The Heritage and Stabilisation Fund 101 – Part Three

10 June 2016


Introduction

In the third of a three-part series we take a further look at the Heritage and Stabilisation Fund of the Republic of Trinidad and Tobago. We look at the future of the fund and discuss the desirability of splitting the fund into two distinct parts that reflect the funds dual purpose. We also take the opportunity to assess other reforms that may improve the returns of the HSF and the transparency and accountability of its operations.

Background

The Heritage and Stabilisation Fund (HSF) was created by Act number 6 of 2007 and received Presidential Assent on the 15th March 2007. The HSF is a successor fund to the Interim Revenue Stabilisation Fund (IRSF), with the balance on the IRSF being transferred to the HSF by provision of section 12 of the Act.

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The first part in this series of blog entries discussed the purpose of the HSF, what the fund comprises of, when the government is obliged to add to the fund, when the government is allowed by law to utilise the fund, whether a minimum balance must be retained on the fund, and who manages the fund on behalf of the citizens of Trinidad and Tobago. The first blog entry in this series may be found here.

 

The second part in this series of blog entries looked at the performance of the fund, the type of investments the fund has made, and how it ranks internationally against other sovereign funds of a similar type. The second blog entry in this series may be found here

We shouldn’t be dealing in Hybrids

The way the HSF is currently structured results in a “Hybrid” fund consisting of a stabilisation element and a heritage element.

The stabilisation element of the fund exists to insulate both fiscal policy and the economy of Trinidad and Tobago from the impact of adverse swings in international oil and gas prices. Since the government derives a large portion of revenue from oil and gas under normal conditions and depression in international prices has a knock on effect on the amount of funds available for the government to spend implementing its policies.

The heritage element of the fund exists to create a pool of savings for the use of and to the benefit of future citizens and recognises that oil and gas are finite assets.

The existence of a stabilisation element in the fund has a direct impact on the agreed Strategic Asset Allocation (SAA) of the fund. Because of the possibility of having 25% of the fund being withdrawn in any given financial year to cover shortfalls in governments anticipated revenue, a large portion of the fund has to be invested in liquid short term investments. These liquid short term investments by their very nature attract low yields and therefore don’t add significantly to the capital growth of the fund.

Contrast this to the heritage element. Because the heritage element of the fund is providing for the long term future (if you like the next generation) the need to withdraw funds is not present. Arguably to maximise the potential growth of the fund in this area it would make sense to invest in the regional markets and areas that are currently driving or expected to drive the worlds future growth. This means investing in emerging markets, something that is currently forbidden in accordance with the SAA. In addition, if you focus on the heritage element of the fund in isolation a greater proportion of the funds should logically be invested in equities since these generally provide higher returns albeit at a greater level of risk.

The contrasting needs of the Heritage and the Stabilisation elements of the fund are the most compelling reason for splitting them into two distinct funds. This would allow the creation of individual SAA’s that satisfy the specific but different aims of each part of the existing fund.

Should we even be focusing on Stabilisation?

There is also a compelling argument for considering the need to have a stabilisation element at all.

To the extent that a reduction in government revenue is caused by a temporary fall in oil and gas receipts such a temporary shortfall might better be covered by using the country’s foreign reserves (or at least a portion of them) first before resorting to the selling of underlying assets in the HSF. If adjustment in oil and gas prices appears to be more medium to long term than arguably the government would be best served in adjusting its expenditure plans down to reflect the lower levels of income expected moving forward.

The Arguments against having a Heritage and Stabilisation Fund

At some point in any discussion on the HSF one has to consider the inevitable question – do we really need a Heritage and Stabilisation Fund at all?

Consider the following:

  • Trinidad and Tobago has urgent infrastructure needs. Apart from improvements to roads and the delivery of clean water to every household, there is the issue of security and crime to deal with. In simple terms how can these needs be met if money is put aside for the future?
  • We are making assumptions about the future and the needs of the next generation without knowing what will happen or what those needs will be. Arguably future generations might better be served if we spend now to deal with the infrastructure problems that exist, and we use every available resource now to diversify the economy away from hydro carbon dependency.
  • Oil and gas reserves while finite won’t actually run out any time soon. New fields might well be discovered so in essence we may be planning for a finality that won’t come any time soon.
  • The economic conditions and the assumptions that existed at the time the fund was created in 2006 have fundamentally changed or in some instances no longer exist. Consider that at the time the fund was created Trinidad and Tobago was experiencing fiscal surpluses, abundant oil and gas revenue was anticipated to continue to generate future surpluses, volatility on financial markets was minimal and the expected return on investment was higher, and in general there was a brighter outlook for the discovery and exploitation of new fields. None of these conditions now exist because the world is a very different place to the one that existed in 2006.

Readers can draw their own conclusions on the merits and validity of such arguments.

Reforms to the Heritage and Stabilisation Fund that make sense

The writer submits that the following reforms to the HSF should be considered.

  • The fund should be split into two component fund elements reflecting the contrasting natures of those two elements. Once this is achieved separate SAA’s should be created for both the Heritage and Stabilisation elements of the fund
  • Consideration should be given to restricting the ability of the government to draw from the fund in consecutive financial years. If oil and gas prices are depressed for the medium-term (perhaps a new paradigm) then it would make sense for the government to consider cutting expenditure as a first means for balancing the books.
  • Incorporating the Heritage and Stabilisation Fund (or two individual funds if they are split) to give it its own legal status.
  • Increasing the floor of the combined fund or in the event that a single Heritage Fund is created removing the government’s ability to use the assets in the Heritage Fund.
  • Requiring an audit of the government funds to ensure that if the conditions are met the government does actually deposit into the HSF.
  • Clarifying the calculation of how much the government is expected to contribute into the fund in each calendar year. The way the legislation is currently framed makes it unclear as to whether the calculation should be performed quarterly or on a cumulative yearly basis. It would make sense to amend section 13) and 14) of the current Act to make it explicit that the assessments of projected versus actual revenues for each quarter are to be computed on a year-to-date aggregate basis.
  • Making it a legal requirement that the HSF can only invest in assets outside of the oil and gas arena.
  • Providing clarification on the formula to be used to determine the reference commodity prices for oil and gas.
  • Consideration should be given to increasing the surplus percentage from 60% to 80% because the IMF and Moody’s are essentially right. We simply don’t save enough.
  • Consideration should be given to investing some of the funds contained in the HSF into renewable energy projects. Although Trinidad and Tobago currently has a viable oil and gas industry it is based on a non-renewable and depleting basket of assets. Oil and gas will not last for ever so sooner rather than later we will reach a stage where our oil and gas industry is no longer viable. We need to plan for that now.
  • Resources should be channelled into greater efforts to diversify the economy away from oil and gas. This is an area we will return to in future blog entries.

Definitions used in this series of blog entries

In accordance with the terms of the Heritage and Stabilisation Fund Act, Petroleum Revenues means the aggregate of the supplemental petroleum tax, petroleum profits tax and royalties but does not include unemployment levy, the oil impost and signature bonuses. The term Consolidated Fund is not defined in the Heritage and Stabilisation Fund Act but is assumed to mean the general revenue and expense account of the Government of the Republic of Trinidad and Tobago as defined in section 13 of the Exchequer and Audit Act of 1959.

Closing thoughts – time to consider your investing strategies

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