Seven Reasons Against Creating a Myanmar Sovereign Wealth Fund

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Seven Reasons Against Creating a Myanmar Sovereign Wealth Fund By Oliver Gilbert*

Introduction Once labeled as part of the “axis of tyranny” by former U.S. Secretary of State Condoleezza Rice, Myanmar’s sweeping democratic and economic reforms over the past two years have attracted wide international attention and prompted foreign individuals and corporations to eagerly eye Myanmar, also known as Burma, as a “final frontier” for foreign direct investment.i Notably, among these potential investments includes the opportunity to further develop Myanmar’s proven energy reserves of approximately 11.8 trillion cubic feet of natural gas and 50 million barrels of crude oil. ii The anticipated influx of investment in the petroleum sector has underlined the need to implement resource management strategies to mitigate problems associated with the “resource curse” that have historically accompanied some countries’ rapid utilization of natural resources. Among these potential strategies is the suggestion by former World Bank Chief Economist and Nobel Prize in Economics winner, Joseph Stiglitz that Myanmar should establish a sovereign wealth fund (SWF) to manage petroleum revenues. iiiiv Sovereign wealth funds are special state-owned funds that generally use foreign exchange reserves to achieve a variety of economic or strategic objectives. Multiple countries have established resource-funded SWFs with mixed results; however Myanmar’s current political and economic landscape cannot support the creation of a responsibly managed SWF at this stage in the country’s national development.

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Oliver Gilbert is an American foreign policy analyst with over seven years of international research experience gained from working in North America, Europe, Africa, and Asia. Oliver holds a B.A. in International Relations from George Washington University and an M.A. in Global Security Studies from Johns Hopkins University. For the past year, Oliver has worked in Chiang Mai, Thailand researching the impacts of transnational oil and gas pipelines in Myanmar. Oliver is a native English speaker and is conversational in Thai.

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Myanmar lacks a balance of payments surplus necessary to responsibly fund a SWF According to Martin Skancke, the Director General of the Norwegian Ministry of Finance, “If a [sovereign wealth] fund is set up with an allocation rule that is not linked to actual surpluses, the accumulations of assets in the fund will not reflect actual savings.”v India recently canceled its existing plans to establish a SWF because of the country’s basic lack of foreign exchange reserves and its projected balance of payments deficits, expected to be approximately 5% of GDP.vi In comparison, Myanmar currently runs an approximately 3.2% deficit for 2012-2013.vii This is an improvement from the previous year’s 4.9% deficit, but coupled with Myanmar’s billions of dollars of external debt, the deficit remains a signal that Myanmar must fulfill financial obligations and balance spending priorities before sterilizing large amounts of national revenue in a SWF. viii Failure to do so may prove any speculative financial investment with a SWF to be as impractical as an individual accumulating credit card debt to invest in the stock market in the hopes that gains will cover the cost of borrowed capital.ix Myanmar lacks technocratic expertise necessary to provide domestic oversight of a SWF Sovereign wealth funds are complex financial vehicles that are managed separately from other central bank activities because funds generally require flexible and innovative methods generally considered outside the scope of regular budgetary operations. x As a result, SWFs require clear financial and legal oversight to articulate a fund’s core mission, management, and allocation structure. When crafting this framework, domestic financial technocratic oversight is often preferable to exclusively foreign expertise to ensure domestic interests are represented and that investment decisions are made following a well-informed understanding of alternatives. After decades of isolation, Myanmar’s banking system remains practically non-existent and the country has very little financial management experience that could be applied towards creating a Myanmar SWF.xi According to Sean Turnell, an expert on Myanmar’s economy at Macquarie University, Myanmar’s economic governance is limited “to a handful of individuals skilled in policy formulation, and fewer still schooled in the attributes necessary for institution building.”xii Turnell also reports that “the IMF and WB have found few, if any, legally qualified (or skilled) counterparties in the Myanmar government” to assist the drafting of laws. xiii The lack of these basic skills is so severe that Myanmar frequently subcontracts legislation drafting to outside partiesxiv where on one occasion, a South Korean sub-contractor’s flawed translations for a corporate taxation law ultimately rendered the law unenforceable.xv Ultimately, the complex inputs necessary for creating a responsibly outlined SWF depend on technocratic expertise that is absent in Myanmar and the lack of this expertise may result in SWF policies and objectives that are disconnected from local perspectives.

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Myanmar does not need a SWF to manage adverse macroeconomic effects of the resource curse Sudden injections of foreign revenue from the sale of resources can trigger a phenomenon known as “Dutch Disease” where the influx of foreign capital causes the real exchange rate to rapidly appreciate followed by wage inflation.xvi Goods then become less competitive in the global marketplace because trading partners are forced to pay higher costs for the same products as a result of purchasing goods with a more expensive currency, also leading to accompanying currency exchange stability.xvii In theory, SWFs can help manage currency exchange rate stability. However, a study regarding SWF Dutch Disease conducted by the Australian Industry Group, an industry group representing over 60,000 Australian businesses, found that SWFs can assist stabilization, but cannot insulate economies from currency appreciation alone and should be complemented by structural reforms to national tax systems, labor market practices, and competition policies.xviii In addition, commodity price volatility in resource-dependent states can inflict severe budgetary crisis. Accordingly, SWFs can govern fund contributions and withdrawals to provide a more dependable estimate of how much resource revenue is available to fund state spending regardless of commodity prices. One successful example of this type of SWF is Trinadad and Tobago’s Heritage Stabilization Fund, established in 2000 and financed with petroleum revenues.xix By establishing an elevenyear price average system, the Fund set estimates of oil prices at US$45 per barrel in 2007xx and when oil’s global price sharply rose in 2008, Trinidad and Tobago gained an additional US$3 billion, or 11% of the country’s GDP.xxi However, without technocratic expertise to design and manage intricate SWF systems, it is unlikely that Myanmar could expect similar successes. Lastly, Deputy Minister of Finance and Revenue, Dr. Maung Maung Thein, commented in late January 2013 that, “commodity price[s] and exchange rate[s] seem stable”, and therefore it is imprudent to divert state funds from much needed development programs to alleviate stability problems that does not yet exist.xxii Myanmar can achieve economic diversification without creating a SWF According to the resource curse theory, resource-dependent countries that fail to diversify their economies can trigger a variety of adverse macroeconomic conditions, including exchange rate and commodity price stability problems, detailed in the previous section. As a result, multiple petroleum-rich states have sought to diversify their economies by using SWFs to make international investments in a variety of global sectors. However, even if a Myanmar SWF could manage stabilization operations, there is wide consensus that countries should prioritize domestic economic diversification over creating a financial safety net to protect against macroeconomic volatility. xxiii Therefore, Myanmar would realize greater benefits by encouraging the development of existing sectors, directing funds towards domestic diversification programs, and strengthening underlying financial policies instead of establishing financial tools to compensate for the lack of initiating these reforms.

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Myanmar derives a large percent of its GDP from petroleum exports, but additional renewable and non-renewable commodities offer promising opportunities for diversification. Myanmar has significant teak, hardwood, gem stone, and garment industries. In addition, Myanmar is the world’s second largest exporter of beans and pulses after Canada. Moreover, tourism grew by 40% from 2011 to 2012 and Myanmar is currently working on a master tourism plan with the ADB and the German-based Hans Seidel Foundation to further expand tourism infrastructure and services.xxiv Myanmar was also formerly known as the “rice bowl of the world” for its globally leading rice exports before the failed “Burmese Way of Socialism” policy sharply reduced agricultural productivity. According to the International Rice Research Institute, Myanmar could improve or regain its agricultural sector’s former status by expanding access to credit for farmers, increasing storage and production facilities, and improving transportation systems.xxv Furthermore, SWFs do not guarantee diversification. Paradoxically, a 2007 IMF report found that “the more reliant a country is on one commodity, the less effective its SWF is in achieving its goals.”xxvi Venezuela’s SWF, the National Development Fund, or Fonden Fund, is a shining example of this dependency. Aside from being a glaring instance of corruption, Fonden’s management of petroleum revenue actually contributed to the increase of Venezeula’s dependence on oil exports, from 80% ten years ago to 96% of exports in 2012. xxvii

Lastly, a 2008 report by Deloitte found that SWFs can, “move up the value curve quickly as they acquire intellectual property and access to research, design, and development that may take years to develop at home.”xxviii However, SWF experts Monk and Dixon have argued that funds, “do not offer an alternative to developing a capable and active workforce.”xxix Therefore, acquisitions of intellectual property by SWFs would likely be of little consequence unless Myanmar’s widely undertrained domestic workforce can actually apply acquired technology towards domestic commercial operations. Creating a Myanmar SWF would carry an excessive opportunity cost SWFs are not inherently guaranteed to succeed due to economic downturns or poor management decisions…and when SWFs lose money, they lose lots. Norway’s SWF, the Norwegian Pension Fund-Global, is considered a world-class example of good governance, transparency, and fund management. However, in 2008, the fund was not immune from the global financial crisis and lost 23% of its value, or approximately US$100 billion. xxx Moreover, funds can suffer even under the expert management of world leading financial services providers. In 2007, Goldman Sachs lost 98% of its allocation of Libya’s US$1.3 billion SWF.xxxi Lastly, even after the worst of the financial crisis, Bahrain’s US$9 billion fund lost US$717 million in 2011.xxxii Similar to concerns of capital loss or destruction, SWFs can underperform in regards to other options available to governments. A team of researchers evaluating Australia’s Future Fund found that the Fund had a negative .3% return compared to investing in standard government 90 day bank bills, effectively questioning the fund’s already transparent management and the opportunity cost of the SWF over standard central bank operations. Furthermore, a report by Revenue Watch also found that domestic investments funded with extractive revenue have a higher social rate of return, such as increasing domestic skills,

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health, or security, compared to SWF assets “sterilized abroad and therefore [make] a better way to transfer wealth across generations.”xxxiii In the same report, Takizawa et. al found that countries with low capital stock, like Myanmar, earn greater benefits from public spending with oil wealth in the present rather than saving for the future. In addition, Van der Ploeg and Venables argue that countries should only establish a SWF after accelerating state development with accumulations of public and private capital. Myanmar is already in crisis. While the country is recovering through its recent emergence in the global economy, the opportunity cost of saving for future challenges or manipulating Myanmar’s economic landscape when Myanmar already exhibits severe symptoms of state failure is not in Myanmar’s social or economic best interests. Myanmar lacks the necessary political consensus to manage a SWF Opposing political interests can force SWFs to diverge from original investment strategies or waste revenue if fund objectives change with each leadership cycle. Myanmar has deep political divisions that must be resolved prior to establishing a SWF to ensure fund operations function as originally planned. Myanmar’s constitution guarantees the military 25% of elected seats in parliament and the military has expressed its unwillingness to cede control because of the need to “safeguard” ongoing reforms. xxxiv This heavy hand could repurpose a SWF in the name of vaguely defined safeguarding efforts. However, Myanmar’s election in 2015 could also result in greater parliamentary success for the NLD and bring a large number of new representatives to government, each with their own interests for how to manage resource revenue. As a result, long-term financial planning tools, such as a SWF, should wait until after 2015 to reasonably gauge prevailing political opinions about the necessity of creating a fund or defining its investment objectives. Furthermore, political control over the ministry that houses a country’s SWF can determine which political party can set spending priorities with the country’s resource wealth. Divisions such as these can be observed in ongoing feuds with SWF planning in Zimbabwe, and in Nigeria, where thirty-six state governors went to court to block the creation of a petroleumbased SWF because annual payouts would decrease state income and because the governors do not trust the leaders in control of the fund. In fact, states or divisions in multiple countries that are dependent on their region’s resource wealth have worried about funneling state funds into a national fund. In a report on SWFs for the Canadian International Council, Madelaine Drohan, a Canadian correspondent for The Economist, recently recommended against establishing a national Canadian SWF because doing so would deny revenue to Canada’s provinces.xxxv In comparison, Myanmar’s Farmland Act and the Vacant, Fallow, and Virgin Land Law specify that the central government owns all land and resources in Myanmar and does not provide any type of resource profit-sharing system for individual divisions and states. These laws are currently under review to provide greater local and regional benefits, but anticipated changes have not yet been finalized. In light of Myanmar’s existing legislation and the global lessons for similar state-level revenue sharing considerations, Myanmar must resolve its land ownership and resource

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profit-sharing disputes before establishing a SWF that could detract critical funds to specific at-risk regions. Myanmar’s extreme corruption would lead a SWF to fail In a survey of 2,662 investments by 29 SWFs made between 1984 and 2007, a team of Harvard Business School (HBS) researchers found that the “political process can introduce short-run pressures on SWFs to accommodate public demands for job creation and economic stabilization within the country” and lead to political intervention that sharply deviates from originally stated plans for long-term maximization. In addition, states may succumb to pressures to grant politicians managerial control over funds instead of ensuring that financial experts and technocrats manage state funds. In the same study, the HBS team compared SWF management to the International Country Risk Guide, a widely accepted metric of country corruption that ranks countries from zero (most corrupt) to ten (least corrupt), and discovered that each point of additional corruption creates a 10.8% greater likelihood that countries with direct investments domestically. Alarmingly, the researchers also observed that politically influenced funds that made direct domestic investments significantly underperformed by 16% in the following six months compared to funds managed by experts without domestic political interference who would otherwise be predisposed to invest globally. According to the 2011 Corruption Perception Index, an annual index released by Transparency International that gauges perceptions of domestic corruption, Myanmar ranked among the most corrupt states in the world at 180 out of 183 countries. xxxvi Myanmar’s extreme corruption and the opaque nature of many global petroleum-fueled SWFs casts serious doubt on the ability of a SWF to overcome significant political pressure that has previously ruined funds or resist corrupt abuses by government officials. Most alarming, however, is the additional corruption that could occur with a SWF. According to a report by Quartz, SWFs do not consistently lead to reductions of corruption in petroleum statesxxxvii and SWFs can serve as slush funds for additional corruption. This is particularly alarming given Myanmar’s privatization reforms, known locally as “pocketization” due to state owned businesses being sold off to well-connected individuals with deep crony ties to government leaders.xxxviii If government leaders are successful in biasing fund objectives to direct SWF investments domestically, as described above, a Myanmar SWF could be used as a seemingly legitimate way to further fund illegitimate crony interests under the guise of domestic economic development. Conclusion Myanmar lacks the basic prerequisite capacities for establishing a SWF and the Ministry of Finance must demonstrate its ability to manage resource revenue prior to outsourcing the responsibility of extractive revenue management to foreign SWF managers or advisors. At best, a Myanmar SWF is far from a panacea to mitigate revenue management and resource curse concerns. At worst, contributions to a Myanmar SWF would poorly prioritize limited funds away from sectors in crisis and could be abused by corrupt interests. Therefore, Myanmar should primarily focus on building underlying state capacities and should not establish a SWF at this stage in its national development.

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References Barta, Patrick. "Final Frontier: Firms Flock to Newly Opened Myanmar." Wall Street Journal. N.p., 12 Nov. 2012, i

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xxii

Thwe, Khin M. "Burma's Budget Deficit Falls to 3.2 Percent." Mizzima. N.p., n.d. Web. 26 Mar. 2013. xxiii Heuty, Antoine, and Juan Aristi. "Fool's Gold: Assessing the Performance of Alternative Fiscal Instruments During the Commodities Boom and the Global Crisis." Revenue Watch. Web. 1 Mar. 2013. xxiv "Mizzima News." Burma Developing Master Tourism Plan. Web. 01 Mar. 2013. xxv "Can Burma Become World Rice Bowl Again?" The Irrawaddy Magazine. Web. 01 Mar. 2013. xxvi Balin, Bryan. "Sovereign Wealth Funds: A Critical Analysis." Johns Hopkins University, 23 Dec. 2009. Web. xxvii "Special Report: Chavez's Oil-fed Fund Obscures Venezuela Money Trail." Reuters. 26 Sept. 2012. Web. 01 Mar. 2013. xxviii Rajagopalan, Priti. "Insurance Firms: The Missing Link in the Sovereign Wealth Fund Acquisition Spree." Deloitte. Web. 1 Mar. 2013. xxix Dixon, Adam, and Ashbey Monk. "The Design and Governance of Sovereign Wealth Funds." Web. Oct. 2011. xxx Qvigstad, Jan F. "The Global Economic Crisis and Its Impact on Sovereign Wealth Funds – the Example of Norway." Norges Bank. Web. 1 Mar. 2013. xxxi Fontevecchia, Agustino. "Goldman Sachs Lost 98% of Libya's $1.3B Sovereign Wealth Fund Investment." Forbes. Forbes Magazine, 31 May 2011. Web. 01 Mar. 2013. xxxii "Bahrain’s Sovereign Wealth Fund Sees Losses Widen." Reuters. Web. 1 Mar. 2013. xxxiii Heuty, Antoine, and Juan Aristi. "Fool's Gold: Assessing the Performance of Alternative Fiscal Instruments During the Commodities Boom and the Global Crisis." Revenue Watch. Web. 1 Mar. 2013. xxxiv Williams, Michael. "The Next Campaign: Cementing Power." Reuters. Ed. Bill Tarrent. 16 Nov. 2012. Web. 3 Mar. 2013. xxxv Yew, Madhavi. "The Case for Sovereign Wealth Funds in Canada." The Star. 8 Jan. 2013. Web. 03 Mar. 2013. xxxvi "Corruption Perceptions Index 2011 View Country Results." Transparency International. Web. 03 Mar. 2013. xxxvii "Do Sovereign Wealth Funds Actually Curb Oil Corruption?" Quartz. Web. 03 Mar. 2013. xxxviii Turnell, Sean. "Burma's Economic Transition: Where It's At, Where It Might Go." AsiaLink, May 2012.

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