A simple model of internal and external balance for resource-rich developing countries

Abstract

We present a simple model of internal and external balance that incorporates key features of resource-rich developing countries (RRDCs). The main result is that ‘government take’—the ratio of fiscal resource revenue to resource output—is a key determinant of the equilibrium real exchange rate (ERER) in these countries. Examining the case of Papua New Guinea, which has grappled with foreign exchange restrictions since 2015, we find that about half of the RER overvaluation estimated at 26% in 2019 would disappear if the current low level of government take was to be lifted to its long-term average. The analysis has two key takeaways for RRDCs. First, changes in the government take require adjustments to the RER and fiscal policy to maintain internal and external balance. Second, economic adjustments to falls in the take are difficult; therefore, policies seeking to stabilise the take over time to promote macroeconomic stability are recommended.