ANALYSIS - Brazil needs to beat corruption to enjoy oil bonanza

RIO DE JANEIRO Tue Sep 1, 2009 5:35pm IST

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RIO DE JANEIRO (Reuters) - Brazil needs to stamp out the dangers of free-spending and corruption if a proposed national oil fund is to help fuel economic growth and avoid the "resource curse" that has soured oil bonanzas in other countries.

Based partly on Norway's successful Petroleum Fund, the social fund announced by Brazil's government on Monday as part of a proposed reform of oil laws will channel oil revenues toward fighting poverty and improving the nation's badly neglected schools.

The aim of an oil wealth fund such as Norway's is to smooth the impact of huge revenues over time to avoid governments going on spending sprees that can disrupt an economy.

But experts say a fund is little protection against the misallocation of oil revenues. Governments can, and often do, change the rules in response to economic and political pressures.

It is more important that the main political parties build a lasting consensus on the use of oil revenues and that corruption is not tolerated.

"In a way it's a good principle but actually there's no evidence of funds making any difference at all," said Macartan Humphreys, an associate professor at New York's Columbia University who has studied the impact of oil wealth.

"The only place funds seem to work are places where it is likely you would have had pretty good fiscal policy."

President Luiz Inacio Lula da Silva has called the discovery of the huge reserves off Brazil's southern coast a "gift from God" that can drive the South American giant's development.

But recent history is littered with newly oil-rich countries that pledged a new era of prosperity only to squander the wealth through mismanagement, corruption or misjudging the economic disruption that a sudden influx of oil wealth brings.

Brazilian officials say they are determined to avoid that trap.

"We are creating the conditions to avoid the oil curse, that terrible curse that has kept many oil-rich countries in poverty," Dilma Rousseff, Lula's chief of staff and likely ruling-party candidate to succeed him in October 2010 elections, said as she presented the plan on Monday.

Under the reform plan, which faces a lengthy battle for approval in Congress, the fund would invest abroad and at home and make regular transfers to the government's budget to be invested in targeted areas.

Rousseff said priority spending areas, including education, the environment, and science and technology, would be defined by a committee made up of government and private groups. Revenue from the funds would be managed by Congress.

With an estimated minimum of 50 billion barrels deep below the ocean and a thick salt layer, Brazil's windfall is worth about $3.6 trillion at current prices, more than twice the size of its entire economy.

Unlike Norway, Brazil has a gaping need for investments in a dismal education system and to make further inroads into poverty that still affects millions of its people.

NEITHER NORWAY NOR NIGERIA

While it is no Nigeria or Angola, where oil resources have fanned corruption and conflict, Brazil also falls far behind Norway in terms of political graft and disunity, raising concern about how it will manage the wealth.

The dangers include the so-called Dutch Disease when oil exports boost a country's currency and hurt its exporters, boom-and-bust cycles caused by abrupt oil price changes, and greater corruption as politicians grab their piece of the pie.

"The Norway experience will not work anywhere else unless you adapt it," said Farouk Al-Kasim, an Iraqi who helped formulate Norway's energy policy and now runs his own oil consultancy there. "Actually you can't adapt it. You need to say 'What can go wrong and how can I minimize the damage?'."

Al-Kasim said Norway had been a model of restraint in managing its oil revenues long before its Petroleum Fund was set up thanks to a political agreement struck in the early 1960s. Norway's fund effectively isolates oil revenue from the economy by investing abroad and returning only the annual above-inflation gains of around 4 percent.

While a fund in itself is no guarantee of avoiding corruption, it can help by encouraging transparency. The balance could be made publicly available online, for example.

Ensuring that the revenues are protected against short-term political pressures, with strict rules on withdrawals and spending targets, would be key to ensuring a "clean" fund.

"What you want to do is build a political constituency that sees a flow of benefits ... to build long-term support for these objectives," said Joseph C. Bell, a partner at the energy practice of Washington law firm Hogan & Hartson. "The key is investment as opposed to consumption."

Despite the temptation for developing countries to spend the revenues at home, Al-Kasim said they should seek to invest about 70 percent of the fund offshore and only use it to invest in "sustainable" areas such as education and infrastructure.

He said Brazil has a good chance of avoiding the resource curse because of its diverse economy, but needs to avoid helping other industries through subsidies.

"They must be extremely selective where they use the petroleum revenue. They can't flood the market."

(Additional reporting by Brian Ellsworth)

(For more news on Reuters Money click in.reuters.com/money)

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