Academic journal article Journal of Southeast Asian Economies

Fiscal Cyclically in Brunei Darussalam

Academic journal article Journal of Southeast Asian Economies

Fiscal Cyclically in Brunei Darussalam

Article excerpt

1. Introduction

The plunge in crude oil prices over the past year, from US$110 per barrel in June 2014 to less than US$40 per barrel as of December 2015, is putting heavy pressure on the fiscal balance of oil-exporting countries. Brunei is no exception. The oil and gas sector accounts for 90 per cent of the government's revenue. The country's projected fiscal deficit for 2015 stood at US$2.2 billion, an astounding 20 per cent of GDP (IMF 2015). GDP in 2015 is also forecast to contract by 1.2 per cent (IMF 2015) to 1.5 per cent (ADB 2015). (1)

The large fall in oil prices necessitates short-run macroeconomic adjustments. According to economic theory dating back to Friedman (1953) and Poole (1970), oil-exporting countries with a flexible exchange rate regime can adjust through an exchange rate depreciation, which increases the domestic price of oil exports when its international price has fallen. This helps to soften the impact of adverse oil prices and hence stabilizes output. However, this is not a viable policy option for the country since the exchange rate regime is based on a currency board arrangement in which the Brunei dollar is pegged at par to the Singapore dollar. Both countries have openly committed to maintaining the Currency Interchangeability Arrangement (CIA) signed in 1967 (see Rajak 2015).

Fiscal policy, therefore, has to bear the bulk of the macroeconomic adjustment costs. Brunei has accumulated surplus oil revenues in its General Reserve Fund (GRF) under the Brunei Investment Agency (BIA), which was set up in 1983. Besides the saving for future generations, the GRF is also used to finance budgetary shortfalls (IMF 1999). According to the Sovereign Wealth Fund Institute, BIA's assets are valued at US$40 billion (SWFI 2015). (2) This fiscal buffer is large enough to absorb fiscal deficits of the projected magnitude for 2015 for about twenty years. In 2008, the country established the Sustainability Fund Act which comprises three trust sub-funds. One of the sub-funds is the Fiscal Stabilization Reserve Fund (FSRF) to make up for government revenue shortfalls. Despite not having explicit fiscal rules, it can be inferred from the objectives of the GRF and FSRF that the government aims to maintain a neutral fiscal stance (i.e. acyclical fiscal policy) so that government expenditure is not disrupted by volatile oil revenues. This is a prudent macroeconomic stabilization measure since procyclical fiscal policy exacerbates the business cycle and therefore cannot be optimal from either a Keynesian or neoclassical theoretical perspective (see, e.g., Ilzetzki and Vegh 2008).

The purpose of this paper is to examine the conduct of fiscal policy in Brunei, in particular, to assess the extent of fiscal cyclicality and its impact on output. This has important policy implications. For instance, if fiscal policy is procyclical, it amplifies the business cycle by increasing output volatility. In this case the government should consider exercising fiscal restraint by adopting clear fiscal rules and strengthening the governance of the reserve funds to ensure government expenditure does not co-move with oil prices. This would allow smoother execution of the planned projects in the five-year national development plans.

The remainder of this paper is organized as follows. Section 2 presents a brief overview of the literature on fiscal procyclicality in resource-rich countries. Section 3 takes a preliminary look at fiscal cyclicality in Brunei. Section 4 describes the methodology used, section 5 discusses the empirical results, and section 6 concludes.

2. Procyclical Fiscal Policy in Resource-Rich Countries

Fiscal policy is defined as procyclical if government spending increases in good times and falls in bad times. (3) This is dubbed the "when it rains, it pours" phenomenon by Kaminsky, Reinhart and Vegh (2004). The fact that fiscal policy is procyclical in developing countries has been documented in several studies (e. …

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