Nigeria’s lack of effective fiscal rules means that the volatility of revenues from its extensive oil and gas resources spills over into national and local budgets. The resulting swings in government expenditure have cancelled out the positive impact of oil revenues on economic development and poverty reduction. This IMF Working Paper looks at how introducing fiscal rules could benefit Nigeria through budget stabilisation.
Over the last thirty years, substantial oil resources have been spent, but with little impact on development. Budgets have shifted in line with volatile oil revenues, resulting in high deficits and pro-cyclical spending. An arrangement under which state and local governments receive half of those revenues has magnified the negative effect on the economy. The government plans to introduce a fiscal rule in the 2003 budget – which could provide the framework for a more stable and predictable fiscal policy. However, this must be accompanied by measures to combat corruption and to increase transparency and accountability.
The paper uses a simple analytical framework to devise fiscal rules that merge concerns about long-term sustainability with the shorter-term goal of reducing budget volatility. The framework shows that:
- In the long term, government consumption should be consistent with preserving the total stock of wealth – both oil and financial. This requires prudent deficits to save oil revenue and convert it into financial assets.
- Consumption financed from oil revenue should equal the real return on the total stock of financial and oil wealth.
- Calculating the maximum consumption of oil revenue compatible with the long-run fiscal target results in a non-oil primary deficit target of 20 per cent of non-oil GDP. This is one rule that could combat spending volatility.
- The second is a price rule that targets a balanced budget at a reference oil price of US$20 a barrel. If the actual price is higher, the extra revenue is saved.
- Both rules would allow Nigeria to carry out a spending programme unaffected by oil price volatility, and large non-price related shocks could be addressed by adjusting the price-based rule.
The benefits of implementing either rule would only be realised if the process were supported by measures to strengthen spending quality and to address corruption and transparency. The current political and economic situation in Nigeria suggests that:
- An appropriate fiscal rule will require some oil revenue to be saved, but the pressing need is for a rule that decouples spending from oil price volatility.
- Deficit-targeting may be preferable because it protects the budget from all sources of oil revenue volatility, but a price-based rule may be easier to introduce due to its simplicity.
- The current expansionary fiscal stance means that a rule could only be implemented gradually. At first, spending may have to be adjusted to offset oil price declines below the reference price.
- For any fiscal rule to be effective, it must enjoy broad-based political support. Making it formally binding could help overcome obstacles.
- It will be a challenge to get political agreement from state and local governments on reforms to support a rule. Including mechanisms with clear benefits for sub-national governments would help win their approval.
- A proper savings mechanism must be established to allow all levels of government to build up financial assets when oil prices are high.