News Column

Sovereign Wealth Fund - Call to Impose Strict Risk Limitations

July 7, 2014

Chaby Barasa

TANZANIA is on course to establish a Sovereign Wealth Fund to manage proceeds from oil and gas finds, but experts caution that to reap maximum benefits from its resources, the country must have in place effective mechanisms to foster good governance and transparency.

The caution comes amid recent findings by the New York -based Revenue Watch Institute (RWI) and the Vale Columbia Centre on Sustainable International Investment (VCC), revealing that vast sums of money made from the extraction of oil, gas, and minerals--much of it in resource-rich countries where most citizens are nonetheless impoverished--are poorly managed and off limits from the oversight of civil society and the media.

"The results of our research are sobering, and we strongly encourage countries that operate these funds to improve how they are governed," said Daniel Kaufmann, president of the Revenue Watch Institute. Kaufmann added: "Countries that don't yet have such funds but are considering them should also heed the report's prescriptions.

With the staggering sums involved, good fund governance could make the difference between succumbing to or, escaping the so-called resource curse." The RWI Report stresses that measures to improve transparency and governance of many natural resource funds are urgently needed to escape the "resource curse."

"This absence of transparency, found in half of the funds identified, presents significant obstacles to good governance and sustainable development," the report reads in part. President Jakaya Kikwete announced in April this year that the government was formulating legislation for the establishment of the Fund whose Bill would be tabled in the National Assembly by the end of this year or early next year.

Formation of the Fund is in line with the 2013 Natural Gas Policy, which stipulates that the Natural Gas Reserve Fund will be established and managed to ensure transparency and accountability over collection, allocation, expenditure and management of all natural gas revenues.

According to the Policy, clear guidelines shall be developed transparently or through national dialogue on the optimum short-term and long-term use of the fund. In addition, transparent and sound fiscal management of the natural gas revenue spending shall be in accordance with national development plans and strategies.

The policy also seeks to create a national oil and gas company, a state-owned firm that will develop and own strategic gas projects and businesses on behalf of the government, and participate in the natural gas value chain using subsidiary companies.

Once dominated by solid minerals, discoveries of significant natural gas reserves in Mtwara and Lindi in 2012 and 2013 now look set to transform the Tanzanian extractive industry. The African Economic Outlook recent report projects that these reserves, estimated at over 43 trillion cubic feet, could attract between 10 and 15 billion US dollars of investment in the next decade.

Major players including Statoil, BG Group, Ophir Energy and ExxonMobil are already involved. Indeed, as these corporations and the country prepare to bring natural gas extraction online, many in Tanzania are reflecting on the country's experience with large-scale mining.

Over the last twenty years, Tanzania has become one of the top four gold producers in Africa. It has also produced large quantities of diamonds, coal, iron ore, nickel, chrome, tin, platinum, coltan and niobium. Mineral exports were valued at 2.3 billion US dollars in 2012, but many agree the sector has not resulted in significant government revenues and has failed to integrate successfully into the rest of the economy.

The Mining Development Agreements the country entered into with Multinational Companies, under the World Bank's guidance are said to have been skewed in favour of the latter, leading to massive losses to the country. In their report, 'A Golden Opportunity?:

How Tanzania is Failing to Benefit from Gold Mining' Mark Curtis and Tundu Lissu, noted six years ago that the country was estimated to have lost about US dollars 400 million due to "low royalty rates, unpaid corporation tax and tax evasion over the past seven years.

Commenting on the best way Tanzania can manage the envisaged Fund, Mr Andrew Bauer, an Economic Analyst at RWI notes that while there is no one-size-fits-all solution to fund management, which entity has ultimate authority over the fund, which entity manages day-to-day operations, and what responsibilities each has should be dependent on the different competencies already found within the government.

"That said, often the Parliament has ultimate authority over the fund, meaning that the fund manager is accountable to parliament. Usually, the President or Minister of Finance is named the "manager" of the fund. And in many cases, the Central Bank is named the day-to-day "operational manager" of the fund since it may be the agency with the most independence and capacity within the government (e.g., Botswana, Chile, Norway).

"In some cases the government decides to establish a separate entity to manage the fund's investments, however the risks of corruption and nepotism may increase if this option is chosen," said Mr Bauer in an email reply to the 'Daily News.' In nearly all cases, the RWI economist observes, the fund is physically held with a custodian institution (e.g., JPMorgan Chase Bank; Central Bank) that is hired to report on transactions and hold the assets for safekeeping.

"Two other points are worth noting. First, the operational manager should be subject to strict legislated criteria as to what assets it can and cannot invest in. Natural gas revenues are public funds which, implies that the government should not gamble with them.

Instead, strict risk limitations should be imposed, such as a maximum percentage that can be invested in 'alternative assets' like real estate and infrastructure, and restrictions on domestic investment and certain financial instruments. "Second, oversight by external independent bodies is just as important as oversight within the government.

Evidence shows that when government officials are aware that they are being watched by outsiders, they are more likely to follow the rules. Parliament, the Controller and Auditor General, and an independent Supervisory Council could be given formal roles to oversee fund operations and management of Tanzania's natural gas revenues. Media oversight is of course also paramount," he explains.

On how citizens can best benefit from the Fund, Mr Bauer notes that one of the most important decisions the government can take is to clarify the purpose or objectives of the fund. He stresses that the principal reasons for extracting natural gas from the ground are to serve national energy needs and to generate revenues to invest in health, education and infrastructure.

"In short, if well managed, a Tanzanian fund could improve the quality of public spending by the government, help reduce wasteful spending, help mitigate, inflation, save some revenues for future generations, or protect natural gas revenues from corruption, all of which might benefit Tanzanian citizens. However the objective of the Tanzanian fund should be made clear."

He says Tanzania can learn best practices from elsewhere."For instance, the Alaska Permanent Fund (USA) and Timor-Leste Petroleum Fund can be considered models of transparency. In terms of independent oversight, Ghana'sPublic Interest and Accountability Committee (PIAC), a legislated body of 13 civil society groups, provides strong oversight of Ghana's three petroleum funds.

As per the RWI's 2013 Report, Ghana's laws and mechanisms which regulate the use of its natural resource funds are the best in Africa. According to the RWI, Ghana had, among many other things, strong deposit and withdrawal rules that helped to prevent the mismanagement of oil revenues. Ghana's natural resource funds, namely, the Ghana Stabilization Fund and the Ghana Heritage Fund, have market values of 54.9 million US dollars and 14.4 million US dollars, respectively.

It said in Ghana's regulatory framework, the objectives of the funds were clear, just as rules on how much could be withdrawn in any given year, which revenues must be deposited and when, use of resource revenues as collateral, investment risk limitations, penalties for misconduct by fund managers and staff and the role of government agencies in fund management.

The Report further noted that there was clarity on, public disclosure of internal audit results, formalized oversight mechanisms, public disclosure of regulatory compiled fund reports and publication of specific investments. It, however, observed that there were "gaps" on issues such as ethical and conflict of interest standards for management and staff, detailed responsibilities of fund managers and staff and public disclosure of independent external audits.

Elsewhere, the Report revealed that Alberta (Canada), Chile, Norway and Timor-Leste have codified comprehensive investment rules that limit the risks fund managers can take and, in Norway's case, impose ethical investment guidelines on fund investments.

Chile and Trinidad & Tobago have established clear and appropriate inflow (deposit) and outflow (withdrawal) rules for their copper and petroleum funds, respectively. The RWI outlines six steps for establishing a fund namely; Set clear fund objectives, such as saving for future generations, stabilizing the budget, or earmarking for development projects, establish fiscal rules for deposits and withdrawals that align with the objectives and establish investment rules that are aligned with the objectives, such as a maximum percentage of assets that can be invested in equities.

The government also has to clarify a division of responsibilities between the ultimate authority over the fund, the fund manager, the day-to-day operational entity and the different departments within the operational entity. Set and enforce ethical and conflict of interest standards for fund staff, require regular and extensive disclosures and audits and establishing strong, independent oversight bodies to monitor fund behaviour and enforce the rules are the other steps to be adhered to.

As for the fund catering for the mining sector, Mr Baeur notes that the macroeconomic challenges associated with natural gas revenues (such as budget volatility and limited capacity to invest such large windfalls) may be larger for oil and gas than for minerals, since natural gas revenues are expected to have a substantial impact on the budget whereas mineral revenues still contribute less than 10 per cent of government revenues.

"Therefore, the benefits of an oil and gas fund may outweigh the benefits of a mineral fund unless mineral revenues increase substantially. At the same time, mineral revenues are also exhaustible and, volatile therefore there may be a justification for putting all these revenues into a single fund.

One question we could ask is: Would putting mineral revenues into a fund make them safer from mismanagement and improve the way they are spent?" However, according to the RWI which monitors the management of commodities in 58 mineral-rich countries and publishes an annual Resource Governance Index, in 2013, Tanzania performed poorly on the index, ranking 27th, mainly because of a lack of transparency in mining contracts.

"It is very problematic to track the revenues from mining in Tanzania," RWI official Silas Olang was quoted saying. "But then it is also very difficult to find out what the money from mining is spent on. We don't know anything about the relationship between the government and the companies."

With estimated gold reserves of about 45 million ounces (1,275 tonnes), Tanzania has become the third-largest gold producer in Africa, after South Africa and Ghana. According to the Bank of Tanzania, the country exported 2.3bn US dollars worth of gold in the fiscal year 2011-12.

The mining sector's contribution to Tanzania's GDP more than tripled between the mid-1990s and 2012, reaching 3.5 per cent. However, since the mining boom started in the early 1990s, the East African country has failed to transform this into wealth for communities near the mines, critics say, hence the need for the government to rectify mistakes and ensure the Sovereign Wealth Fund works for the population from grassroots.

Dr Honest Prosper Ngowi, Senior Lecturer, Researcher and Consultant (Economics and Business) Mzumbe University, Dar Es Salaam says the proposed Fund is a good way of managing the expected revenues from the natural gas wealth. "The purpose should be to stabilize the economy by taking away extra money from circulation as part of ways of avoiding Dutch Disease.

If the country gets 'too much' cash than the economy can absorb, the economy can operate artificially including very high inflation," he cautioned. He says the funds should be used to diversify the economy away from natural gas (invest in non gas related sectors such as agriculture, industry, tourism and others).

"The Fund is important too as a way of saving. What is important when the country wants to use money from the fund is to use the interest rate (return) from the Sovereign Fund. "Given the huge size of the expected cash, such Funds should be placed or invested, abroad with experienced Fund Managers who will invest the funds on behalf of the Government. Best practices of such funds exist from some countries such as Norway," observed Dr Ngowi.

He stressed on the need to learn from best performers, but also ruled out a Sovereign Wealth Fund to cater for mining. "No. We are not making huge earnings from the sector to warrant such a fund in mining," he says. A member of the Tanzania Extractive Industry Transparency Initiative (TEITI)-Multi Stakeholder Group, Buberwa Kaiza cautioned that a thorough study must be conducted before tabling the Sovereign Wealth Fund bill in parliament.

"We don't have to rush or work under pressure," notes Mr Kaiza who calls for a national strategy, complete with policy and strong institutions such as a court, to be in place before the SWF. Mr Kaiza who is also the National Coordinator of the Publish What You Pay (PWYP) campaign says the country could only start reaping oil and gas fruits after a decade or more, hence in the meantime, the government must iron out thorny issues such as ownership of the resources. He says ideally, the government must own the gas economy.

"Having wasted the opportunity in mining, the government must be smarter and make sure past mistakes are not repeated in the oil and gas sector," he says. Dr Rugemeleza Nshala, Executive Director of Lawyers Environmental Action Team (LEAT) says ideally the country, should have thought of having such fund to cater for mining revenue yesterday, but "all was not lost as government could ensure maximum revenue from the sector by addressing taxation, transfer pricing by mining firms and other pertinent challenges afflicting the sector," he observes.

To ensure the anticipated Fund does not destabilize the economy, the funds must be spent wisely lest they lead to inflation, cautioned Dr Nshala, stressing that a clear strategy must also be in place to ensure the funds serve future generations. Dr Nshala calls for a clear vision and commitment saying Tanzania can learn best practices from Botswana and other countries that have excelled in managing such funds.

Quoting various critics, The AfricanGlobe's recent report observes that while many African countries are busy setting up sovereign wealth funds, they (funds) may not serve the long-term interests of poor countries that still need to invest in basics such as schools and roads.

The report says Africa could reap more from its resources by investing in education, energy, and transport to feed other industries, rather than parking the money in liquid but low-yield assets in safe havens, as sovereign funds tend to do. "Many successful wealth funds belong to countries with surpluses and rich citizens, which can afford them.

This is not the case with many African governments struggling to feed or educate their people," said Kwame Owino, the chief executive at the Nairobi-based Institute of Economic Affairs. "It would be a luxury to have.

The political will may exist, but the economics of it suggest that a sovereign wealth fund is not a good idea for many African countries," he said. "In many of these countries as well, transparency is a big problem and the amount of leakage that takes place in public funds is a reason to be concerned."

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Source: AllAfrica

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