Design and Management of Nigeria's Sovereign Wealth Fund

8/7/2019 Design and Management of Nigeria's Sovereign Wealth Fund

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DESIGN AND MANAGEMENT OF NIGERIA’S SOVEREIGN WEALTH FUND:

LESSONS FROM NORWAY, AZERBAIJAN AND KAZAKHSTAN.

PART 1

1.0 INTRODUCTION

Since the first crude production in 1958, Nigeria’s total Oil revenue is in excess of $600

billion1. Fiscal indiscipline, poor macroeconomic specifications and public embezzlement

have meant that much of it was wasted over the years. Decaying and inadequate public

infrastructure, poverty, widespread corruption and sectional violence and revolt have result.

According to the CBN (Central Bank of Nigeria), “Nigeria requires investment of around $15

billion annually for the next six years to achieve the target of joining the league of 20 most

industrialised nations in the world by 2020 2” i.e. vi sion 20:2020. Achieving this target will

require more than commitment from the government; access to funds and making judicious

use of such funds will be of importance in this regard.

The main source of Government revenue in Nigeria is earnings from Oil exports.

Government revenue from Oil “ consists mostly of a share of the resource rent, i.e. the

unearned income from the exploitation of natural resource. ”3 In economics, resource rent is

defined as difference between the fair market value of the resource and the cost of

extraction4

, this premium arise as a result of the scarcity of resource relative to demand. Fromthis, two deductions can be made. One, resource rents respond to market prices of that

resource which is volatile and subject to wild fluctuations. Second, for depletable resources

1 Tunde Fabunmi (March, 2010), Untapped Billions from Bee in the Punch Newspaper of Sunday, 21 March,2010. Accessed on Saturday 19 March, 2011.2 Comment by Mr Onyebuchi Ibedu., Deputy Director, Banking Supervision, CBN at the just-concluded secondannual lecture series organised by the Nigeria Institute of Quantity Surveyors (NIQS). 3 Mathias Lucke (October, 2010), Stabilization and Savings Funds to Manage Natural Resource Revenues:Kazakhstan and Azerbaijan vs. Norway , Kiel Working Paper No 1652, Kiel Institute for the World Economy

(KIWE), Kiel Germany.4Ibid.



such as crude oil, the annual stream will cease when the resource reserve is exhausted.

Therefore, over reliance on this source of income could lead to a number of problems among

which include resource curse, which is evident in many natural resource-rich countries

including Nigeria; variations in fiscal performances against targets/budgets due to price

fluctuations and a general inability to prosecute infrastructural projects due to irregularity and

a lack of stability of this revenue source.

To reduce the uncertainty in resource revenue and to provide sustainable long-term source of

income, many resource rich countries have for many years used and operated Stability and

Sovereign Wealth Funds (SWF) to cushion the effects of fluctuations in resource prices,

budgets and to provide savings as austerity measures and for future generations after the

depletion of the resource. The Finance Minister of Nigeria said recently that “Currently, there

are more than 50 sovereign wealth funds in operation globally and they, together, manage

over $3 trillion in sovereign assets”. The framework design and administration are some of

the attractions of Sovereign Wealth Funds (SWF). Norway and Alaska have been used as

examples of the few resources-endowed economies that have been able to insulate their local

economies from the “resource curse” 5 syndrome and provided for the future by setting up

transparent and well managed SWFs that have been the reference point for all other operators

of SWFs. Other countries with SWF include Azerbaijan, Kazakhstan and Qatar, etc. Nigeria

remains one of only three Organization of Petroleum Exporting Countries (OPEC) members

without a SWF; others are Iraq and Ecuador. It had operated Petroleum (Special) Trust Fund

(PTF) in the past and more recently, the controversial Excess Crude Account (ECA) since

2003 to provide short-term stability in revenue for the three tiers of government in Nigeria.

5

Resource Curse refers to the paradox that countries and regions with an abundance of natural resources, specifically point-source non-renewable resources like minerals and fuels, tend to have less growth and worsedevelopment outcomes than countries with fewer natural resources .

http://en.wikipedia.org/wiki/Natural_resource

http://en.wikipedia.org/wiki/Fuel

http://en.wikipedia.org/wiki/Fuel

http://en.wikipedia.org/wiki/Natural_resource



The administration of the ECA is fraught with many problems including the lack legal

standing, the short-term target of the fund and the absence of defined modalities for

withdrawals from the account. As a result, The Federal Executive Council (FEC) is proposing

the establishment of a SWF. The bill seeking to establish the SWF and the Nigeria Sovereign

Investment Authority (NSIA) to manage and administer the fund is presently with the

Legislature (NASS) who are expected to pass the bill into law before the expiry of the

administration on May 29 th, 2011. “According to the proposal, the NSIA will be divided into

three distinct structures, as follows; Infrastructure Fund, Future Generations Fund, and

Stabilization Fund.” 6

This paper will review the performance and experiences in the administration of SWF from a

number of countries including Norway, Azerbaijan and Kazakhstan taking a close look at

their peculiarities and similarities and make policy recommendations to Nigerian authorities

on how to structure the design and management of the fund.

The rest of the paper will be structured thus: part two, short introduction of the Oil sector and

its contribution to Government revenue and review of literature on the management and

investment vehicles of SWF and withdrawals therefrom. Part three will review issues with

ECA and look at the proposed SWF/NSIA then consider country case studies among which

are Norway, Azerbaijan, and Kazakhstan and summarize the peculiarities of their funds. Part

four will be recommendations and conclusions, then, references.

1.1 BACKGROUND ON NIGERIA’S OIL I NDUSTRY

According to the CIA, Nigeria’s population is 155,215,573. This makes it the most

populated country in Africa and the 8 th in the world. It has abundant deposit of

6 Ubah, C. Edward., Re-thinking the Sovereign Wealth Fund in Daily Sun of March 9 th, 2011. Accessed on

20/03/2011.



objectives. There is a large pool of literature; even dedicated platforms for SWFs and they

have become very popular alternative investment vehicles for resources-rich countries.

2.1. SOVEREIGN WEALTH FUND (SWF): ITS MEANING AND OBJECTIVES.

Various definitions have been given for SWF among them include “SWF as special

investment funds, created or owned by governments, to hold foreign assets for long-term

purposes” (IMF) 8; “SWF as public investment agencies, which manage part of the (foreign)

assets of national states” (EU Central Bank) ; “SWF is a state-owned investment fund

composed of financial assets such as stocks, bonds, real estate, or other financial instruments

funded by foreign exchange assets ” (SWFI). These include: proceeds of privatizations, the

official foreign currency operations, balance of payments surpluses, fiscal surpluses, and/or

receipts resulting from commodity exports . SWFs can be operated as a fund, corporation or a

pool. SWFs are not limited on investment possibilities, they can also invest, albeit indirectly,

in domestic state-owned corporations. About 58% of SWFs are funded by receipts from Oil

and Gas related revenue. As at March 2011, there was over 50 SWFs with a total asset value

of about $4.256 trillion. Table below shows a list of selected funds with their asset values at

March 2011.

8 Simone Mezzacap (2009), “ The so-called "Sovereign Wealth Funds regulatory issues, financial stability and

prudential supervision , in EU Economic Papers.



There are three basic objectives for establishing SWF among natural resource dependent

economies, these are stability against price and revenue volatility; saving for rainy day and

for future generations. The SWFI listed a number of objectives, among them are:

Stability of budgetary and fiscal policy against the volatility in prices and the wild

swing in international product market.

Protect domestic economy (industries) against the effect of the Dutch Diseasesyndrome.

Provide alternative means of income and savings for future generations. This is moreso

as oil and gas are exhaustible resources.

Act as means of funding socio-economic infrastructural objectives of government.

Helps in long-term political and economic development strategy formulation for

sustainavle development.



The diversified investment portfolio of the fund provide a shield against exposure to

risk and poor investment choices.

2.2 INVESTMENT INSTRUMENTS OF SOVEREIGN WEALTH FUND

Available data indicates that in recent times, SWFs have grown in size, number and and

prominence, especially due to the high oil prices in 2007 and 2008 that witnessed growths in

managed assets of 18% and 17% respectively 9. This growth has resulted in the diversification

of investment and risk from sovereign debt to private equity; in other words, a shift from high

liquidity to more diversified risk and long-term investment portfolio. This has raised concern

in the OECD countries, where these funds are invested, on security and political implications

for the sovereignty of the state. The USA have been more vocal in its concern over the

growing trend in private equity participation of SWFs.

2.3.0 SUSTAINABLE MANAGEMENT OF RESOURCE REVENUES: ECONOMIC

PRINCIPLES.

For natural resources dependent economies such as Nigeria, government revenue typically

fluctuates with the world oil price. Because of this volatile fluctuation and the terminal nature

of the resources, many economists and experts have argued for a fiscal arrangement that

guarantee constant income and provide savings for future generations. One such argument is

the Hartwick rule on the investment of exhaustible resource income for sustainable

development and intergenerational equity. Also the permanent income hypothesis (PIH)

which posits that current consumption is not only a function of current income but also of the

permanent income, i.e. expected lifetime income. We will briefly discuss these below.

2.3.1 HARTWICK RULE

9ibid



“Invest all profits or rents from exhaustible resources in reproducible capital such as

machines.” 10 This famous quote by John M Hartwick in an article in 1977 heralded what has

become known as the Hartwick rule which says countries with abundant natural resources

should invest the rent from such resources in reproducible capital such as machine, where the

net investment between man-made capital and natural resources is zero. Under this

arrangement, the current generation lives off current flows from machines and labour. It gives

the same weight to both current and future generations. “This injunction seems to solve the

ethical problem of the current generation short-changing future generations by over

consuming the current product from such exhaustible resources” 11 Matthias Lücke (2010).

This rule has two significant objectives, sustainable consumption path and the equitable

distribution of benefits from natural resources through generations.

One argument against this rule is that it leaves current consumption too low when assessed

from a utility maximization point because future generations will be better off anyway if

technological progress follows the pattern of the last two centuries as such, it would be

defensible if the current generation consume some resource rent rather invest all in

reproducible capital, Matthias Lücke (2010).

2.3.2 PERMANENT INCOME HYPOTHESIS

The permanent income approach recommends first calculating the expected net present value

of all expected net future revenues from these resources; and then calculating the constant

real amount (or annuity) that, received forever, would yield the same net present value. It

recommends limiting government spending natural resource revenues to only this constant

annuity amount and saving the rest abroad (to mitigate the potential effect of Dutch disease).

The drawback of this approach is that it implies borrowing against future expected income

10 Hartwick M. John, Intergenerational Equity and the Investing of Rents from Exhaustible Resources

11Ibid



and, according to Collier et al. (2009), while “directing all resource revenues to current

consumption is wasteful and inequitable, postponing consumption into the distant future is

wasteful and inequitable as well ”. They suggest an optimal fiscal rule for developing

countries which involve saving a part of the revenue and allow for more investment and

consumption from the rent than in the permanent income approach (Milan Brahmbhatt 2010).

3.0 THE PROPOSED NIGERIA SWF

After decades of wasteful fiscal policies in which most of the windfall gains from oil export

was spent with no commensurate development and decaying public infrastructure, the

Nigerian Government have decided to set up a sovereign wealth fund to better plan and

manage the rent from oil export. In this section, we will set out past attempts at establishing a

stabilization account and, the structure and composition of the proposed SWF.

3.1.0 PAST EXPERIENCE WITH STABILIZATION ACCOUNTS

3.1.1 PETROLEUM (SPECIAL) TRUST FUND (PTF)

The PTF was established in 1994 strictly, as an intervention agency to cushion the effect of

the increase in the price of petroleum products. The government promised with the

promulgation of Decree 25, “to distribute the gains from the increase on social and

infrastructural projects.” (Pini Jason 1998). The performance of the fund was dogged with

many issues ranging from its mode of operation, which was considered a parallel government

to allegations of bias in project execution. Overall, it achieved the twin objectives for setting

it up which were “to rehabilitate infrastructures and re- orientate the people.” (Pini Jason

1998). It was able to rehabilitate roads, hospitals, schools and create jobs through the award

of contracts both construction works and consultancy services. It was wind up by the

government in 2000.



3.1.2 EXCESS CRUDE ACCOUNT (ECA)

The ECA was created to save windfall profits from periods of high oil prices in 2004 by the

Olusegun Obasanjo Government. “By setting a conservative oil benchmark price and saving

the revenues received over that price, the government sought to discontinue the destructive

pattern of volatile spending.” (RWI, 2010). However, the indulgent governance structures

have allowed extensive ad hoc withdrawals from the fund to finance recurrent spending

among the tiers of government in Nigeria. The Fund was operated as short-term revenue

stabilization fund without legal or parliamentary standing, (RWI, 2010). As a result, the

present government has proposed the establishment of a SWF, with legal and parliamentary

structures to collate and better manage the oil revenues of the government.

3.2.0 THE PROPOSED NIGERIA SOVEREIGN WEALTH FUND (NSWF)

Like the practice among natural resources endowed countries, Nigeria is proposing a SWF to

better manage and address the problems associated with the abundance of natural resources-

the so called “resource curse”. The attraction of SWF is the sound management, legal

background and its operational transparency. A recent Oxford Economics overview of SWFs

(OER, 2008) listed four reasons why countries with abundant resources have become

attracted to SWFs- macroeconomic stabilization, seeking higher returns, future generations

and the development of domestic economy. The fund will be managed by an independent

agency, the Nigeria Sovereign Investment Authority (NSIA). Like other countries with

SWFs, Nigeria’s fund will be divided into three separate funds namely:

3.2.1 The Future Generations Fund (FGF) : The FGA will build and intergenerational

savings base by investing in long-term assets that will generate adequate return to accumulate

wealth for future generations of Nigerians and provide equitable distribution of the resource

wealth for all generations, (Ighomwenghian, K, 2011).



3.2.2 Nigeria Infrastructure Fund (NIF): According the proposal for setting up the

NSWF, the NIF will be used to bridge the national infastructure gap by providing financing

for the development of critical infrastructure across Nigeria. Additionally, 10% of the NIF

will be devoted to regional government-sponsored development projects that promote

economic development in under developed sectors or regions in Nigeria.

3.2.3 Stabilization Fund (SF): “The Stabilisation Fund will protect the budget by

providing a stable, last resort source of finance when the budget smoothening account is

deemed to be insufficient”. “This stabilisation function will ensure the smooth functioning of

government and delivery of key services during periods when oil revenues from petroleum

sales are less than the level anticipated and approved by the National Assembly and the

budget smoothening account does not have s ufficient balances.”, (Ighomwenghian, K, 2011).

3.3 The role of Nigeria Sovereign Investment Authority (NSIA)

The NSIA will be a statutory corporation created by the NASS to manage all the funds under

the NSWF and will be responsible to Nigerians. The NSIA will carry out the intentions of

government for setting up the fund, i.e. to build a savings base for the benefit of future

generations, enhance development of infrastructure in Nigeria and provide stabilisation

support in times of economic stress. It shall have a Governing Council, Board and Executive

Management.

The Governing Council shall provide advice and counsel to the board as regards the

objectives of the authority, but shall observe the independence of the board and officers of the

authority. In the words of the Minister of Finance, Aganga, “This way, Nigeria is escaping

from its boom-and-bust cycle of the past, and planning for stable long-term growth and

development. ” (Ighomwenghian, K, 2011).

The NSIA will receive $1 billion as start-up capital. Subsequently, it will receive monthly

funding from surplus oil revenues above the national budget - using the well-established oil



price benchmark rule. NSIA will distribute the surplus revenue into the three “ring-fenced ”

funds: the NIF; the FGF and the SF.

4.0 CASE STUDIES

As mentioned earlier, there is a large number of SWFs with various characteristics and

performance. Norway’s GPF-G is considered a model fund in management and transparency,

we will therefore, consider Norway, Azerbaijan and Kazakhstan due to similarities of their

economies to Nigeria.

4.1 NORWAY’S GOVERNMENT PENSION FUND -GLOBAL (GPF-G)

Norway’s fund, called Government Pension Fund – Global (GPF-G), was established in 1990

when its oil output was approaching peak production. Fund assets grew rapidly when oil

price increased sharply during the early 2000s. Presently, the fund is one of the biggest

sovereign wealth funds worldwide with assets of approximately $556.8 billion (SWFI, 2011).

Allocations to the fund (and possible withdrawals) are fully integrated into the annual

government budget process (Lücke, M. 2010). Annual non-oil deficits are meant to be

financed from the capital income of the resource fund alone. The fund aims for a 4% real

return in the long run, based on a strategy of maximizing financial returns with moderate risk.

This strategy is known as the 4% rule, i.e., annual non-oil deficit should not be more than the

expected 4% real return on the fund.

Although, there is no legally binding provision on government and parliament to follow the

4% rule, they provide an anchor for the budget process and have been consistently observed.

However, non-oil deficits above the expected real return on fund assets are acceptable during

recessions, as long as they are offset by deficits below the limit when GDP grows (Lücke, M.

2010).

The Ministry of Finance sets benchmarks for the composition of total assets by classes

(equities: 60%; fixed income: 35%; real estate: 5%) (Lücke, M. 2010). The investment



strategy of the GFP-G generally aims at diversifying risk while simultaneously producing a

high rate of return in the long run, “subject to the observance of ethical guidelines ” (Lücke,

M. 2010). Norway’s central bank is responsibility for the management of the fund, although,

it uses the services of external fund managers for a small part of the portfolio. All fund assets

are invested abroad to shield Norway from the detrimental Dutch Disease effects.

4.2 STATE OIL FUND OF AZERBAIJAN (SOFAZ)

SOFAZ was established by presidential decree in 1999 as an extra-budgetary fund under

presidential control . SOFAZ receives government share from production sharing agreements

(including both the government’s and SOCAR’s shares), bonus payments, acreage fees,

dividends, revenue from the transit of hydrocarbons over the c ountry’s territory and capital

income from fund investments. Annual expenditures of SOFAZ are not to exceed expected

revenues, effectively preserving the nominal value of assets from year to year (Lücke, M.

2010). Expenditures consist mainly of transfers to the national budget. Other expenditures

have included the financing of Azerbaijan share in the Baku-Tbilisi-Ceyhan oil pipeline

(SOFAZ 2010). The fund expenditures are controlled by presidential decrees, which could be

overridden by a countermanding decree. Once oil revenues have reached peaked, SOFAZ

assets should target annual growth rate of at-least 25% of the SOFAZ revenues for that year.

Broadly, authorities aim for a non-oil deficit compatible with macroeconomic stability.

However, there is no agreed definition of the sustainable non-oil deficit.

The investment strategy of SOFAZ has been conservative; targeting portfolio diversification

at minimal risk. Most assets are managed by SOFAZ itself and are invested into fixed income

instruments, including bank deposits, money market funds, securities, including sovereign

debt securities, bonds, and mortgage securities. Debtors include governments, financial



institutions and state agencies of countries with long-term (sovereign debt) ratings of at least

A (S&P, Fitch) or A2 (Moody’ s) (Lücke, M. 2010); its assets grew slowly to little more than

US$ 2 billion in 2007, but shot up to more than US$ 11 billion in 2008 (Lücke, M. 2010).

This increase was caused by high oil price as well as the peculiar time profile of government

oil revenues under the production sharing agreement for the Azeri-Chirag-Guneshli (ACG)

offshore fields.

4.3 NATIONAL RESOURCE FUND OF KAZAKHSTAN (NRFK)

The NFRK was established in 2001 by presidential decree as a special account of the

Government of Kazakhstan with the National Bank. The government has changed the rules

governing revenues and current expenditures of the fund several times (Makhmutova and

Steiner 2005). Before 2007, there was separation between the savings and the stabilization

part of the fund. Although the rules have since been modified, the government’s attempt to

withhold control over a portion of oil-related revenues from parliament is instructive (Lücke,

M. 2010). A reference level for the world market oil price was established and oil-related

revenue accruing to Kazakhstan is calculated on this basis. From this hypothetical revenue,

10% is allocated to the NFRK savings portfolio – irrespective of the actual oil price. If the

price is higher than the reference price, excess revenues would go to the stabilization part of

the NFRK; if the actual price was lower, the stabilization fund could be drawn down to make

up for the shortfall, as long as funds were available (Lücke, M. 2010). Since mid-2006, all

government revenue from the oil sector is transferred to the NFRK, after being accounted for

in the state budget (Sartbayev and Izbasarov 2007).

The NFRK makes “guaranteed” transfers to the state budget to pay for development -related

expenditures (capital spending, health, and education) as well as “targeted” tr ansfers of a

more ad-hoc nature. Monthly tables on the Finance Ministry website list inflows and outflows

of the NFRK only by major categories. There is no published annual report or other



documentation of investment strategy or performance. So far, Kazakhstan is also not a

member of the International Forum of Sovereign Wealth Funds (SWF) that promotes the

“Santiago Principles” (IWG 2011) to increase the transparency and accountability of SWF

operations.

4.4 SUMMARY OF FUNDS

The table 2 below summarize the funds considered.

5.0 RECOMMENDATIONS

Looking through the attributes of the funds considered the paper make the following

recommendations considering the peculiarity of Nigerian economy and its needs.

The NSIA should be independent of executive interference so as to guarantee objectivity

in management operations;



The fund should not be seen as parallel government. Fund expenditures, especially for

infrastructural development should be incorporated into the budget process;

There should be a clearly defined operational standard on fund income and expenditure;

While saving for future generation implies intergenerational equity, a sizeable part of

the fund should be channelled towards infrastructural development. This is because,

such investment improves the wellbeing of present generation as well as the possibilities

of future generations;

The fund should not be seen to replace the responsibility of government, it should

complement government effort at national development;

The enabling law should spell out the composition of fund asset portfolio and any

ethical standards for investment;

There should be adequate system of control to check the activities of fund management

and guarantee reasonable utilization of fund; and

The government must avoid all the problems of past funds by making sure there is wide

consultation and agreement among all tiers of government.

5.1 CONCLUSSIONS

This paper reviiewed the resource funds in Norway, Azerbaijan and Kazakhstan and found a

array of objectives, operational rule and institutiional arrangements. This is as a result of the

numerous, sometimes contradictory objectives of the funds. While a strong, transparent

institutional framework, as in the case of Norway, is a neccesary requirement for its success

and sustainable growth, the lack of defined legal framework for withrawals and fund

utilization could spell problems for countries like Nigeria. As a result, it will be important

that the enabling laws is comprehensive and avoid ambiguities. The performance of the

funds for Azerbaijan and Kazakhstan still suffer from executive influence but there is



marked iimprovement in the transparency position of Azerbaijan fund. Nigeria should can

benefit in terms of transparency and management by joining the IWG for SWFs.

Design and Management of Nigeria's Sovereign Wealth Fund

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