Gabon’s oil revenue currently accounts for 60 percent of its government’s total revenue, but the country’s oil reserves are expected to be depleted within 30 years. A distant worry? Not really, suggests a back-ground paper prepared for the IMF’s annual consultation with Gabon. Adjustment is never easy. Old habits are hard to break, and reaching a sustainable fiscal position will take several years. All the more reason, the paper argues, to plan ahead. The sooner a country implements fiscal adjust-ment, the better off it will be in the long run.
For oil-producing economies, large (but exhaustible) oil revenues often create the illusion that binding budget constraints have disappeared. Abundant government resources inevitably generate political pressures to spend a larger portion of current income than could be maintained beyond the period of oil production. In addition, excessive spending creates dependencies and vested interests.
It is this non-oil balance that offers the crucial measure of how much oil revenue is being injected into the economy and what will need to be done to contain expenditure when oil revenue declines.
How can policymakers gauge their long-term needs? It is useful to have a benchmark against which to judge current fiscal policy. Gabon today runs large overall fiscal surpluses, but the key fiscal indicator—the non-oil fiscal balance—shows a significant deficit. And it is this non-oil balance that offers the crucial measure of how much oil revenue is being injected into the economy and what will need to be done to contain expenditure when oil revenue declines.
Political-economy considerations argue for defining a clear fiscal anchor that can give the legislative branch, and the electorate, a means to distinguish between sound, forward-looking fiscal policies and ones that address only immediate demands. Ideally, of course, such a framework is established at the start of oil production, before habits are formed. But even mature oil exporters have much to gain from pursuing a voluntary, gradual fiscal adjustment that aims to achieve a sustainable deficit and helps preserve national wealth for future generations as well.
Setting the fiscal anchor
While existing models based on the permanent income hypothesis can estimate appropriate long-run targets, they usually abstract from short-run political costs associated with adjustment toward that level. An abrupt, onetime consolidation followed by a constant expenditure path (equal to the expected annuity value of oil wealth and nonoil revenue) is the canonical policy recommendation.
Political reality often precludes such a radical approach, however. It seems more sensible to acknowledge that habits are indeed hard to break (that is, consumers become used to a given level of consumption, including of public goods). Adjustment that incorporates habits can help ease the pain for consumers and increase the political acceptability of the needed reform. For Gabon, the IMF staff used a quantitative model that simulates the non-oil fiscal deficit that can be maintained even after Gabon’s oil revenue runs out and describes the optimal adjustment path toward this level. In line with the literature, this path is defined as the one that a social planner would choose. The model also contains differential interest rates on sovereign debt and financial assets, which introduces further realism into the analysis of optimal fiscal policy and debt management.
What guidance does this exercise offer policy-makers? Three principal conclusions emerge. First, Gabon’s current fiscal policy stance cannot be maintained. The permanently sustainable non-oil fiscal deficit, estimated at about 5 percent of non-oil GDP, is well below the level of 12 percent recorded in 2005. The authorities will need to tighten fiscal policy to smooth government spending over time. Second, spreading the bulk of the adjustment over three to five years, taking into consideration consumption habits, is appropriate. This recommendation differs from the sharp correction prescribed by permanent-income models. Although the speed of adjustment does influence the long-run fiscal position, this trade-off is relatively small if the adjustment occurs within the medium term.
And, finally, it would be advisable for the government to pay off expensive debt, both domestic and external, as soon as possible. The interest rate spread between sovereign debt and financial assets argues in favor of front-load-ing fiscal adjustment, thereby increasing the permanently sustainable fiscal deficit. Moreover, still unresolved issues regarding the remuneration of fiscal reserves in the Economic and Monetary Community of Central Africa zone, together with the uncertainty regarding future economic conditions, provide policymakers with precautionary motives for balancing the political considerations for gradualism against economic arguments for accelerating fiscal adjustment and transferring a larger portion of oil wealth to future generations. For instance, a reversal of real oil prices to the 2000-05 average of $30 per barrel of oil would reduce the permanently sustainable deficit to 3¾ percent of non-oil GDP.
A proactive adjustment…should be accompanied by improvements in the quality of public expenditure so that private investment is crowded in.
A choice for the future
At this critical juncture in Gabon’s history, oil prices are high, and the authorities have a choice to make between a voluntary, gradual policy adjustment toward a permanently sustainable fiscal policy stance and a continuation of current policies until the decline in oil production (or unexpectedly falling prices) imposes a large and rapid contraction. If Gabon elects to pursue a proactive adjustment, that process should be accompanied by improvements in the quality of public expenditure so that private investment is crowded in. Enhanced public financial management would help offset the costs of fiscal adjustments while providing assurances that government spending (including investment) can generate adequate growth and social pay-offs and help attain Gabon’s socioeconomic development objectives. The country’s most disadvantaged segments, in particular, stand to benefit from such steps.
Daniel Leigh, IMF Fiscal Affairs Department
Jan-Peter Olters, IMF African Department
This article is based on Gabon: Selected Issues, IMF Country Report No. 06/232. Copies are available for $15.00 each from IMF Publication Services. Please see page 192 for ordering details. The full text is also available on the IMF’s website (www.imf.org).