Is East Africa Ready for a Sovereign Wealth Fund for its natural Resources?

Kenya, Uganda and Tanzania are among the new frontier economies in the oil and gas industry that have over the last decade announced significant hydrocarbon discoveries.

These East Africa Countries (EAC) countries have introduced laws to manage oil and gas resources for the benefit of all stakeholders. Kenya, for instance, introduced a petroleum act earlier this year; the Act stipulates that 75% of the proceeds from commercial oil and gas produced be retained by the national government, with county governments hosting the deposits receiving 20% and local community receiving 5%.

This is a departure from an earlier version of the petroleum bill which had 5% of oil royalties going to sovereign fund incorporated.

Tanzania, with an estimate of more than 55 cubic trillion of natural gas, also revised its petroleum act in November 2015; a major step towards the Country’s fiscal and economic stability, with the hope that the natural resources would promote social and economic progress for Tanzanians.

Natural resources, including oil and gas, are dire. They slowly run off over time and consequently a slow clock of resource depletion is inevitable. So what is the most rational approach for EAC governments, particularly Kenya, Uganda and Tanzania?

The region has an opportunity to learn from some of the best and worst models in the world and explore and adopt what works for EAC. It is therefore the responsibility of the political class, decision makers and policy makers to prime up the hydro carbon sector as a driver for wealth creation and regional integration.

Can the Norwegian Model Work for East Africa?

The Norwegian model is the most influential model used and talked about worldwide as far as natural resource is concerned. Norway is the most successful natural resources managed county in the world today, and has a sovereign wealth fund to manage their natural resources. So why is it not prudent for East African countries to adopt this model in managing their own natural resources? Why does it make economic sense for Norway to have a sovereign wealth fund but not EAC?

The answer lies in the economic structures of these two countries. The basic economics of these countries are different. Norway has a much higher invested capital stock to labour force ratio than any other country in the world. It is also the most capital-rich country in the world, and so by adding to Norwegian capital stock would not be very productive. It makes much more sense for Norway to buy more capital stocks in foreign countries such as Brazil or China which it does with its sovereign wealth fund. When a country has sufficient capital stocks domestically, adding stocks do not yield much return and therefore it makes better economic sense to buy capital assets in foreign countries since the return on those assets is higher and more productive.

On the other hand, EAC are on the extreme end, with totally different economic fundamentals. Not only do they have an underdeveloped manufacturing and agricultural sector, they also have less capital accumulation to labour force ratio than almost any other part of the world, consequently what makes economic sense for these countries is to use the savings from the natural resource proceeds to build capital stocks rather to fund their developmental needs rather than a sovereign wealth fund.

It is therefore prudent for these governments to adopt policies that focus on building the capacity to invest in capital stocks, which is what I call investing in investment. By doing this, governments will respect their obligation to the future generations as far as natural resources are concerned.

Capital stock involves the act of investment itself, a set of infrastructure developments, roads, rail networks, airports, public hospitals etc. It involves reducing consumption levels.

So is a Sovereign Wealth fund entirely Inappropriate Policy Approach for East African Natural Resources?

The simple Answer is no !

Sovereign wealth fund helps to avoid two inherent scenarios that countries with natural resource may experience.

One is what I will call plunder by the current generation of what should benefit future generations. It’s important to note that wealth from the natural resources are not only for the current but also for the future generations , and governments being a custodian of peoples interest are obliged to put in place policies that take in to account this aspect . One such policy tool is having Sovereign Wealth fund in place.

The other scenario is what Natural resource Economist refer to as the ‘‘Dutch Disease ’’ symptoms, this is a term used to refer to Negative consequence arising from an increase in a country’s income as a result of revenue wealth from the natural resource discoveries, which leads to huge increase in foreign currency inflows which subsequently results to Domestic currency appreciation in relation to foreign currency.

What this does is it contracts the entire economy by making exports expensive (especially those of other sectors say agricultural sector), thus having export sector uncompetitive on the global market, so to arrest this situation Sovereign wealth fund is necessary.

If government takes some of the foreign exchange realised from sale of Natural resource and put it in a fund that can be invested overseas, that pressure of domestic currency appreciation goes away.

What should be the question for policy makers is, what proportions of oil & Gas revenues should be invested in Sovereign wealth fund abroad? In respect to EAC there are many developmental needs that are currently pressing and putting all the revenue into a wealth fund overseas does not make economic sense. The proportion of revenue invested in a Sovereign wealth fund should only be enough to ease the appreciation of domestic currency which its adverse effects is a contraction of the entire economy. The rest which forms a greater percentage, should be invested domestically for developmental and provision of public services, by so doing governments of EAC will be taking care not only for the current but also future generations.