Fiscal Regimes and Fiscal Frameworks in Resource-Rich

Developing Countries :Lessons Learned and Policy

Recommendations for Mozambique

Victor Lledó, IMF Resident Representative for Mozambique

African Development Bank - High Level Seminar

Managing Revenues and Optimizing the Benefits of Coal and Gas Resources in Mozambique

Maputo, February 27, 2013

Outline

Fiscal Policy in Resource- Rich Developing Countries:

What has the IMF learned? What the Fund recommends? How it improved its policy advice delivery?

IMF advice on Fiscal Policy in Mozambique

Modalities: Policy discussions, TA, and Capacity Building Fiscal Regimes for Mining and Gas/Petroleum Fiscal Frameworks for the Resource-Rich Environment Next steps

Conclusions

Fiscal Regimes in RRDCs: Lessons Learned

Revenue generation is often the main benefit brought from extractive industries.

There is no optimal fiscal regime, but the government must be aware of the trade-offs across different objectives to find its most appropriate regime. (e.g. early revenues vs. investment efficiency; progressivity vs. competitiveness)

Progressive and transparent fiscal regimes are more stable, credible, and , depending on the design, do not compromise efficiency.

EI tax administration can be made easier by simplifying and consolidating the fiscal regime in fewer legal instruments; adopting publicly available parameters to calculate tax bases; consolidating the administration of specific taxes such as royalties;

Getting to an Appropriate Fiscal Regime

Some Elements Establish by law, or published contracts. Minimize discretionary

and negotiated elements.

Provide government with a revenue stream in all production periods, but also with an increase share of revenues as profitability increases (progressivity). System should be based on (i) royalty (early revenues), (ii) regular corporate income taxes; and (iiii) a tax on rents.

Stable and Credible. Fiscal terms must be robust in the face of changing circumstances.

Watch out for transfer pricing and review international treaties

Fiscal Frameworks in RRDCs: Lessons Learned

Fiscal frameworks in RRDC were not dealing effectively with the exhaustibility (spending over time) and volatility (spending in good times and bad times) of resource revenues leading to bad economic performance = Low savings +Boom-Bust

RRDCs’ distinct characteristics make traditional advice on how to spend revenues over time inadequate.

Permanent Income Hypothesis (PIH) :Sustain constant government spending across time, with no distinction between consumption and investment; no frontloading to current generations

PIH is silent on where to invest, domestically or abroad

Low current incomes need some titling of consumption toward poorer current generations

Credit constraints/capital scarcity /infrastructure gaps invest in domestic assets ; infrastructure.

Capacity constraints speed of scaling up; design of fiscal rules/savings institutions

Fiscal Frameworks in RRDCs: Lessons Learned (cont.)

The design of fiscal frameworks depend on the resource horizon and affects the choice of fiscal rules and indicators;

Long horizon (higher than 30 years) how to manage volatility-Structural primary balance based on a price smoothing rule

Short horizon (lower than 30 years) how to manage exhaustibility

-Non-resource primary balance (NRPB) rule

Fiscal Frameworks in RRDCs: Objectives

Is the resource revenue large relative to total revenue?

Is the resource revenue permanent (long-lasting) or temporary?

Priorities:Macro-stabilityDevelopmentExamples:Iraq, Nigeria

Priorities:Macro-stabilityExamples:Kuwait, Other GCC

Is the economy capital scarce? Is the economy capital scarce?

Priorities:Macro stabilityFuture generationsDevelopmentExamples:PNG, Timor-Leste, Ghana

Priorities:Macro stabilityFuture generationsExamples:Norway, Netherlands

Yes

No

Temporary

NoYes Yes

Permanent

Getting the Fiscal Framework Effective

• Flexibility. Allow countries to use resource wealth for productive investments (e.g. infrastructure, human capital, etc.) without endangering short-term macroeconomic stability and fiscal sustainability.

• Instruments . Tools to help policy-makers manage resource revenue volatility (e.g. as price trends can shift abruptly) and exhaustibility issues (as resources are non-renewable).

• Institutions. Capacity to undertake long-term revenue forecasts, establish a medium-term orientation of the budget, implement quality public investment projects, and manage special institutions such as natural resource funds

An effective fiscal framework provides (i) a set of indicators to inform the analysis, (ii) fiscal rules to address volatility and sustainability issues, (iii) institutions to ensure the transparent and efficient use

of resource wealth

Fiscal Policy in RRDCs: Expanding Advisory Work

New Trust Fund with lead donors – Norway, Australia, Switzerland, and EU Commission, together with the Netherlands, Oman and Kuwait .

5 year program, US$25 million, commenced May 1, 2011 .

Permits large scaling up of TA advisory work, especially fiscal.

Stronger focus on training and capacity building;

Organized in Modules;

Initial Africa projects: Congo DR, Sierra Leone, Guinea, Mozambique;

In Mozambique : 3 missions on fiscal regime and one mission on fiscal framework.

Fiscal Regime for Mining and Gas/Petroleum in Mozambique – General

Recommendations

• Comprehensive package of reform better than piecemeal reform.

• Consolidate legislation and regulation in one law/regulation.

• Timing: approved / implement new fiscal regime before any major acreage release process is initiated

• Combine three main fiscal instruments:– Royalty– IRPC (general framework) with sector specific rule– Progressive mechanism

• State participation and Infrastructure Financing: – State participation should be kept modest to ensure timely implementation;– Government revenues from the project should not be used to secure financing.

• Hold a transparent, effective and inclusive consultation process

• Enhance collaboration between AT, MF, MIREM and INP

Fiscal Regime for Mining and Gas/Petroleum in Mozambique – General

Recommendations (cont.)

• Indirect Taxes: - Government budget of the VAT should be on a net rather than

gross basis;- Accelerate VAT refunds and eliminate VAT exemptions once

refund situation has been normalized normalized;- Avoid export taxes

• Fiscal stability parameters (time, parameters) should not vary by contract;

• Clarify rules for the taxation of capital gains in corporate income tax. Remove mining and petroleum from scope of current rules allowing reduction of the gain through the personal income tax.

Fiscal Regime for Mining in Mozambique : Specific Recommendations

• Combine three main fiscal instruments: Royalty; IRPC; Progressive mechanism (not yet in place; RRT recommended)

• Royalty Reforms: tax base, valuation and rates

• Create / clarify specific IRPC rules for mining (ring fencing, royalty deductibility, treatment of infrastructure costs, transport costs, etc).

• Introduce a RRT (progressive mechanism): tax rate of 10 percent applicable to projects with a pre-tax rate of return ≥ 18%

Fiscal Regime for Gas/Petroleum in Mozambique : Specific recommendations

• Keep three main fiscal instruments: Royalty; IRPC; Progressive mechanism (currently set in EPCC)

• Several technical refinements recommended to the current R-Factor progressive mechanism (Rate of Return as alternative)

• Remove all fiscal provisions from the EPCC and include them in the Petroleum Fiscal Law

• Create IRPC specific rules for petroleum

• Clarify pending fiscal issues for LNG projects

Mozambique – Resource Revenue Prospects

Huge potential , but difficult to ascertain with some confidence the magnitude and time profile of revenues from coal and gas owing to

- Size of the total proven reserves are preliminary and other fields could be discovered in the near future;

- Rate of gas production and prices are difficult to predict given uncertainties about actual investment plans of companies over the next decade;

- Mozambique’s position in the international coal and, particularly, gas market has not yet been defined;

- Contract negotiations are still on-going and the fiscal regime yet to be decided

Assuming gas production/export starts in 2019 and increases gradually to reach full capacity by 2036, revenues from gas only could reach 15 percent of non-LNG GDP and account for almost 40 percent of total revenues by the end of the next decade;

Fiscal Framework in Mozambique: Objectives

Is the resource revenue large relative to total revenue?

Is the resource revenue permanent (long-lasting) or temporary?

Priorities:Macro-stabilityDevelopmentExamples:Iraq, Nigeria

Priorities:Macro-stabilityExamples:Kuwait, Other GCC

Is the economy capital scarce? Is the economy capital scarce?

Priorities:Macro stabilityFuture generationsDevelopmentExamples:PNG, Timor-Leste, Ghana

Priorities:Macro stabilityFuture generationsExamples:Norway, Netherlands

Yes

No

Temporary

NoYes Yes

Permanent

Moçambique ?

Fiscal Framework for Mozambique – Short-term Recommendations

• Given the uncertainty of actual resource revenue flows (and

evolution of aid flows) a prudent fiscal policy is recommended in the initial phase before production starts (2013-2018)

Implement fiscal regime as recommended and contracts in line with this fiscal regime.

Maintain a prudent debt management strategy that addresses pressing infrastructure bottlenecks without jeopardizing macroeconomic stability and debt sustainability :

Avoid large increases in spending; Cautious use of NCB and monitoring of the overall debt level; Step up efforts to build capacity and institutions to establish

clear investment priorities in line with its absorption capacity

Fiscal Framework for Mozambique – Short-term Recommendations (cont.)

• Decisions about how much to save and invest, or whether to set

up a Sovereign Wealth Fund (SWF), do not need to be taken now, but the debate and preparatory work as well as institutional development process should start as soon as possible.

• Strengthening technical capacity and technical units is the priority

– Develop capacity to measure GDP in the resource sector and to estimate the non-resource fiscal primary balance, key fiscal indicator to assess the macro-fiscal stance;

– Create a macro-fiscal unit within the Ministry of Fiance responsible for revenue forecasting, debt management, determine appropriate fiscal stance.

– Approve procedures to select, monitor and evaluate public investment projects;

– Expand audit capacity at the Revenue Authority

– Expand capacity at the PPP unit.

– Prepare study on what should be the appropriate fiscal rule

Fiscal Framework for Mozambique – Medium-Term Recommendations

• Should the revenues become very large as a share of total revenues and sustained over a long period of time (more than 35 years), fiscal space could increase markedly and managing volatility and avoiding absorptive capacity constraints would become the main challenge.

• Medium-term priorities: - Understand and tackle absorptive capacity. -PFM reforms, including the introduction of a medium-term

expenditure framework and the proper recording of financial transactions at

each stage of the expenditure chain (commitment, verification and payment) are already important.

- Implement fiscal rules/stabilization funds to mitigate volatility

Next Steps

• Enlarge IMF technical assistance under the MNRW-TTF:

– Module 1: Fiscal Regime Support the consultation process and the finalization of the revised EI fiscal regime

– Module 2: Tax Administration Support the implementation of the new fiscal regime to increase revenue collection from natural resources

– Module 3: Macro Fiscal Frameworks Support the preparation of the fiscal framework and required institutional capacities for scaling up public investment

– Module 5: Natural Resources Statistics Contribute to better account for the economic contribution of the resource sector

• Strengthen current technical assistance to PFM :

– Public investment project evaluation and selection– Debt management– Quality of the spending process– Budget and planning– Reporting– Control and Audit functions

Conclusions

Well-designed and implemented fiscal regimes for natural resources can make a substantial contribution to the revenue needs of Mozambique.

But resource revenues will only make a difference if they are managed through effective fiscal frameworks.

Mozambique has taken very positive first steps by becoming a full EITI member and by drafting revised mining and gas fiscal regime.

Critical to sustain the momentum by finalizing the fiscal regime with proper consultation and strengthening technical and institutional capacity to enforce the new regime and to design and implement an effective fiscal framework.

Obrigado !