Macroeconomic Stabilization Fund (FEM)

What Is the Macroeconomic Stabilization Fund (FEM)?

The Macroeconomic Stabilization Fund (FEM) was established by Venezuela to stabilize cash flow from oil production. However, the administration of President Hugo Chávez, who came to power soon after, ignored the fund and attempted to dismantle it later. His administration is reported to have used the fund's proceeds to subsidize oil prices and in various failed economic schemes throughout the country.

Understanding the Macroeconomic Stabilization Fund (FEM)

The Macroeconomic Stabilization Fund or Fondo de Estabilización Macroeconómico (FEM) (as it is called in Spanish) was created in 1998 at the request of the International Monetary Fund, or IMF, as a fund to receive income generated from oil production above a certain price per barrel and pay out the difference if the price fell below that level.

Regulation of the fund by the central bank board began in 1999. By December 2001, the fund had US$7.1 billion in assets, and in 2003, the government tapped the fund to cover its fiscal budget deficit, withdrawing more than US$6 billion. As of November 2018, the fund held a mere $3 million.

Various calculations have shown that Venezuela could have avoided the crisis in its economy that started in 2012, if it had stowed away money from its oil revenues into the fund. According to one calculation, the country could have saved $146 billion between 1999 and 2014, a time during which oil prices rose dramatically. The Economist has a more conservative estimate for savings of $26 billion by 2012. Reinvesting that amount into government debt and income-generating schemes would have garnered further earnings for the government. Norway, which has a similar fund, earned higher returns from its investments. The Venezuelan government could have earned returns along similar lines.

The IMF suggested a peg of $9 per barrel for the price of oil as reference when the fund was formed. Given the oil market's volatility, subsequent fund inflows were to be calculated by using the difference between the average of the price for a barrel of oil for the past five years and the daily price. FEM would receive the difference, which would be invested in government debt or other such instruments to generate income.

Stabilization Funds

A stabilization fund is a mechanism set up by a government or central bank to insulate the domestic economy from large influxes of revenue, such as from commodities like oil. A primary motivation is maintaining steady government revenue in the face of major commodity price fluctuations as well as the avoidance of inflation. This usually is accomplished through the purchase of foreign denominated debt, especially if the goal is to prevent overheating in the domestic economy.

The first such fund was in Kuwait in 1953. Stabilization funds since have been set up for Russia, Norway, Chile, Oman, Kuwait, Papua New Guinea, and Iran. They also may be set up for exchange rate stabilization in the European Financial Stability Facility, the U.K. Exchange Equalization Account, and the U.S. Exchange Stabilization Fund.

Dependence on revenue from natural resources tends to cause fiscal volatility and macroeconomic instability. Reducing this dependence is made difficult by the so-called Dutch disease, which occurs when the production of natural resources attracts large foreign capital inflows. This in turn causes appreciation of the real exchange rates and weakens the competitiveness of domestic tradable sectors. The current account deteriorates, making the economy vulnerable to price swings. In addition, governments of resource-rich economies, especially those lacking strong institutional and legal framework, tend to make more-than-proportional increases in discretionary spending following commodity-driven fund inflows.

Studies have shown that stabilization funds contribute to smoothing government expenditure. Expenditure volatility in countries with stabilization funds can be 10% to 15% lower than that in economies without them. Stabilization funds can smooth expenditure volatility. A strong institutional framework is key in managing stabilization funds and their resources. Export product diversification tends to reduce expenditure volatility. Countries with better-managed real expenditure have less volatile public spending. And then, domestic and international financial markets can function as buffers to smooth expenditures. Better institutions have been shown to reduce fiscal volatility.