The global oil situation is particularly interesting at the moment. At $30 a barrel of crude, the oil price stays high even though world demand is low. The previously fashionable view that the American seizure of Iraqi oil resources would break OPEC and send the price of oil plummeting has turned out to be nonsense. Even with improved security, it will take 5 years’ investment to get Iraq oil fully on stream. And the American economy is now recovering strongly. So the price of oil should stay high, or even go up, in the foreseeable future.
The announcement by Mr.Kudrin that Russia will start an oil stabilization fund comes, therefore, at a good moment. It means that the fund can look forward to several years of surpluses. This is both an opportunity and a danger.
An oil fund should be seen as an instrument of macro-economic stabilization. Today most finance ministers in the world are committed to ‘balancing the budget over the business cycle’. Government revenues are set to equal government spending when the economy is growing normally. If output grows above trend, the budget is in surplus, if it grows below trend, the budget is in deficit. Surpluses are applied to repaying debt, deficits are financed by borrowing. They are, that is, segregated from normal revenue streams. If the finance minister gets his sums right, the national debt remains the same over the cycle, with no tendency to grow or contract. A constant debt-GDP ratio is thus a key indicator of fiscal sustainability.
In a country like Russia, half of whose budget revenues are derived from taxes on oil, setting up an oil fund is the equivalent of a commitment to balance the budget over the cycle. Only in this case, it is an oil price cycle. This strategy is dictated by the fact that oil prices are more volatile, and therefore more destabilizing for the budget, than fluctuations in GDP. Government taxes and spending are set to balance at the ‘average’ oil price over a period of years. (Over the last five years, the average would have been $22 a barrel.) The oil fund accumulates surpluses and incurs deficits when the price of oil is above or below the average. The surpluses are used to pay off debt, and the deficits are financed by acquiring debt, leaving the debt-GDP ratio constant over the cycle. A fund which works like this sends a strong signal that the government is committed to long-term sound finance.
The key to the success is to realise that an oil fund is a limited instrument for a specific purpose. The danger is that it will be used to solve other problems, which will destroy its usefulness as a stabilising mechanism. The first danger is that politicians will spend the surpluses on vote-winning social programmes. This has happened in Venezuela. The best way to guard against this is to open a special account with an independent Central Bank, out of the control of politicians. This is what Norway does.
A more subtle danger is that the fund will be seen as a direct means to combat the so-called ‘Dutch disease’. This is a situation where earnings from oil exports drive up the value of the currency, reducing the competitiveness of other domestically produced products. Investing fund surpluses in foreign securities would counteract the tendency for the exchange rate to rise.
This is true, but the same result can be achieved by paying off foreign debt, which is a better policy, especially at the start when the fund is trying to build up credibility. Of course, it is important that Russia become less dependent on energy exports. Properly used, an oil fund can contribute to this aim, but it should do so indirectly, by promoting domestic financial stability. This will make possible low real interest rates, which (together with bank reform) is the main condition for the growth of small and medium-sized enterprises needed to bring about a more diversified pattern of economic growth.
Robert Skidelsky 