Among the most important discussions Parliament will have in the Autumn session is one on the draft law on the proposed Future Heritage Fund, submitted by the President on 12 June, 2015. Its purpose is to create a mechanism to (i) collect parts of minerals revenues and other State incomes and put these into a fund for future generations, and (ii) regulate the use of the money so collected in the fund, to be called Future Heritage Fund (FHF). Previously, Parliament had allowed the President to recall before any discussion an earlier draft he had submitted on 13 October, 2014.
The draft seeks to close down the Human Development Fund and to replace it with the Future Heritage Fund, which is proposed to be managed according to international experience with sovereign wealth funds. It sets down in detail the structure and organization the FHF will have when it formally replaces the Human Development Fund, in 2018.
Is the FHF a good idea? Is this what resources-rich Mongolia needs and can handle to the actual benefit of its people? We asked two internationally known economists for their views, which appear below.
Only right rules can prevent gambling with public money
(Andrew Bauer is senior economic analyst at the Natural Resource Governance Institute. Earlier, he served on Canada’s G7/8 and G20 teams as an international economist at the Department of Finance. At NRGI, Bauer advises governments and parliaments on macroeconomic management, natural resource revenue sharing, and governance and accountability mechanisms. He has advised governments or legislators on sovereign wealth fund governance in Canada, Ghana, Indonesia, Mexico, Mongolia, Myanmar, Timor-Leste, and Uganda, among others. Bauer holds an MSc in Economics for Development from Oxford University and a BA in economics and international development studies from McGill University.)
This is the opinion of Andrew Bauer who knows the Mongolian economy and has studied the draft bill on the sovereign wealth fund. His views in his own words follow.
Mongolia has been blessed with abundant natural resources. The State Great Khural now has an historic opportunity to protect the nation’s endowment using the government’s proposed Future Heritage Fund. If managed correctly, this Fund can save some of the nation’s wealth and ensure that future generations have access to higher education, roads, healthcare and security. But if governed by the wrong rules, the Fund could threaten Mongolia’s future, contribute to a national debt crisis and gamble away the nation’s wealth in risky financial investments.
As Senior Economist at the Natural Resource Governance Institute (NRGI)—the good governance international policy institute where I work—I have advised parliamentarians and government officials in more than a dozen countries on establishing sovereign wealth funds. I have seen amazing results where a country’s people have been able to benefit from these funds. And I’ve seen several examples of where they have had the opposite effect. I want to share with you what can happen when these funds are mismanaged. I also want to encourage the State Great Khural to make changes to the draft bill to ensure that future generations really do benefit from mineral revenues.
Unlike most other sovereign wealth funds which are financed out of fiscal surpluses and/or were established in countries with low or declining public debt levels, the Future Heritage Fund in Mongolia is being proposed in a context of significant budget deficits and a large and growing public debt. In the IMF’s words, Mongolia is right now “at high risk of debt distress”. If the fund’s rules stay as drafted, it could lead to a situation whereby mineral revenues are deposited into the fund and are invested in foreign assets at 2-4 percent real return (the current average real return for low-to-moderate risk profile sovereign wealth funds), at the same time as the government is borrowing on international financial markets and paying 5-10 percent real interest (the current rate, which could rise).
We have witnessed this situation in other countries, most recently in Argentina, Ghana and Venezuela. The policy response has been the same in each: Breaking budget rules to draw down on national savings in order to finance spending or reduce the public debt burden. In each, the response hasharmed the government’s credibility with investors and the public. In Argentina, the public pension fund, ANSES, made over $14 billion in low interest loans to the government from 2013-14, putting elderly savings at risk. In Ghana, the government raided the oil-financed Ghana Stabilization Fund using a legal loophole to cap the size of the fund and continues to borrow heavily. In response, the IMF and the government have just agreed on a bailout package that involves public sector job cuts. In Venezuela, the government emptied the Macroeconomic Stabilization Fund which had stood at $7.1 billion in 2001. The country now faces a fiscal crisis and violent protests on the streets against economic hardship.
These policy responses may or may not be wise given the fiscal challenges each government has faced. However, they all highlight the dangers of borrowing at a high interest rate and attempting to save simultaneously. In Mongolia, the likely response could be to break any savings rules immediately, thereby undermining confidence in the Future Heritage Fund and the government’s commitment to intergenerational equity. An alternative policy option would be to pass legislation that addresses the need for savings in the long-run while addressing Mongolia’s acute spending and debt challenges today.
A second point is that several countries have articulated limits on investment risk in legislation. This prevents the government from going gambling with public money, for instance by investing in Moscow real estate or over-the-counter derivatives, the instruments that contributed to the global financial crisis. Many countries also designate special legislative bodies with overseeing and approving powers over sovereign wealth fund finances. Neither specific controls on investment risk nor a formal role for the State Great Khural beyond regular budgetary oversight is currently included in the Future Heritage Fund bill.
There is good reason to establish the Future Heritage Fund. It is different from the Human Development Fund which simply transfers mineral revenues to specified budget items or distributes them in cash, or the Budget Stabilization Fund, which is meant to finance the budget during an economic downturn. Unlike these other funds, the Future Heritage Fund is being created to save finite mineral revenues for future generations. In doing so, it can help prevent the Dutch disease, a situation where natural resource revenues overwhelm the economy and make other industries uncompetitive. If designed correctly, the new fund could also make Mongolia’s mineral wealth more transparent and improve public accountability.
Success of the Future Heritage Fund will depend on establishing the right rules. International experience indicates that if the fund’s rules are inappropriate or if the majority of politicians do not agree to governing rules before the fund is launched, then the rules are likely to be broken. In the best case, breaking the rules undermines confidence in the government. In the worst case, it can lead to corruption and Mongolia’s natural resource wealth will have been wasted.