Nigeria: Fiscal Policy and Economic Policy Coordination at a Crossroads

There’s a paradox in an oil-producing country struggling with macroeconomic performance at a time when oil prices are generally high. In Nigeria, this paradox largely reflects lower oil production, higher fuel subsidies, and underlying macro-structural challenges. Real GDP growth fell to 2 percent during the third quarter of 2022, and year-on-year inflation reached 21 percent in October, with food inflation at nearly 24 percent. About 63 percent of Nigeria’s population is multidimensionally poor, and Nigeria’s debt service-to-revenue ratio at the federal government level reached 83 percent during the first eight months of 2022. In short, the country is facing significant fiscal-macroeconomic challenges, with implications for both current and future administrations.

In a new note, I consider a range of issues that a new administration in Nigeria will need to address to bring about a more integrated and comprehensive fiscal policy framework, focusing on improved domestic resource mobilization, enhanced expenditure efficiency, alternative sources of fiscal-deficit financing consistent with macroeconomic stability and growth, reduced or eliminated quasi-fiscal activities, and effective coordination between monetary and fiscal policy. Unless Nigeria’s new administration changes course, the country’s economic strategy will remain on shaky ground.

The macroeconomic landscape

Despite higher oil prices, Nigeria’s balance of payment is under pressure owing to the country’s reduced production of crude oil, higher import prices for refined fuel products and food, and negative net capital outflows associated with domestic macroeconomic challenges and increasing interest rates in advanced economies. The gaps between the parallel market and official exchange rates have widened considerably, with the former currently at about N750 to $1 and the latter at N445 to $1 (investors and exporters’ FX window). External reserves stood at about US$37.2 billion as at end-November 2022 (5.2 months of imports of goods and services) compared to US$40.5 billion (5.7 months of imports of goods and services) as at end-December 2021. International rating agencies recently downgraded Nigeria’s sovereign rating, citing ongoing fiscal and external weakening in the context of higher crude oil prices.

Nigeria’s macroeconomic stability is in jeopardy given its current policy trajectory. The government’s unfettered access to central bank financing and the extensive use of quasi-fiscal activities have delayed much-needed fiscal consolidation, allowing fiscal vulnerabilities to build up, with current and future adverse macroeconomic consequences. Despite the fragility of real GDP growth in Nigeria, higher interest rates in advanced economies would continue to result in increased domestic interest rates to sustain some levels of capital flows, ameliorate exchange rate pressures, and reduce stubbornly high inflation. The cost of servicing public sector debt will increase. To build resilience and absorb the cost of a higher interest bill, the new administration that will come to office by May 2023 needs to imbibe fiscal prudence.

The 2023 federal budget

The link between the current and incoming administration is the 2023 federal budget. Against this background, the budget focuses on maintaining fiscal viability and ensuring smooth transition to the incoming administration. The proposed 2023 federal government budget implies a general government fiscal deficit of about 6 percent in 2023 compared to estimated 6 percent in 2022. A general government deficit of this magnitude would entail additional central bank financing in view of the difficult external environment and the need to limit crowding out of the private sector. Macroeconomic trade-offs imply that when inflationary pressures are high as is the case in Nigeria, fiscal policy should protect the most vulnerable while pursuing a tightening stance to avoid overburdening monetary policy in the fight against inflation. Tightening fiscal policy requires prioritizing spending among competing needs and mobilizing revenues in a growth-friendly way. A more ambitious fiscal consolidation could send a powerful signal that policymakers are aligned in their fight against inflation, which, in turn, could reduce the size of required policy rate increases to keep inflation expectations anchored and keep debt-servicing costs lower than otherwise.

Political parties’ manifestos and fiscal policy direction

General elections will take place in 2023 and many political parties have launched their manifestos, laying out their economic agendas for the next four years. As the campaigns progress and Nigerians engage with the political parties, the following questions deserve special attention:

• How will the programs and projects of the new administration be financed to deliver on growth and social objectives? 
• What are these political parties’ strategies in the near to medium term to bring about improved macroeconomic stability in Nigeria? 
• Will these political parties encourage or discourage the use of central bank financing of fiscal deficit?
• How will these parties strike an appropriate balance between the use of fiscal incentives to promote investment and expanding the tax base? 
• Will these political parties produce a revised 2023 budget or will some of the key issues raised be reflected in the 2024 budget?
• Will these political parties expand or reduce the public sector?

A framework for moving fiscal policy forward

As the political process evolves, the current government needs to take additional fiscal measures to set the stage for the new administration. The current administration should lead the required fiscal adjustment process by transparently and significantly reducing the cost of governance and administrative capital expenditures. The current administration could also: (i) assess consistency between the external and fiscal accounts in 2022; (ii) review the arrangements underpinning the importation of refined fuel products, including estimated daily consumption; (iii) analyze the structure and composition of oil production in Nigeria (joint ventures and production sharing contracts) and implications for public sector oil revenue collection; and (iv) address through effective monitoring and surveillance the thorny issue of oil theft and pipeline vandalization.

The new administration should put in place a comprehensive framework for moving the fiscal policy agenda forward, with attention to the following areas:  

• Revenue: Georgia’s experience offers key policy lessons for the incoming new administration. First, political commitment at the highest level and broad buy-in from stakeholders are crucial to improving revenue collection. Second, countries that implement revenue administration measures in conjunction with tax policy reforms tend to experience larger revenue gains. 
• Tax policy: redesigning tax incentives toward growth-enhancing activities and assessing the effectiveness of existing fiscal incentives would be useful. Efforts to design more progressive tax systems and boost tax collection—particularly, property and/or land taxes—will surely help. This will have to be combined with increasing the VAT rate, streamlining existing VAT exemptions, and increasing existing excise rates on alcoholic and tobacco products.
• Expenditure: the following expenditure-related issues need to be at the heart of fiscal policy design and implementation: (i) enhancing the quality of public investment by further improving the procurement process and establishing a public investment management unit; (ii) removing fuel subsidy combined with building consensus; (iii) implementing cost-reflective electricity tariffs; (iv) enhancing coverage and efficiency of social assistance programs; and (v) undertaking civil service reform.
• Financing: macroeconomic stability is key in exploring financing options and appropriating risks. The use of advance market commitment to potentially reduce risks and attract additional financing could be explored. There is urgent need for enhanced efforts by international financial institutions, including IDA (the World Bank’s concessional arm, which includes a private sector window), to use their expansive lending toolkits to further catalyze more private infrastructure finance in Nigeria. 

The quality and strength of policy institutions matter in navigating a country through economic challenges. These important foundations must be adequate and robust for the proposed fiscal measures to work and produce the desired results. Nigeria has in place a number of fiscal rules as stipulated in the Fiscal Responsibility Act (2007). The Central Bank of Nigeria Act (2007) limits the size of monetary financing of fiscal deficit as well as the size of its direct intervention. The main reason behind these rules is to anchor the conduct of fiscal and monetary policy and ensure macroeconomic stability.

If these rules are not respected on a consistent basis, it will be extremely difficult to achieve and maintain macroeconomic stability, as policy credibility wanes. Respecting or implementing existing legislation pertaining to monetary and fiscal policies will signal policy commitment and bring about credibility. Moving forward, the new administration could introduce a fiscal and monetary policy coordination council. There are countries that already have such a structure in place (the Coordinating Council in Egypt; and the Monetary and Fiscal Policies Coordination Board in Pakistan). Nigeria could also benefit from such an arrangement.