National Budget 2006

National Budget 2006

These pages contain information in English about Norway's National Budget for 2006, presented to the Storting as Report no. 1 (2005-2006) on 14 October 2005. The National Budget presents the Government's program for the implementation of economic policy and projections for the Norwegian Economy.

Royal Norwegian Ministry of Finance

Per-Kristian Foss
Minister of Finance
October 2005

Taxes – Main Features of the 2006 Proposal

Fiscal Budget 2006 - Continued Strong Economic Growth

The Establishment of the Government Pension Fund

Organisation of the Government Pension Fund and its relationship to economic policy

Press Release

No.:

Date:

Contact:

Therese Riiser Wålen , Telephone 22 24 41 09 , Mobile 940 50 886

Organisation of the Government Pension Fund and its relationship to economic policy

The following is based on chapter 3 in Proposition no. 2 (2005-2006)

1 Organisation of the Government Pension Fund and its relationship to economic policy

1.1 Purpose of the Government Pension Fund

1.1.1 Background

The Pension Commission’s proposal to establish the Government Pension Fund was based on analyses showing a substantial long-term need to tighten public sector finances. The Commission drew particular attention to the forthcoming increase in central government spending on pensions, health and care services in the years ahead combined with a sharp fall in petroleum revenues in a few years’ time. The Commission accordingly pressed home the need for central government to build substantial economic reserves in the years ahead to pre-empt a heavy increase in the financial burden on the economically active population.

The Pension Commission stated that while establishing a pension fund does not in itself increase pension system sustainability, it could make it easier to gain support for a prudent long-term fiscal policy that puts aside adequate funds in the years ahead. It also drew attention to the difficulties that a number of other countries earning substantial revenues from non-renewable natural resources have faced when central government seeks to build up substantial financial wealth. It was against this background that the Pension Commission called for the establishment of a Government Petroleum Fund, based on the Government Petroleum Fund and the National Insurance Fund.

The Government’s Pensions White Paper supported the Pension Commission’s call for the establishment of a Government Pension Fund. The Government also supported the Commission’s view that saving in the Pension Fund should be in the form of a general accumulation of reserves, i.e. the size of the Fund and annual transfers to the Fund should not be directly related to changes in central government pension liabilities under the National Insurance Scheme. Moreover, the current capital in the Fund can only finance a limited part of the pension obligations that have already accrued. At the same time the White Paper pointed out that funding a specific portion of the National Insurance Scheme’s obligations could result in very large annual fluctuations in central government spending in the event of changes in the oil price, return on capital or pension obligations. A continued buffer fund would be needed to deal with this uncertainty. The White Paper also pointed out that a solution directly linking the annual transfers to changing pension commitments under the National Insurance Scheme could make it more difficult to find an overall balance between pension expenditure and central government spending and revenues in other areas.

The White Paper announced the Government’s intention to act on the Pension Commission’s proposal to give a broader discussion of the capital of the Fund, in relation to the developments in government pension obligations under the National Insurance Scheme. This will serve as a supplement to other indicators of the sustainability of government finances in the annual budget documents.

1.1.2 The ministry’s assessments

Establishing a Government Pension Fund will in the ministry’s view underpin and manifest the need for an economic policy that sets aside substantial funds in the years ahead to help finance future pension disbursements under the National Insurance Scheme. After the Pension Fund is established The Ministry of Finance will give a broader discussion of the capital of the Fund, in relation to the developments in government pension obligations under the National Insurance Scheme. This will serve as a supplement to other indicators of the sustainability of government finances in the annual budget documents.

Upon establishment of the Government Pension Fund, its capital will be far smaller than central government pension liabilities under the National Insurance Scheme. As described in the Pensions White Paper, saving in the Pension Fund will not be directly linked to these liabilities. Moreover, transfers from the Fund will not be earmarked for pension purposes. Hence the national insurance scheme will continue on a pay-as-you-go basis. By supporting the build-up of financial reserves on the part of central government, the Government Pension Fund will contribute significantly towards financing current disbursements under the National Insurance Scheme, while at the same time safeguarding flexibility in the exercise of economic policy. The ministry expects the Government Pension Fund to be set up in such a way as to maintain central government financial saving, see section 1.3.

The object of the Government Pension Fund is set out in section 1 of the Bill:

“The Government Pension Fund shall support central government saving to finance expenditure on pensions under the National Insurance Scheme and safeguard long-term interests through use of Government petroleum revenues.”

The Government Pension Fund’s object clause carries forward the purpose of, respectively, the Government Petroleum Fund and the National Insurance Fund. According to the rules governing the National Insurance Fund, authorised in the National Insurance Act, the Fund shall, by way of accumulating assets, be of the greatest possible utility to the National Insurance Scheme. The Petroleum Fund Act requires the Government Petroleum Fund to safeguard long-term interests through use of petroleum revenues. These long-term considerations were formulated with a view to financing future pension payments under the National Insurance Scheme.

1.2 Organisation of the Government Pension Fund

1.2.1 Background

There are differences in the formal rules governing the Government Petroleum Fund and the National Insurance Fund. The Government Petroleum Fund is regulated by Act no. 36 of 22 June 1990 which assigns the task of managing the Petroleum Fund to the Ministry of Finance. The ministry has delegated the operative management of the Fund’s assets to Norges Bank. The rules for the operative management are set out in regulations, clarifications of the regulations and a management agreement between the Ministry of Finance and Norges Bank.

Formerly, the Petroleum Fund is a krone deposit in a special account with Norges Bank. Norges Bank invests this deposit in its own name in financial instruments and cash deposits denominated in foreign currency. The return of the Petroleum Fund equals the return on these investments.

The National Insurance Fund was established in 1967 under the National Insurance Act (no. 12 of 17 June 1966). The Fund is regulated by rules adopted by the Storting under the National Insurance Act (no. 19 of 28 February 1997). The rules empower the King to issue further guidelines on asset management and on their implementation. This task has subsequently been delegated to the Ministry of Finance, see Royal Decree of 17 January 1991.

The Pensions White Paper recommended basing the Government Pension Fund on its own legislation, drawing on the Government Petroleum Fund Act and the rules governing the National Insurance Fund. The White Paper placed the exercise of ownership of the Government Pension Fund in the hands of the Ministry of Finance, as in the case of the Petroleum Fund. The Government premised that no management board or administration was needed for the Pension Fund, and that existing activity should be broadly continued in, respectively, Norges Bank and the National Insurance Fund.

1.2.2 The ministry’s assessments

Basing the Government Pension Fund on its own legislation gives the Fund a formal anchor, promotes the purpose of the Fund and strengthens its role in shaping economic policy. The name of two arms of the Government Pension Fund should be established in the Bill in such a way as to reflect the current division of responsibility between Norges Bank and the National Insurance Fund, including the role played by the Government Pension Fund in shielding the domestic economy from the effects of fluctuating petroleum revenues[…] The ministry expects these names to be used in reporting and communications regarding the operative management of the two arms of the Government Pension Fund.

The ministry states that establishing the Government Pension Fund will not in itself affect the operations of Norges Bank or the National Insurance Fund. Nor will the Government Pension Fund have its own management board or administration: the responsibility currently held by the executive boards of Norges Bank and the National Insurance Fund for the operative management of, respectively, the Petroleum Fund and the National Insurance Fund, will be continued within the new fund structure. This responsibility includes overseeing compliance with the Funds’ guidelines.

As announced in the Pensions White Paper, ownership of the Government Pension Fund will be exercised along the same lines as the Government Petroleum Fund. Hence the Bill authorises the Ministry of Finance to issue dedicated regulations for the management of both the domestic arm and the international arm of the Government Pension Fund. While this continues the current arrangement for the Government Petroleum Fund, it entails a change in relation to the National Insurance Fund whose rules are currently set by the Storting. The guidelines for management of the two arms of the Pension Fund will be anchored in the Storting, as in the case of the Government Petroleum Fund.

Norges Bank will continue to invest the equivalent of the krone account in foreign securities after the establishment of the Government Pension Fund. The international arm of the Government Pension Fund to be managed under the current Petroleum Fund management agreement between the Ministry of Finance and Norges Bank. The ministry aims to establish a management agreement with the National Insurance Fund.

1.3 Relationship to the guidelines for economic policy

1.3.1 Background

The Stoltenberg (I) administration presented on 29 March 2001 White Paper no. 29 (2000-2001) entitled Guidelines for Economic Policy. A majority of the Storting endorsed the new guidelines which entailed a gradual phasing in of petroleum revenues into the economy, roughly in step with the trend in expected real return on the Government Petroleum Fund (the fiscal rule). Budget policy thus has a medium-term anchor.

Regulations of the same date established new monetary policy guidelines. Monetary policy would now aim for stability in the Norwegian krone’s national and international value. Norges Bank’s operative implementation of monetary policy was to be oriented towards low and stable inflation, defined as an annual consumer price increase close to 2.5 per cent over time. Further, monetary policy was to contribute to stabilising output and employment trends and to stable exchange rate expectations. Hence monetary policy has a clear role in stabilising economic developments.

White Paper no. 29 (2000-2001) primarily justified the new budget policy guidelines in terms of the need for a clear, long-term strategy for phasing petroleum revenues into the Norwegian economy. The White Paper opens with the following statement:

“Petroleum revenues have been substantially higher over the past two years than assumed earlier. This has resulted in large transfers to the Government Petroleum Fund, and greater scope for use of the return on the Fund’s capital. The Petroleum Fund is expected to continue to show substantial growth in the years ahead. This has provided more leeway for fiscal policy. Against this background, the Government considers there is a need for a clear, long-term strategy for petroleum revenue use.”

This statement closely relates the budget policy guidelines to petroleum revenue use in the Norwegian economy. The need for a balanced economic development calls for the Petroleum Fund to be invested directly abroad, thereby shielding the domestic economy from the effects of fluctuating petroleum receipts.

The Pension Commission’s projections of the trend in general government finances were based on retention of the fiscal rule for budget policy. The Commission also called for a long-term guideline to the effect that unfunded retirement pension liabilities under the National Insurance Scheme should not increase over time as a share of value creation in the non-oil economy. This would prevent rising pension liabilities being passed on to coming generations.

In the Pensions White Paper the Government premised that the fiscal rule for petroleum revenue use should remain the operative guideline for fiscal policy, justifying this in terms of the steady, long-term and prudent phasing of petroleum revenues into the Norwegian economy that fiscal rule implied. Since central government would continue to promote capital outflow by way of financial saving abroad, establishing the Government Pension Fund would not raise significant new problems for monetary policy.

The Government pointed out that the Pension Commission’s proposal not to allow unfunded pension obligations to increase over time as a share of value creation in the non-oil economy is not a suitable operative guide for fiscal policy on a year to year basis. Annual changes in the oil price, return on capital and pension liabilities could result in too large fluctuations in general government budgets for that to be the case. The Government also pointed out that the trend in unfunded pension liabilities could serve a didactic purpose in illustrating the sustainability of fiscal policy in the long-term, see section 1.1.

1.3.2 The ministry’s assessments

In the longer term, higher spending on an ageing population combined with diminishing revenues from petroleum operations will confront Norway with substantial budget policy challenges. The budget forecasts in the Macroeconomic Perspectives White Paper (no. 8 (2004-2005)) showed a long-term need to tighten general government finances even if the pension reform is carried out along the lines proposed by the Government in the Pensions White Paper. Hence a substantial accumulation of assets needs to be planned for the years to prevent major burdens being passed on to future generations.

The ministry also points out that current receipts from petroleum operations differ in nature from central government’s other revenues since their corollary is to some extent a reduction in central government petroleum wealth. The budget policy guidelines recognise the special nature of petroleum revenues and seek to ensure that these revenues will also benefit future generations. Central government’s net cash flow from petroleum operations is transferred in its entirety to the Government Petroleum Fund, whereas the guidelines only require the expected real return on the Fund to be actually used.

A steady, prudent phasing-in of petroleum revenues is also needed in the interest of a balanced development of the Norwegian economy. The currency inflow from petroleum operations is substantial and uneven. The budget policy entails predictable petroleum revenue use that is independent of current revenue flows. Moreover, investing a substantial portion of the petroleum revenues abroad promotes exchange rate stability. Hence there are important stabilisation policy and monetary policy rationales for the petroleum fund mechanism and the fiscal rule, and these must also be safeguarded ahead.

In keeping with the Pensions White Paper, the guidelines for budgetary policy will be continued along the present lines, and after the establishment of the Government Pension Fund the aim will, over time, be to match the structural, non-oil budget deficit to expected real return on the capital of the international arm of the Government Pension Fund at the start of the fiscal year (corresponding to today’s Petroleum Fund).

Maintaining the guidelines for budget policy entails that central government saving in today’s Petroleum Fund will be continued in the international arm of tomorrow’s Government Pension Fund. As at present, Fund revenues will equal central government’s net cash flow from petroleum operations, net financial transactions related to petroleum operations and return on Fund investments. The international arm’s expenditure will similarly comprise an annual transfer to the Treasury pursuant to a decision by the Storting. The Storting has previously drawn up guidelines for the Government Petroleum Fund under which the transfer will cover the non-oil budget deficit projected in the newly balanced budget.

The ministry also intends central government saving in the national arm of the Pension Fund to continue along current lines. No funds have been transferred to or from the National Insurance Fund since 1979. Since the return on the Fund’s invested capital is continually added to the Fund, the Fund has contributed to central government saving. For the period to 2050 the present value of continued saving is put at just under NOK 150 billion, given a technical assumption of 4 per cent real return.

1.4 The Government Pension Fund’s asset management

Establishing the Government Pension Fund does not in itself entail a need to revise the investment strategy of the two sub-portfolios making up the Pension Fund. The Government Pension Fund will build further on the management environments at the National Insurance Fund and Norges Bank. The guidelines for the management of the Government Petroleum Fund and the National Insurance Fund will (upon the establishment of the Government Pension Fund) be retained for the international arm and the domestic arm of the Government Pension Fund.

The ministry emphasises that the current division of responsibilities between the Petroleum Fund, which can only be invested abroad, and the National Insurance Fund, which chiefly invests in Norway, will be retained. This division will preserve the petroleum fund mechanism’s stabilising effect on the Norwegian krone, see section 1.3.