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Accounting for natural resource sales: is it time for a rethink?


The way governments account for the profits made from commodities like oil can encourage unsustainable behaviour, according to the Goa Foundation. Should accounting rules be changed?

Norway's sovereign wealth fund, filled with the country's oil cash, is the biggest in the world in terms of assets under management.

 


The perils – and tensions – over how pension liabilities are treated in government accounts are well known.

But according to one Indian NGO, another accounting anomaly, with implications not just for financial sustainability and intergenerational fairness, but the environment, corruption and even the accuracy of GDP figures, is slipping comparatively under the radar.

Rahul Basu of the Goa Foundation told PF International that a relatively simple accounting change could alleviate “much of the resource curse”, help countries avoid significant volatility in their finances and prompt the perspective change on resource extraction needed to stem climate change.

The Goa Foundation argues that treatment of receipts from the sale of natural resources needs to change. Rather than treating them as revenues, as is currently standard international practice, the foundation says they should be recorded as capital receipts instead, which would properly reflect the fact that they represent the sale of a non-renewable asset.

Treating such income as revenues, however, is problematic for a number of reasons, it argues in a recent report.

One that has had clear implications for numerous countries in the past few years is the level of volatility such income introduces into government budgets.

The slump in oil prices, beginning in 2014, has sent the finances of even some of the wealthiest nations, like Saudi Arabia, into disarray. The country struggled to maintain its levels of lavish public spending as its oil income collapsed.

Basu highlighted this as another problem: while prices are high, additional revenues are treated as “windfalls”, encouraging higher spending, for instance on subsidies or tax breaks, that are difficult to take away when prices fall. Saudi Arabia, for example, had to roll back on some spending cuts amid mounting discontent.

Countries like Norway, meanwhile, that tend to strip such income out of their budgets and save it instead, emerged relatively unscathed.

 

How does Norway do it?

Internationally, Norway still records its natural resource receipts in much the same way as everybody else. Domestically, however, its model is very different.

Norway’s oil revenues are largely excluded from the budget, and instead transferred into a government pension fund. Rather than cutting taxes or spending its oil cash, the country has amassed huge wealth in this way. The fund today is worth nearly $900bn – the world’s largest pool of cash.  

It is also one of the world’s highest profile investors, with a stake in almost 9,000 companies. While the government can tap into its wealth, it can strictly only do so at a level linked to the expected returns the fund will make from its investments. Its so-called “fiscal rule” forbids it drawing down on the fund’s capital. Last year marked the first time the government used this ability to withdraw.

Norway’s model ensures the country preserves its wealth for future generations – long after the oil has run out. It also means the country’s budget is not too reliant on oil wealth, or affected by its volatility. With the majority of Norway’s wealth invested abroad, the country has also largely avoided the so-called Dutch disease – a decline in non-oil exports due to a strong currency.

As well as the creation of the fund, however, Norway’s success is built on strong governance, management, fiscal policy and transparency. 

 

The “windfall” metaphor, Basu continues, prompts thinking about natural resource receipts that is very different to that around income that is inherited or saved. “The moment you use that word, [your thinking] becomes ‘let’s have a party, we’ve won the lottery’.”

As well as encouraging spending, the Goa Foundation posits that the revenue treatment also encourages the sale of resources in the first place, even when the price is low.

For countries whose budgets rely heavily on natural resource receipts to deliver even basic services however, holding off on sales might not be an option, especially when prices are low for prolonged periods. The slump in oil prices has prompted many to diversify.

It’s also worth noting that the world’s major oil producers – the OPEC group of countries – have limited production to respond to low prices, rather than increased or even maintained it.

On the other hand, countries like Nauru have quickly depleted their entire natural resource reserves, and have very little to show for it today.

“Calling mineral receipts windfall revenues leads to governments extracting more, and as it is a windfall, the contracting terms are not examined closely,” Basu says, noting this leads to underpricing and drives crony capitalism and corruption.

He continues: “If we viewed mineral receipts as capital receipts from the sale of the family gold, the questions would be: why are we selling our inheritance; is this the right time to sell; what is the value, and did we suffer a loss; and did we save the money for future generations? At the much deeper level we feel that this is critical from the perspective of global warming.”

Basu highlights that private sector mining firms do take into account how large their base of mineral assets is and how much of this they have used, as well as what they have received in exchange.

“In the public sector, they say ‘this is what we’ve got and this is income, but we’re not looking at what we’ve lost in the past.’”

The Goa Foundation argues that this means countries could be “significantly overstating” their GDP and savings, which includes income from natural resources but not their depletion.

Using World Bank development indicators, the foundation estimated that $27tn worth of resource and energy assets have been depleted.

“Even if we assume 30% has been saved, we have likely been overstating global income and savings by $19tn to the extent that mineral asset depletion has not been correctly accounted for in GDP calculations,” its report said.  

Attempting to include these in GDP would encounter some quite technical difficulties, and hinder other international efforts, such as attempts to link GDP and fiscal statistics, which restrict how such income can be treated.

Most international institutions – namely the International Monetary Fund – do already urge countries to recognise that income from natural resources requires special treatment.

The fund has for years highlighted a number of the points raised in the report: such revenues are volatile; reflect the sale of a non-renewable asset, which will eventually run out; and  as such, income from natural resources should be used very carefully, often in ways that will generate more income in the future.

It recommends countries use a range of different fiscal indicators for natural resource revenues, such as non-oil balances, to give a better sense of how sustainable a resource-rich country’s fiscal position is.

The fund also gives specific guidance on how to ensure good fiscal transparency in such countries, calling for such information to be published on the balance sheet and for better statistics on the size and use of natural resources.

For Basu, however, this does not go far enough. The public – key to changing the behaviour of politicians – doesn’t delve into the details of such reporting, and instead pays attention to headline figures, like GDP.

He adds that even countries like Norway still have to report their oil receipts as revenues because of the international consensus, despite the fact that they effectively implement a different accounting treatment through their domestic law.

“If you change it, then everybody will essentially start following the Norway model,” Basu explains. “If they did have to report revenues in this manner, because this is how everybody is compared, then automatically things would change.”

However, countries like Norway differ from most resource-rich nations in a host of other ways when it comes to transparency, governance and fiscal policy – issues institutions like the IMF place most of their focus on when it comes to improving natural resource management.

As Paulo Medas, deputy division chief of the IMF’s fiscal affairs department told PF International: “We agree it is important to highlight mineral revenues from the sale of non-renewable resources.

“However the challenges of managing natural resources to promote sustainable growth go well beyond accounting issues. These include robust fiscal policy frameworks and strong institutions, especially on governance and transparency.”

The issue is also one of custom. Treating natural resource receipts as windfall revenues has become standard practice, and standard-setters like IPSASB do not currently have guidance in this area – although it may be developed in the coming years. The IMF, meanwhile, develops its guidelines based on consultation with countries and experts from around the world.

 “The problem is this is historical and nobody has really looked at this issue in the past 100 years,” says Basu. “We’re probably the first people to say, ‘well, let’s change this’.”

 

Emma Rumney

Emma is a reporter at Public Finance International. She also writes for Public Finance in the UK.

Read her tweets: @emma_pfi


source: www.publicfinanceinternational.org

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