Introducing the Government Resource Triangle
COVID-19 and lower oil prices are accelerating the Global Megatrends that are reshaping our region. The impacts of these Megatrends are already being felt and PwC’s ADAPT Framework highlights the specific challenges facing policymakers in the Middle East. Fiscal policymakers feel these Megatrends even more acutely:
Governments throughout the Gulf face short- and long-term fiscal pressures…
In this blog, we introduce a fiscal policy-oriented perspective on how to balance the competing pressures on government resources.
The Government Resource Triangle
The impacts of the Megatrends, COVID-19, and lower oil prices on Gulf countries create a unique set of fiscal decisions across three counterbalancing fiscal perspectives that form the "Government Resource Triangle”.
Policymakers must consider how to balance these fiscal perspectives to maintain fiscal and economic stability, promote intergenerational fairness, and preserve comparative standards of living in the medium to long term. The three perspectives are as follows:
Annual fiscal spend perspective
A government’s annual budget is arguably the single most important document after the constitution because it sets the future direction of government policy by communicating the programs it intends to fund. But, as governments face revenue shortfalls, growing social spending, and expenditure crowd-out by interest payments, policymakers may need to reimagine the budget. For example, social safety net reforms may be necessary to reign in excessive spending growth along with changes to the revenue raising mix to support economic growth.
Government financing perspective
Annual fiscal spend is balanced against a funding plan that lays out how to fund budgetary shortfalls. Gulf countries have an added complexity in that they must also fund any balance of payment shortfalls to protect currency pegs. Balance of payment shortfalls will be in focus this year as oil export revenues decline - shifting current account balances lower or into deficit. Net outflows of foreign investments is also likely as investment [in the region] slows and local currency shifts to dollar-denominated assets for safety. Several Gulf sovereigns/governments also have domestic and foreign debts that are maturing in the medium-term that must also be financed.
This perspective also forces consideration of whether to fund shortfalls using reserves, domestic borrowing, or foreign borrowing. All options have trade-offs: domestic borrowing may crowd-out private sector borrowing needed for economic growth, foreign borrowing may be more difficult to pay in the future, and pulling from reserves may limit resources available for other goals. All raise questions about intergenerational fairness. In facing these realities, governments may decide the financing costs are too steep, which would then force a review of the annual fiscal spend perspective.
Government reserves perspective
Large government reserves exist in most Gulf countries from past government surpluses; in many instances, central banks and sovereign investment funds (SIFs) were the traditional recipients of these reserve assets. But, when those surpluses turn to deficits, what should be done with government reserves? Should government reserves be used to close deficits? If so, how might the goals and intergenerational wealth preservation objectives of SIFs be impacted? Without utilising government reserves, policymakers must focus on the other two perspectives of the Government Resource Triangle, either by rebalancing the annual spending or incurring more debt.
A primer to balancing the Government Resource Triangle
The current fiscal challenges facing Gulf countries - as highlighted in our June 2020 Middle East Economy Watch 2020 - make the Government Resource Triangle all the more relevant as fiscal policymakers face tradeoffs between stimulus spending, recurring social spending, increasing revenues, debt financing, and drawing from reserves at the expense of intergenerational wealth preservation and economic development objectives. A multi-faceted response from policymakers is necessary to tackle the trade-offs inherent in The Government Resource Triangle and may include:
Stakeholders should be brought together to focus on three strategic areas that overlap with the three perspectives of The Government Resource Triangle. These strategic areas should be defined and developed in parallel and recursively as new information and trade-offs come to light.
Clarifying government budget requirements to balance the annual fiscal spend perspective
Stakeholders will have to focus on clarifying government budget requirements through a mix of strategic and tactical items, including:
- Developing a medium term economic forecast to better understand fiscal determinants for revenues and expenditures.
- Defining clear and robust fiscal rules1 that are rationalized and applied to medium term fiscal planning activities and annual budgets.
- Refreshing (or, developing) 3-5 year medium term revenue and expenditure frameworks to account for the new economic forecasts and fiscal rules.
- Reforming government budgeting processes to link the annual budget directly to the revenue and expenditure envelopes defined in the medium term expenditure framework.
Assessing funding requirements over the medium term to balance the financing perspective
Management of government financing requirements will need to be proactive and focused on the medium term through activities like:
- Clearly identifying revenue shortfalls from the medium term expenditure framework.
- Defining clear rules or targets for funding plans - including budget deficit targets, domestic versus foreign debt splits, debt instrument mixes, etc.
- Developing medium term financing plans that account for revenue shortfalls, debt financing requirements, government reserves’ drawdowns, and balance of payment considerations (based on the medium term economic forecast).
- Creating processes to assess underlying liquidity constraints in meeting the financing plan.
Revisiting the management of government reserves to balance the government reserves perspective
The need for foreign reserves in the short-term will increase pressure on governments to consider using government reserves to fill government budget shortfalls. While some advocate for the permanent income hypothesis (PIH) approach to reserves management 2- which suggests government reserves in the Gulf may be insufficient to meet long-term social objectives based on current government spending levels and therefore should not be touched - we believe it is more likely that governments will need to reimagine their management of government reserves as well as their relationships with their SIFs. This includes:
- Revisiting the purpose and objectives of SIFs. While many funds initially focused on capital maximization, today these funds could play a more important role in supporting domestic investment to support economic development, assist in foreign investment attraction, and support intergenerational wealth transfers.3 New management modalities could include transferring existing government assets (i.e state owned enterprises or physical assets) and projects to SIFs in exchange for cash. In doing so, SIFs can also help optimise government asset financial performance in order to reduce future government budget outlays and help find private investors to take on funding risks.
- Increasing transparency around the existing government reserves by disclosing more information on their asset mix, liquidity, investment policies, and historical performance to help policymakers better understand how government reserves can support the economic development objectives of the central government in fiscally leaner times. For SIFs, encouraging adherence to the Santiago Principles4 via publication of annual reports and statements on investment objectives is also a worthwhile objective; more broadly, governments could work to develop annual asset statements across the various government reserves available in SIFs, central banks, and elsewhere.
- Reassessing the governance model for SIFs to ensure it is insulated from political pressures. This can provide an additional firewall to ensure government reserves contained in SIFs are used for investments that have the best chance at meeting the commercial-oriented objectives of the fund.
- Developing appropriate fiscal rules to govern drawdown of government reserves assets to complement rules that govern contribution rates. Drawdown rules can act as a constraint to help shift balancing activities back to the annual fiscal spend and government financing perspectives of the Government Resource Triangle.
In Summary
The Government Resource Triangle is a helpful tool that can help fiscal policy makers better articulate and consider the trade-offs that exist in the fiscally constrained times that lie ahead. Using the three perspectives outlined can help policymakers better define the strategic and tactical changes that may be needed to better support fiscal [and economic] resilience for their countries.
1) IMF, “Fiscal Rules Dataset,” March 2017.
2) Mirzoev, T., et. al., “The Future of Oil and Fiscal Sustainability in the GCC Region,” IMF. 6 February 2020.
3) Jackson-Moore, William & Shouki, Tarek, “Keys to Success: How to Maximise the Opportunities Presented by Sovereign Development Funds,” IFSWF. Accessed on 27 July 2020
4) International Forum of Sovereign Wealth Funds (IFSWF), “Santiago Principles,” accessed on 23 July 2020.
