Resource revenues can fluctuate dramatically, varying with the development of new discoveries, price changes and fiscal provisions. Effective utilization of revenues requires that expenditure be smoothed and that investment and outlays be built up over time. A gradual buildup is likely to be necessary to ensure the quality of public spending and to avoid adverse macroeconomic repercussions.
In budgeting, it is critical to take account of volatility of commodity prices and revenue flows, something that has been particularly apparent during the financial crisis that began in 2007. Such a domestic expenditure pattern can be achieved by saving a portion of revenues during high revenue periods, holding the surplus in a "stabilization fund ", and then drawing down the saved revenues during low revenue periods. Smoothing can also be enhanced by limited foreign borrowing or adjustment of the rate of resource depletion. Assets held for the purposes of stabilization have a different function than longer term, “future generations” assets, and their management may be designed accordingly. However, both types of asset can be held in a combined fund with a portfolio of different holdings.
The amounts paid into the fund should be held in international financial assets. If the government relies upon domestic savings it will cushion its own expenditure during fluctuating events, such as a period of low prices, only at the expense of passing all the contraction in resource revenue on to domestic households and firms as it liquidates its domestic savings. A better strategy is for the government to smooth public expenditure by means of foreign financial assets, avoiding adverse effects on domestic households and firms when the fund is drawn down. Such policies can be made more effective by ensuring transparency and by taking the response of private sector actors into account.
Stabilization or "future generations" funds should not be designed to deal with large financial downturns—the size necessary to cushion an economy against such events would be inefficient for the country to bear across the remainder of the business cycle.
Smoothing public expenditures around fluctuations in revenue has implications both for the scale of foreign asset accumulation and its composition. Although the objective is not to build an exclusively long-run fund, less liquid assets may need to constitute a substantial part of the accumulation during boom periods (at least until a significant cushion of holdings is established). The investments will need to be sold during periods of low global commodity prices, which may coincide with global recessions and low asset prices. A stabilization fund should therefore hold a portion of its investments in a reasonably liquid form and some portion in a form that is less exposed to fluctuations in value. Effectiveness will be enhanced if there are transparent rules or guidelines for triggering asset accumulation and withdrawals, with any deviations subject to public debate and formal procedures.
Smoothing of expenditures may also require borrowing in international capital markets. Such borrowing may be particularly valuable in the interval between resource discovery and significant revenue flow, during which time an initial ramping up of expenditure is appropriate. Governments can use such borrowing to facilitate the anticipated increase in private investment. However, it is important to signal prudence, both internationally and domestically. Caution must be exercised to avoid driving up the cost of capital to the private sector. An international facility (such as IBRD lending) is preferable to private borrowing as a means to ensure this. An international facility can help reinforce the government’s direction of sustainable spending.
Over the longer term, resource wealth should be used to reduce government debt, not increase it.
The postponement—and hence smoothing—of spending can alternatively be achieved by limiting the rate of resource depletion. If the resources are left in the ground, economic principles suggest that their expected return will be competitive with the returns of foreign financial assets. Leaving resources in the ground can also reduce the risk of their misappropriation; for example, by government revenues being allocated to fund consumption for political ends rather than being invested in domestic assets. The costs of any deferred development strategy include current unpopularity and delay in the diversification of the total asset portfolio of the economy. Such diversification could be achieved by extraction and conversion of resource wealth into a broad portfolio of other assets.
