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Domestic Public Debt of Externally Indebted Countries:
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The country in our model, however, is implicitly able to develop the natural resource sector through FDI. In practice, and despite borrowing constraints, this is feasible since there are substantial rents from resource extraction that foreigners can appropriate. These rents then make the extractive industry foreign investment attractive even in the face of the usual barriers to international capital flows related to sovereign immunity and poor governance in recipient countries.
One may still wonder why a properly motivated government would not finance high-yielding public investments through its own revenue effort. A variety of distortions—some playing a role in the model presented here and many not—can explain why this typically has not happened. We emphasize two. One is again the financing constraint and closed capital account, which implies that to finance the scaling-up, countries would need to go through drastic fiscal adjustments and, therefore, possible substantial reductions in private consumption and investment.
Second is the weak and distortionary domestic tax system captured here by low effective tax rates and the ineffectiveness of the income tax. CEMAC Application: Investing Without a Resource WindfallSolid and dotted-dashed lines assume a front-loaded and a gradual scaling-up path without a windfall, respectively; dashed lines assume a front-loaded scaling-up with a windfall. Y-axis is in percent deviation from the path without a windfall unless stated otherwise. As expected, when scaling up without a windfall, the consumption tax rate has to adjust substantially.
In particular, when public investment is front-loaded solid lines , the consumption tax rate has to jump drastically from 0. In the gradual scaling-up case dotted-dashed lines , private consumption does not fall as much, but the consumption increase in the new steady state is still minimal.
Without a windfall, welfare is higher if the scaling-up is not undertaken. In contrast, with the windfall, welfare is generally higher under either scaling-up approach all-investing or sustainable investing than with full saving of the windfall saving in an SWF. The CEMAC application shows that the sustainable investing approach can address the exhaustibility issue when investing under a short revenue horizon.
This section demonstrates how this approach can also manage volatility in the context of the Angola application. Revenue volatility is introduced by fluctuating oil prices mimicking historical dynamics. With a long revenue horizon and high fiscal dependence on resource revenue, the resource fund analyzed for Angola is a stabilization fund, providing a fiscal buffer to smooth government spending.
The policy rule for savings in a resource fund is revised to allow for depositing and withdrawing, as shown in Equation Conversely, when there is a revenue shortfall, the fund is drawn down to maintain a level of investment commensurate with the given investment path. In the case of insufficient buffer, investment spending is cut to maintain a nonnegative balance in the fund.
Average standard deviation in percent from a de-trended path based on simulations. The spend-as-you-go approach is similar to the all-investing approach analyzed earlier. Instead of assuming that all resource revenues above the initial level go to investment, it is assumed that 60 percent of additional revenues goes to investment and the rest 40 percent goes to government consumption.
With sustainable investing, we specify public investment to gradually increase from 8.
Given a high government consumption to GDP ratio in of Both the labor and consumption tax rates are set at their initial steady-state levels, while transfers experience small fluctuations to clear the government budget constraint. Table 3 compares the average standard deviations of public investment expenditure, private consumption, non-oil GDP, and the real exchange rate from to in percent deviations from their trend paths.
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All four variables exhibit more volatility—about 60—70 percent more—with spend-as-you-go. Despite a rather smooth investment path, public investment under the sustainable investing approach can still experience some fluctuations. When large negative revenue shocks hit, the stabilization fund may not have sufficient balance to support a predetermined investment level, forcing investment expenditures to dip, resulting in the adjustments in macroeconomic variables.
In an economy that is highly resource dependent, the fiscal channel through which resource revenue volatility can affect macroeconomic stability is made explicit here. Conversely, when oil revenue declines, a procyclical fiscal policy as captured by spend-as-you-go can lead to a collapse of overall demand, generating a boom-bust cycle commonly observed in resource-rich economies.
When following the sustainable investing approach, one question remains to answer: How large should a stabilization fund be in an environment of uncertain future revenue? A more aggressive scaling-up leads to faster build-up of public capital and potentially higher economic growth. As more resource revenue is devoted to investment, less can be saved, leaving the economy vulnerable to negative shocks. To address this policy question, we show how stochastic simulations can be used to advise the allocation between investment and saving in a stabilization fund.
Angola Application: Conservative vs.
Public Investment in Resource-Abundant Developing Countries
Aggressive Scaling-Up under Sustainable InvestingY-axis is in percent deviation from the path without a windfall unless stated otherwise. The middle solid lines are mean responses based on simulations. The bands in solid lines are one-standard-deviation intervals, and the bands in dotted lines are two-standard-deviation intervals. Also, the very different performance of the stabilization fund confirms our conjecture that a more aggressive scaling-up plan leaves the economy with a small to little buffer.
By the end of , the stabilization fund is on average only 1. Since the stabilization fund is insufficient most of the time, the mean scaling-up magnitude from to at 15 percent also deviates much from the predetermined 20 percent. In contrast, the conservative path with a much larger buffer allows the realized investment path to follow closely the predetermined path. Without much disruption in the investment pace, the depreciation rate of public capital is also kept low in most cases. The average depreciation rate of the 95 percent upper bound is 0. The aggressive path on average accumulates more public capital 40 percent vs.
The one- two- standard-deviation lower band is 7.
When oil revenues are hit by a sequence of large negative oil shocks, the aggressive path, which does not have much buffer, cannot sustain investment even at the level to maintain existing capital, and hence public capital can fall below the initial steady-state level. Similar to the outcome with spend-as-you-go, large swings in public investment and hence public capital lead to great instability in the economy.
As shown in Figure 5 , the confidence intervals are wider for non-oil GDP under the aggressive path. The one-standard-deviation interval ranges from 5. Moreover, despite a more stable economy with the conservative scaling-up path, households on average enjoy a similar magnitude of consumption as under the aggressive path. The endogenous depreciation channel plays an important role in linking revenue shocks to macroeconomic volatility.
Bad revenue outcomes imply investment well below replacement rates, resulting in an increase in depreciation rates, thus amplifying the effect of the negative shock on the capital stock and hence output.
Related Domestic Public Debt of Externally Indebted Countries (Occasional Paper (Intl Monetary Fund))
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