This document discusses sovereign wealth funds (SWFs) and their potential role in macroeconomic stabilization in home economies. It begins by explaining what SWFs are and how they differ from foreign reserves, pension funds, and private wealth funds. The document then discusses several research areas related to SWFs, including their potential impacts on home countries. It finds that SWFs can help facilitate fiscal stabilization and savings. The document outlines some methodological issues in analyzing the impacts of SWFs and describes its analysis of how SWFs may reduce fiscal procyclicality and improve fiscal balances/sustainability in home countries. It finds evidence that SWFs are most effective when complemented by other fiscal institutions like rules and

1. SOVEREIGN WEALTH FUNDS AND
MACROECONOMIC STABILIZATION IN THE
HOME ECONOMY
Ibrahim Elbadawi (ERF)
Raimundo Soto (Pontificia Universidad Católica, Chile)
Hoda Youssef (World Bank)

2. WHY HAVING SWF?
 SWF are not “foreign reserves”.
 Central banks focus more on liquidity and safe-keeping of
reserves. SWFs focus on returns, diversification, and risk-taking
and to a large extent they are institution-building mechanisms
 SWF are not “pension funds”
 SWFs are not financed with contributions from pensioners and
do not have a stream of liabilities committed to individual
citizens.
 SWF are not “private wealth funds”
 Objectives of SWFs are usually more complex
 Impacts of SWF on home economies may go beyond those of
foreign reserves, pension funds, or private investment vehicles 2

3. SOVEREIGN WEALTH FUNDS
 Research Areas in SWF
 What role for SWF?
 Why are there SWF?
 How to best set up and manage SWF?
 What are SWF’s effects on global capital markets?
 What drives SWF investment strategies?
 What are SWF’s effects on home economies?
3

4. POTENTIAL IMPACT OF SWF ON HOME COUNTRIES
 Facilitate fiscal stabilization and fiscal saving
 Also introduce more professional and comprehensive investment
and risk management frameworks
 Enhance transparency and accountability in the management of
government financial assets.
 Support monetary policy
 Exchange rate management, if appropriate SWF investment policies
 Better management of the public-sector balance sheet
 Improve asset management strategy when SWF are consistent with
an economy’s underlying macro-fiscal objectives.
 Improve external stability in the current and capital account.
 Relevant for countries with SWFs and/or receiving large SWF
inflows.
4

5. POTENTIAL IMPACT OF SWF ON RESOURCE-RICH
COUNTRIES
 Help managing excess reserves being accumulated during good
times (particularly in countries with fixed exchange regimes).
 Help break the link between resources windfalls and
government expenditures that exacerbates boom and bust
cycles. Procyclicality is a crucial issue for Arab oil-rich
countries.
 In fact, it is an issue for emerging economies and resource
rich countries as well
 Even “graduated countries” can have relapses (Frenkel et al,
2013). Global crisis and its aftermath. 5

6. EFFECTIVENESS OF SWF ON FISCAL
PROCYCLICALITY
 Key issue: when SWFs are associated with better fiscal
outcomes, what causality?
 Do countries with prudent fiscal policies tend to establish SWFs?
 Do SWF help in adopting a counter-cyclical fiscal policy?
 If the inception of SWF is endogenous, econometric models
would yield inconsistent (biased) estimates of the effects of the
potential contribution of SWF to dampening fiscal procyclicality
(or, more generally, supporting the fiscal stance).
6

7. EFFECTIVENESS OF SWF ON FISCAL
PROCYCLICALITY
 Previous case studies.
 SWF are not per-se successful in making budget expenditures
less driven by revenues availability, commitment to fiscal
discipline & sound macroeconomics are key (Fasano, 2000).
 SWF do not have impact on expenditure volatility due to lack
of integration with the budget, institutional weaknesses, and
inadequate controls (Le Borgne and Medas, 2007).
 Implicitly, all assume SWF are exogenous.
7

8. EFFECTIVENESS OF SWF ON FISCAL
PROCYCLICALITY
 Case studies evidence for resource-rich economies.
 Bjørnland and Thorsrud (2015): SWF in Norway has induced
more (not less) procyclicality with commodity prices since
2001: rule of withdrawing a fixed percentage of a growing
fund each year is not sufficiently countercyclical over the
commodity price cycle.
 Corbo et al. (2016) also conclude that, by design, Chile’s SWF
rule is not countercyclical (actually, a-cyclical) and not an
adequate stabilization instrument.
8

9. EFFECTIVENESS OF SWF ON FISCAL
PROCYCLICALITY
 Other studies.
 SWF contribute to smoothing government expenditures in 68
resource-rich countries (Sugawara, 2014). Government
expenditures are but one part of the issue. SWF are
exogenous.
 The ability to conduct countercyclical fiscal policy depends
on the quality of their institutions and/or the availability of
financial resources either in domestic or international capital
markets (Calderón et al. 2016, Frenkel et al., 2013).
 Omitted from previous research
9

10. MAIN OBJECTIVES OF THIS PAPER
 We investigate whether the existence of a SWF helps dampening
or overcoming fiscal procyclicality. We test the effects of SWF on
fiscal balances and, thereby, on fiscal sustainability. We discuss
whether oil-rich countries are different.
 Why fiscal procyclicality?
 Costly stop-and-go policies can induce macroeconomic volatility, depress
investment in real and human capital, hamper growth, and harm the poor.
 Expansionary fiscal policies in good times that are not fully offset in bad times
may produce a large deficit bias and lead to debt unsustainability and
eventual default.
 Complements our companion paper on investment strategies
10

11. METHODOLOGICAL ISSUES
 Unveiling the impact of SWF on the fiscal stance:
 Has the treatment (implementing a SWF) had any discernible effect
on fiscal procyclicality or fiscal balances?
 Controlling for other potential determinants of the fiscal stance
 Recognizing countries are quite heterogeneous (individual effects)
 Capturing the characteristic significant inertia of fiscal variables
 General model:
𝑃𝑖𝑡 = 𝑓 𝛼𝑖, 𝑥𝑖𝑡, 𝐷𝑖𝑡, 𝑃𝑖𝑡−1
 Causal effects depends crucially on the validity of the implicit or
explicit identification assumptions:
 Treatment must be exogenous
11

12. METHODOLOGICAL ISSUES
 General econometric model:
𝑃𝑖𝑡 = 𝑓 𝛼𝑖, 𝑥𝑖𝑡, 𝐷𝑖𝑡, 𝑃𝑖𝑡−1 + 𝜀𝑖𝑡
 Use dynamic panel-data models to account for heterogeneity,
fundamentals, and inertia
 Instrumental variables in first-differenced model (Arellano-
Bond GMM-type estimator)
 This would not solve endogeneity issues in the treatment
variable
12

13. METHODOLOGICAL ISSUES
 Endogeneity of fiscal institutions
 SWF may be endogenously set up as a response to the fiscal
stance: reverse causality from fiscal outcomes to SWF
 Create an instrument to deal with such endogeneity
 Probit-model for the presence of a SWF in 146 countries 1984-2015
 Use predicted probability of having a SWF in place as instrument
 “Fundamentals” –which are lagged—include
 Export proceeds: foreign trade (% GDP), export concentration,
and natural resource rents (% GDP).
 Macroeconomic stance and general development level:
inflation and real per capita GDP in US$.
 Government revenue structures: revenue instability (coefficient
of variation of revenues computed using a rolling three-year
window) and federalism.
 Idiosyncratic factors: including a dummy for GCC economies.
 Institutional factors: political participation and accountability
13

14. INSTRUMENTATION OF FISCAL RULES & COUNCILS
 We also control for two other key fiscal institutions: Fiscal Rules
and Fiscal Councils
 These are independent public institutions aimed at strengthening
commitments to sustainable public finances through various
functions, including public assessments of fiscal plans and
performance, and the evaluation or provision of macroeconomic
and budgetary forecasts.
 May be endogenous, therefore we create instruments for probability
 We follow Schmidt-Hebbel and Soto (2017) to select the
appropriate set of fundamentals and generate instruments for four
national rules placing limits on government debt and government
expenditure, as well as targets on revenues and the fiscal balance. 14

15. MEASURING FISCAL PROCYCLICALITY
 We define and measure procyclicality as:
 Correlation of the cycle in government expenditures and the cycle of
GDP, both at constant prices.
 Correlation of the cycle in fiscal balances and the cycle of GDP, both
at constant prices.
 The data were obtained from World Development Indicators,
World Economic Outlook, and IMF Fiscal Database
 Cycles: we de-trend variables in logs using the HP filter
 Correlations: we use 10-year rolling correlations to avoid
transient phenomena (5 years yield similar results).
15

16. DETERMINANTS OF FISCAL PERFORMANCE
 In addition to our SWF instrument, we control for the
following sets of “fundamentals”
 Access to borrowing by governments. Capital account
openness and financial development largely determine the
ability of governments to borrow money in domestic and
external markets to fulfill their financial needs.
 Institutional determinants of fiscal performance. Political
representation, political accountability, perceived political
stability of government, corruption, fiscal federalism.
 Exchange-rate and monetary regimes. Exchange regime (de
jure and de facto), monetary unions.
 Fiscal Institutions. Fiscal rules (instr.), fiscal councils (instr.),
fiscal revenue instability and SWF (instr.)
 Cyclical phenomena. Business cycles, resource-rent cycles and
price instability.
 Overall development, as customarily measured by GDP per
capita in constant US$ of 2000.
16

17. MAIN RESULTS I: PROCYCLICALITY OF
GOVERNMENT EXPENDITURES
 Find significant inertia in fiscal outcomes ⇒ static models
are inadequate. 90% of a shock dissipate in 4 years.
 Countries tend to have lower levels of procyclicality if
 They belong to monetary unions
 Inflation is low
 Business cycles are smaller
 Fiscal revenues are stable
 We found no role for political instability, political regimes,
or political accountability.
 SWF significantly lower procyclicality
 Reinforced by a fiscal rule on expenditures
 Not reinforced by fiscal councils.
17

18. MAIN RESULTS II: PROCYCLICALITY OF FISCAL
BALANCES
 Find significant inertia in fiscal outcomes ⇒ static models
are inadequate. 90% of shocks dissipate in 9 years.
 Countries tend to have lower levels of procyclicality if
 They belong to monetary unions
 Inflation is low
 Business cycles are smaller
 Fiscal revenues are stable
 Political accountability (checks and balances) is high
 We found no role for political instability, political regimes.
 SWF significantly lower procyclicality
 Reinforced by a fiscal rule on debt ceilings but (surprisingly)
hampered by balance rules
 Not reinforced by fiscal councils.
18

19. MAIN RESULTS III: FISCAL BALANCES
 Find significant inertia in fiscal outcomes ⇒ static models
are inadequate. 90% of shocks dissipate in 9 years.
 Countries tend to have “better fiscal stance” if
 They are more stable in political terms
 If they conduct monetary policy using fixed exchange regimes
 Hit by (transitory) upswings in business cycles or resource
prices
 SWF significantly improve “fiscal stance and
sustainability”
 Direct effect and indirectly by lowering revenue instability
 Direct effects larger in more developed economies
 Expenditure fiscal rules enhance the positive effect of SWF, but
revenue rules works in the opposite 19

20. IMPLICATIONS FOR GCC ECONOMIES
 GCC countries pioneers of SWF (Kuwait, Saudi Arabia)
 GCC hold around 40% of SWF wealth (2017)
 Fiscal sustainability not an issue in most GCC
 Fiscal procyclicality is an issue:
 most SWF are not stabilizing instruments
 SWF however
 Are not enough to instill fiscal discipline
 Have not supported building modern fiscal institutions
 Are not supported by other fiscal institutions (rules, councils)
20

21. CONCLUSIONS
 In this paper we:
 Study the likely effects of SWF on the fiscal stance of the
home economy
 Fiscal stabilization and fiscal saving (sustainability)
 Fiscal procyclicality is a key issue for most Arab oil/gas exporters
 Fiscal procyclicality/stability are key issues for most emerging
economies
 Provide a rigorous methodology to deal with
 Unobservable country heterogeneity
 Isolating the role of SWF from other determinants of fiscal stance
 Inertia and dynamic adjustments
 Potential endogeneity of fiscal institutions: SWF, fiscal rules, fiscal
councils
21

22. CONCLUSIONS
 In this paper we:
 Create measures of fiscal procyclicality and instruments for
fiscal institutions
 Test our models using data for 140 countries in the period
1984-2015 (data availability)
 Find that SWF do have a stabilizing effect in the home
economy as they reduce fiscal procyclicality
 Find that SWF do increase fiscal sustainability in the home
economy as they improve fiscal balances
 Other fiscal institutions complement and amplify the benefits
of SWF, such as fiscal rules and (less clearly) fiscal councils
 Are aware that SWF can have other unmeasurable benefits
(fiscal transparency, accountability, etc.)
 Suggests a road for GCC as well as non-GCC MENA countries
22

23. APPENDIX
23

24. MAIN TYPES OF SWF
 Stabilization funds
 Savings funds
 Reserve investment corporations
 Development funds
 Contingent/pension reserve funds
 We do not separate SWF by type since
 SWF may be hybrids
 Money is fungible (with varying costs)
 Circumstances dictate
24

25. HIGH OIL-PRICE PROCYCLICALITY IN GCC COUNTRIES
25

26. MILD/NO OIL-PRICE PROCYCLICALITY IN GCC COUNTRIES
26

27. OIL-PRICE PROCYCLICALITY IN OTHER ARAB COUNTRIES
27

28. LINABURG-MADUELL SWF TRANSPARENCY INDEX
28
Source: SWFI

29. FIGURE 1
PROCYCLICALITY IN GOVERNMENT EXPENDITURES AND DEVELOPMENT LEVEL, 1980-2015
29
On average, negative
relationship …
… but there’s a lot of
heterogeneity
Per capita GDP US$ 13,500

30. FIGURE 2
PROCYCLICALITY IN GOVERNMENT EXPENDITURES AND RESOURCE RENTS, 1980-2015
30
On average, positive
relationship …
… but there’s a lot of
heterogeneity
Rents per capita US$ 500

31. ON GRADUATION FROM FISCAL PROCYCLICALITY
FRANKEL, VEGH, VULETIN, 2013
31
Fiscal Procyclicality
Fiscal Countercyclicality

32. ON GRADUATION FROM FISCAL PROCYCLICALITY
FRANKEL, VEGH, VULETIN, 2013
32