What Role for SWFs in Africa’s Development?

Need for good governance elephant in room.

November 18, 2010

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1307741_elephantsIn Algiers earlier this month, the IMF hosted a very interesting ‘high level seminar’ (in collaboration with The Bank of Algeria) that aimed to diagnose the main challenges facing resource-rich countries in Africa and, more importantly, offer up “implementable, context-specific solutions”. And, on the topic of solutions, IMF Managing Director Dominique Strauss Kahn suggested that strong and well-governed institutions were fundamental stepping stones to overcoming the resource curse:

“Strong institutions will play a critical role in ensuring that well-designed policies are indeed effective. Strong fiscal institutions help prevent excess spending in times of plenty—thus leaving enough resources for times of want. And strong financial institutions help manage the impact of spikes in capital inflows on the broader economy…Sound management of foreign exchange reserves is a critical complement in this regard. Unfortunately, strong institutions have been missing in many resource-rich economies. As a result, economic performance in many countries with abundant natural resources has been quite poor. And even worse—the blessing of resource riches has too often turned into the curse of conflict…A strong commitment to good governance lies at the heart of responsible management of natural resource wealth. Good governance helps ensure that commodity revenues can benefit all in society. This is why institutions with a high level of accountability are so important.”

As you can well imagine, the topic of SWFs (and in particular “petroleum funds”) came up quite a bit at this event. And, after a detailed reading of all of the seminar papers available (which you can find here), I can say that the most pressing topic for this group was not whether African countries should establish SWFs but, rather, how African economies could minimize political interference in SWFs once they had been established. In other words, how can these countries tame the discretionary influence of politicians over the operations of these funds.

For example, Thorvaldur Gylfason argues that for SWFs to be useful in Africa, there must be…

“…firewalls erected between sovereign wealth funds and the heat of the day-to-day political process. This is a question of checks and balances, of finding ways to reduce the risk that natural resource revenues are misspent or even squandered for short-term political gain.”

In addition, Augustin Fosu argues that it is crucial to delink the “vagaries of oil prices” from the budgeting process. In other words, Fosu thinks clearly defined rules that limit subjective and discretionary decision making within the fund are necessary, and he uses the Norwegian and Nigerian cases to make his argument:

“A key policy rule associated with the [Norwegian] fund was that only the expected earnings from it (estimated to be 4 percent of the domestic value of the fund) would be transferred to the state budget every year, with any change in the transfer rules to be approved by parliament.”

In contrast, Fosu highlights the experience of Nigeria’s Excess Crude Account:

“By 2007, the amount in the Account had reached US$17.3 billion from $5.1 billion in 2004 …Unlike the case of the Norway Petroleum Fund, Nigeria’s ECA does not have a well-defined legal framework for its operation, allowing powerful political interests to prevail on its disposition. The recent withdrawals might be prudent in terms of meeting unanticipated exigencies associated with the 2008-09 economic crisis; however, the process also underscores Nigeria’s weak governance.”

And here’s the punch line:

“The important lesson here is that it is not sufficient just to set up a fund, but that the necessary legal and policy framework should complement its establishment.”

Finally, Ragnar Torvik offers up an interesting analysis of petroleum fund design and, in turn, highlights which characteristics facilitate success (and which don’t):

“When institutions do not place strong checks on politicians, petroleum funds may simply make the problem worse, because the funds concentrate the resource income. In turn, such concentration may make it easier for the political elite to monopolize the property rights to the resource wealth. When institutions do place strong checks on politicians, however, petroleum funds may contribute to a socially beneficial development. Petroleum funds may help ensure a sustainable use of the petroleum wealth, efficient management of the financial wealth that resource abundance generates, and that payments out of the fund are allocated to socially efficient projects. However, even in easy places the design of petroleum funds is difficult.”

To summarize, SWFs will only contribute to sustainable development in frontier economies if the design and governance systems are in place to stop corruption and misappropriation. I don’t think it would be possible to agree more!

This post originally appeared on the Oxford SWF Project website.

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