Optimal fiscal management in an economy with resource revenue-financed government-linked companies

We present a dynamic stochastic general equilibrium (DSGE) model in which a resource-rich government allocates its excess resource rents between a resource stabilization fund and the facilitation of costly domestic fund-raising activities of sovereign wealth funds (SWF), which holds a portfolio of government-linked companies (GLCs). Despite being less productive efficient, GLCs' operation benefits from scale economies tied to the resource sector: its profitability is procyclical to commodity shocks. The model is estimated to Malaysia using the Bayesian approach, with the results suggesting a business cycle heavily influenced by resource shocks. Based on this, we solve numerically for a socially optimal combination of excess resource savings allocation. We find the present allocation to be sub-optimal, regardless of the structural shocks. This suggests that the Malaysian economy might have hit its absorptive capacity constraint (i.e., a domestic economy saturated by GLCs).