Starting last week, and continuing for five more weeks, the Business Guardian is providing excerpts of the most recent International Monetary Fund’s (IMF) Article IV consultation report on the economy of T&T. The IMF mission was led by Judith Gold and the report is based on research visits in November 2011 and February 2012. Most of the hard economic data was collected during the first visit in November. The staff report was completed on March 14 and on March 28, the executive board of the IMF concluded the 2011 Article IV consultation discussions with the Government. The public information notice was published on April 27, but the actual staff report was not released until June 1. In the second excerpt, the IMF deals with T&T’s Heritage and Stabilisation Fund.
The Heritage and Stabilisation Fund (HSF) of T&T, established in 2007, is an important national asset, which has broad-based political and social support. Its creation reflects the country’s high dependence on energy. The fund, with assets of US$4.1 billion (18 per cent of GDP) at end-September 2011, is currently under review by the authorities in line with legislative requirements. The HSF has performed well despite adverse global economic conditions and volatile financial markets since its creation, and compares favourably to other sovereign wealth funds (SWFs) in transparency and governance.
Notwithstanding the HSF’s strong record, this note provides a number of recommendations in the context of the review. In particular:
• The design of the HSF could be aligned with the government’s broader strategy for managing public finances and the sovereign balance sheet. In light of depleting energy reserves, a medium-term fiscal strategy outlining how much to save, consume, and invest will be essential to support the HSF savings and withdrawal rules.
• Sustained transfers to the HSF could be based on a return to fiscal surpluses over the medium term to increase net wealth.
• The HSF Act could be amended to establish a clearer focus on the heritage objective while preserving the stabilisation objective of the HSF to provide some scope to manage the impact of high volatility of energy price on public finance.
• Given a heritage focus and the HSF’s current size, the minimum HSF balance and maximum withdrawal rules are outdated and could be adjusted to provide a tighter constraint on withdrawals.
• A clearer focus on savings together with more constraints on withdrawals would support an investment strategy with a longer-term focus.
• The rules for calculating deposits into the HSF could be clarified and made public, by specifying which prices are used, lengthening the time horizon for calculating average prices, and adjusting the time frequency and lags for making deposits.
B. Background and Portfolio Performance
The Heritage and Stabilisation Fund was established to save and invest energy revenue in excess of budgetary projections. In March 2007, the Parliament passed the HSF Act replacing the Interim Revenue Stabilisation Fund (IRSF) with the HSF. The IRSF was introduced in 2000 to promote fiscal discipline, cushion the impact on the budget and the economy of unexpected drops in oil prices, and strengthen public sector savings. In the same year, the Government transferred US$66 million (1.0 per cent of 2000 GDP and about 5.0 per cent of official reserves) into the IRSF.
The HSF, like the IRSF, has a stabilisation objective, but the HSF also has a heritage objective with an emphasis on accumulating net savings over time for future generations. The creation of the HSF reflects in part past experience.
In the 1970s, the country benefitted from substantial increases in energy revenue as a result of high oil prices, and at the same time embarked on expansionary fiscal policies. In the absence of significant savings of energy revenue, the country was forced to undertake painful fiscal adjustment when oil prices dropped in the early 1980s. The HSF Act introduced changes to strengthen the management of excess energy revenue through improved governance and rules for transfers into and out of the fund.
The HSF governance structure compares well to international best practices for SWFs, set forth in the Santiago principles, especially on transparency and accountability. The Parliament’s role is to define the legal framework and to perform oversight. The HSF Act provides for a five-member Board of Governors. There are currently four serving members, consisting of two representatives from the private sector, including the chairman, and one representative each from the Central Bank (CBTT) and the Ministry of Finance. According to the HSF Act, members of the board should be persons of proven competence in finance, investment, economics, and business management or law and should satisfy the criteria for a fit and proper person under the Financial Institutions Act. The board members are appointed by the president on the advice of the Minister of Finance for a three-year term and are eligible for reappointment. The board determines the operational and investment guidelines and reviews portfolio performance. In line with the HSF Act, the board delegates operational responsibility for management to the CBTT, which recruits external fund managers and custodians and produces quarterly and annual financial reports. The Minister of Finance approves deposits and withdrawals, and presents annual reports, including audited financial statements to Parliament. Following Parliamentary approval, the reports, which detail the HSF’s transfers, fund size, investment strategy and portfolio performance, are published in line with the Santiago Principles.
The auditor general audits the fund. The HSF scores well in terms of public information disclosure almost on par with the more established SWFs, such as the Norway Government Pension Fund and the Alaska Permanent Fund. The HSF portfolio was highly concentrated in short-term assets up to August 2009, reflecting a conservative investment strategy in the face of financial market turmoil. Assets are held abroad, providing a line of defense against volatile external flows, and preventing the repatriation of proceeds from contributing to the deterioration of competitiveness of the nontradable sector. The HSF’s investments are guided by the Strategic Asset Allocation (SAA) determined by HSF Board. Its objectives aim to maintain sufficient liquidity for potential withdrawals, while also preserving and augmenting its long-term real value. Consistent with this, the SAA envisages a portfolio of 65 per cent fixed-income securities and 35 per cent equities.
In September 2007, the HSF Board approved a three-year transition plan for the SAA from a fully liquid portfolio composed of fixed-income securities. However, following the onset of the global financial crisis, the board decided to postpone its implementation until markets stabilised. Implementation of the new SAA began in September 2009, and was completed in January 2011. In the interim, the HSF was managed conservatively in the mode of the country’s foreign reserves during the crisis.