment Fund (PIF) purchased more than USD 9 billion in shares of companies including Carnival Cruise Line, Live Nation, Boeing, Bank of America, Citigroup, Disney and Facebook. The Qatar Investment Authority (QIA) and the plethora of UAE funds have also been proactive, for instance in renewable energy, vaccine makers and online learning.
Another asset management trend is growing divestment from fossil fuels. Norway’s SWF recently made news when it divested from USD 13 billion in fossil fuel investments. Six of the largest SWFs have committed to a degree of investor activism, considering the energy transition in their asset allocations and encouraging companies to address climate change risks. This is part of a broader trend. Institutional investors with assets under management of USD 14 trillion, such as university endowments, pension funds, religious organizations, foundations and even the governments of Ireland and New York City have also made commitments to divest from fossil fuels.
Some SWFs continue to bet on fossil fuels—for instance, PIF now holds major stakes in BP, Shell, Total, Suncor and Equinor; the QIA is financing new oil and gas exploration in Brazil, Côte d’Ivoire and Namibia; and Timor-Leste invested USD 650 million in its own Greater Sunrise field—however, it is likely that the trend will continue toward divestment. After all, the energy sector has been the worst-performing sector on the stock market over the last decade.
Fiscal prudence has served many countries well. Having fiscal space has meant less pressure to cut healthcare, education or infrastructure, take on unsustainable debt, raise taxes during a pandemic or accept financing conditions from foreign powers. The cases of Botswana, Chile, Peru, Kazakhstan, Namibia, Tanzania, Timor-Leste and Trinidad and Tobago show that even low- to middle-income countries can adopt this strategy. They are likely to emerge from the crisis with relatively stronger economies and in better shape than most resource-rich countries.
Fiscal space serves as insurance against future crises from any number of potential sources, whether natural disaster, financial crisis or pandemic. It also improves the quality of public investment and prevents over-borrowing by granting governments the room to smooth their spending during the economic booms and busts that are typical in resource-dependent countries. To develop their economies, governments should invest in infrastructure and social services up to their absorptive capacity limits, but must also maintain enough fiscal space to respond to the unexpected.
Countries in serious fiscal crises provide cautionary tales. Algeria, Nigeria and Venezuela each had a large SWF that officials emptied during the good years. Angola, Ecuador, Gabon, Mozambique, the Republic of Congo, Suriname and Zambia each borrowed heavily in the good years. These countries, and others, are now facing tough decisions as the pandemic and its economic fallout spread.
At the same time, there is significant room for improving the performance of SWFs. As the subnational cases show, fiscal rules must be well designed to be effective tools for fiscal stabilization. Many are either pro-cyclical or not fit-for-purpose. The result is that many SWFs fail at their macroeconomic raison d’être. While structural balanced budget rules have worked well in Chile and Norway, expenditure rules may be more appropriate for low- to middle-income countries since they are simpler to implement and have higher rates of compliance.
Investment guidelines have served SWFs well during the crisis. Fund managers may wish to strengthen rules around asset allocation, prohibited asset classes, rebalancing and risk management following the crisis. They may also wish to consider the benefits of divestment from fossil fuels. This would not just help fight climate change but also diversify their economies away from natural resource dependence, an imperative for many resource-rich countries as they face the energy transition, and is likely to lead to higher real long-run returns.
Finally, having a large SWF also does not necessarily make resource-dependent governments responsible managers of public money. In fact, around 50 percent of SWFs are so opaque that they could be deemed slush funds. Just 18 out of approximately 50 governments with traditional SWFs publish annual returns information. In other words, we do not actually know how most are performing. Despite improvements over the past decade, SWF managers should aim higher when it comes to funds’ transparency and disclosure practices.
Andrew Bauer is a consultant to the Natural Resource Governance Institute.
Image: “Administration of Tungsten, Rwanda” (CC BY-NC 2.0) by Fairphone