Fixing the roof while it rains: three strategies to address governments’ breakeven challenges

It’s no surprise that governments of resource-rich countries have had to adapt budgets and spending plans to respond to the “lower for longer” commodity price environment of the past two years. The scale of adjustment required – and the scope of options available to address economic challenges – depends on factors that are often highly country-specific.  But there are three common strategies governments can implement in response – or suffer the consequences.

First, countries must understand the particular factors they face before developing appropriate strategic responses. These challenges may include:

  • government debt and the existing fiscal position (deficit/surplus as a percentage of GDP)
  • the nation’s fiscal breakeven resource price
  • potential for incremental growth from oil and gas
  • the overall size, maturity and growth prospects of the economy
  • concentration and dependency of the economy on income from domestic natural resources
  • relative size of private and public sectors
  • the proportion of GDP supported by government spending, subsidies and transfers
  • scale and liquidity of financial reserves
  • population, age profile and other social factors
  • domestic, regional and global political considerations.

Wood Mackenzie has studied the position of five key oil-exporting nations in the Middle East.  Sovereign fiscal breakevens for these countries are materially higher than current oil prices. Without action, the longer oil prices remain low, the greater the fiscal challenges will become in these – and many other – resource-rich countries.

Sovereign fiscal breakevens

But the severity of a nation’s fiscal pressures is not simply a function of the gap between the oil price and a country’s fiscal breakeven point. A country’s ability to act depends on their available options to fund income shortfalls. Key short-term levers, such as use of liquid financial reserves, adjusting government expenditure or accessing international capital markets to issue debt are all country-specific.

Government revenue, expenditure and fiscal balance

The problem is that resource-rich nations hold limited reserves in highly liquid assets.  And government spending is often heavily concentrated in areas such as:

  • embedded structural transfers to citizens
  • strategic infrastructure investments
  • long-term economic development initiatives
  • societal and industrial subsidies
  • education
  • healthcare

So when urgent action may be needed, the options to respond can be highly constrained – forcing governments to fix their roofs while it rains.

Total financial reserve assets+Public debt

Ironically, in periods where resource prices exceed national fiscal breakevens, the impetus for governmental change, societal reforms and economic diversification is low. In times of plenty, growth of the public sector, transfers to citizens and direct and indirect subsidies often balloon.  “Strategic” investments of surpluses tend to focus on economic development initiatives which aim to add value to the country’s abundant, low-cost natural resources. While this can accelerate economic growth and add to the overall size of the economy, it does little to change structural dependence on a country’s natural resource endowment.

Economies that develop in this way can increase sector concentration and their energy dependency, as the resulting industries are energy focused and capital, rather than labour, intensive.  Meanwhile, indigenous technology, as well as service sector and knowledge-intensive industries, may be hindered rather than enhanced since their growth often requires imported technology and skills. International companies then gain a first-mover presence in the growing economy – further exacerbating the challenges the country faces if resource prices fall below the fiscal breakeven point.

Government revenue

Governments of resource-rich nations are now facing a harsh reality: their need for change is greatest when the options for change are most constrained.  So how can they address their fiscal breakeven challenges?

Every country’s situation is unique, so an independent, analytical, data-driven approach is essential. Wood Mackenzie helps governments to analyse their fiscal position and outlook, identifies their options for change under different scenarios, and advises on optimal strategies for more resilient futures.

We have identified three of the most effective response strategies – Borrow, Spend Less and Spend Smarter – to help those in resource-rich countries, from governments to national oil companies, financial institutions to investors. Here’s a snapshot of what these strategies involve:

chevrons

 

For further information on Wood Mackenzie or a one-to-one discussion, please contact Chris Shepley.

0 Comments

Leave a reply

Your email address will not be published. Required fields are marked *

*

Log in

Forgot your details?