Sovereign wealth funds and macroeconomic stability in oil‐exporting African countries

• Author: Mutiu Gbade Rasaki,Christopher Malikane
• DOI: http://doi.org/10.1111/opec.12128
• Date: 01 June 2018
• Published date: 01 June 2018

Sovereign wealth funds and macroeconomic

stability in oil-exporting African countries

Mutiu Gbade Rasaki and Christopher Malikane

Mutiu Gbade Rasaki is a Postdoctoral Fellow and Christopher Malikane is an Associate Professor, Macro-

Financial Analysis Group, School of Economic and Business Sciences, University of the Witwatersrand, 1

Jan Smuts Avenue, Johannesburg 2050, South Africa. Email: mutiurazaq@gmail.com

Abstract

This paper investigates the effectiveness of sovereign wealth funds (SWFs) in reducing

macroeconomic volatility occasioned by oil price shocks in oil-exporting African countries. The

oil price boom-bust cycles complicate fiscal operations, distort budget implementation and trigger

macroeconomic instability in oil exporting African countries. We formulate and simulate a

dynamic stochastic general equilibrium model that features SWFs and the fiscal sector. We

compare a baseline model without the SWFs to a model with the SWFs. The simulation analysis

suggests that the establishment of SWFs can mitigate the vulnerability of oil-exporting African

countries to oil price shocks. In particular, SWFs can reduce fiscal expenditure and real exchange

rate volatility. Furthermore, SWFs can stabilise the level of external debt and reduce the level of

money supply thereby sterilising the oil revenue. Since oil price shock is one of the important

external shocks inducing economic instability in oil-exporting African countries, the creation of

SWFs can insulate these economies from external shocks.

1. Introduction

Unpredictable and volatile oil price is one of the macroeconomic challenges facing oil-

exporting countries. Sharp and persistent fluctuations in oil prices distort fiscal

operations and create fiscal uncertainty in oil-exporting countries (see El Anshasy and

Bradley, 2012; Spatafora and Samake, 2012). More so, fluctuations in oil prices induce

exchange rate volatility in oil-exporting countries leading to the Dutch disease syndrome

(see Blokhina et al., 2016). Furthermore, studies have also shown that oil price shocks

induce macroeconomic instability in oil-exporting countries (see Mehrara and Oskoui,

2007). To deal with the macroeconomic challenges caused by oil price shocks, different

measures have been proposed. A number of studies recommend fiscal rule and

strengthening of fiscal institutions (see Baunsgaard, 2003; Frankel, 2011), while others

recommend the establishment of sovereign wealth funds (SWFs) (see Shabsigh and Ilahi,

2007; Mehrara et al., 2012).

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The gap that this study seeks to fill is to examine whether the establishment of SWFs

can reduce macroeconomic instability in oil-exporting African countries. While findings

have shown that the establishment of SWFs can minimise macroeconomic uncertainty in

oil producing countries (see Usui, 2007; Basu et al., 2013), there have been few

empirical studies evaluating the effectiveness of SWFs in oil-exporting African

countries. Few studies such as Triki and Faye (2011) only discuss the potential roles

the SWFs can play in African economies. The creation of SWFs has been identified as an

important mechanism for reducing income volatility and macroeconomic instability in

oil-exporting countries (see Mehrara et al., 2012).

This study is significant for policymakers in oil-exporting African countries. Given

the strong positive correlation between oil revenue and government expenditure in these

countries (see Baunsgaard, 2003), the study will provide measures for the de-coupling of

fiscal operations from the volatile oil revenue. Similarly, the study will provide the

mechanism for mitigating the effect of export revenue on domestic money supply. Raju

and Melo (2003) show that coffee price shocks significantly affect money supply in

Columbia. Lastly, the study will also assist the policymakers in the efficient management

of oil revenue.

This study contributes to the existing literature on SWFs in two respects. First, we

construct a monetary dynamic stochastic general equilibrium (DSGE) model that

features the SWFs for oil-exporting African countries. We introduce SWFs in the

government budget constraint and in the exchange rate equations to investigate the fiscal

and the exchange rate channels of the SWFs. Second, we simulate our model to

investigate whether the creation of SWFs can reduce fiscal instability, exchange rate

volatility and macroeconomic volatility in oil-exporting African countries.

The rest of the paper is organised as follows. Section 2 reviews the existing literature

on commodity price shocks and macroeconomic fluctuations. Section 3 presents the

stylised facts on oil prices, fiscal balances and macroeconomic aggregates. Section 4

describes the model for the study. Section 5 discusses the simulation results and

summarises the findings. The last section draws conclusion and suggests policy

implications.

2. Review of literature

Empirical evidence on the impact of resource abundance on growth has been quite

mixed. The resource curse hypothesis posits that resource abundance weakens institution

and reduces economic growth. For example, Sachs and Warner (2001) and Papyrakis

and Gerlagh (2004) find that resource wealth promotes corruption, weakens institution,

reduces savings and decreases economic growth. In contrast, Alexeev and Conrad

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152 Mutiu Gbade Rasaki and Christopher Malikane