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PROJECT TOPIC – MACROECONOMIC EFFECT OF GOVERNMENT BUDGET DEFICIT IN NIGERIA 1970-2011

MACROECONOMIC EFFECT OF GOVERNMENT A BUDGET DEFICIT IN NIGERIA 1970-2011

 

ABSTRACT

This study investigates macroeconomic effects of government budget deficit on economic performance in Nigeria from 1970 – 2011 using a co-integration and error correction model. The result indicate that the variables GDP, EXCHR and INF which affects economic performance, showed a positive value, indicating a positive relationship between budget deficit and macro-economic performance. However, INTERE and INVEST indicate a negative signs,
implying an inverse relationship between budget deficit and interest rate and investment during the period under consideration. The co-integration test result obtained using Johansson test procedure confirms one long run equilibrium relationship between the variables thereby conforming to Granger representation theorem which states that a long run equilibrium relationship implies error correction mechanisms. The error correction model result  indicates that all the coefficients were correctly signed and statistically significant at 1 percent level The Granger causality test result indicates that there is a bi-directional causality between Budget deficits and GDP.

There exists a bi-directional causality between exchange rates and budget deficits. Granger relationship between interest rates and budget deficits showed that there exists a non bi-directional causality between the two variables. It was found that inflation does not Granger cause budget deficits and Budget deficits do not Granger cause inflation. The causality between budget deficit and investment indicate a bidirectional relationship. Again the second test (simple regression) on exchange rate single effect revealed that budget deficit has a positive relationship with exchange rate. The structural stability test
result indicates that there is evidence of structural instability during the period under consideration. Statistically, the t-statistics of the variables indicates that only three variables which include GDP, EXCHR and INF were statistically significant. The study therefore recommends that when fiscal deficits are used to correcting economic problems or adjusting economic variables, such deficits should be implemented with close monitoring of it’s specific effects on target economic variables.

Thus based on the result obtained, an effective fiscal policy that is conscious of inflation and investment should be put in place to checkmate the problem found with inflation and investment in this work. Furthermore, curbing corruption, an important source of fiscal deficits in Nigeria, will help to reduce the deficits and ensure prudent management of national resources.

CHAPTER ONE

INTRODUCTION
1.1 Background of the study

Rapid and sustained output growth of the domestic economy of Nigeria has since the political independence in 1960 been of paramount importance to successive governments in the country. Consequently, governments have since implemented several national development plans and programmes aimed at boosting productivity, as well as, diversifying the domestic economic base. The goal of this has been for the attainment of high levels of economic development that would translate into an improvement in the living standards of the populace, and hence a reduction in poverty through an increase in the domestic output and the creation of employment, and thereby, the maintenance of a favorable balance of payments position (Ariyo, 1997 and Ojo et al, 1998). The infrastructural and capital resources required for the attainment of the objectives identified  above have however been scarce. This has  necessitated the interventions of the governments in the economy through the provision of the required huge capital outlay necessary for large-scale
production in heavy industries and for the provision of other infrastructure. Government interventions were made possible by the oil boom of the early 1970s when Nigeria earned unprecedented amounts of foreign exchange from the export of crude oil (Sikkam, 1998).

Government expenditures thus grew rapidly with a similar growth in the bureaucracy. But the oil glut that followed meant that government revenues declined significantly (Akor, 2001). As governments were reluctant in reducing the bloated expenditures that had resulted during the oil boom, they were forced to seek alternative means of financing their expenditures. Governments thus resorted to budget deficits. Budget deficits, a situation where current expenditure exceeds current expected income, have become a recurring feature of public sector financing in Nigeria. The Keynesian demand-side economics emphasized the need for expansion in government expenditures even beyond current income, particularly during depressions when the economy suffers from an insufficiency of active demand, such as the Great Depression of 1929 to 1932, and more recently, the 2008 Global Financial and Economic Crisis.

This will thereby increase the demand for productive output, resulting in unemployment being overcome and general improvement in macroeconomic
performance (Anyanwu and Oaikhenan, 1995; Ogboru, 2006). The policy of budget deficits has however posed challenges to the Nigerian economy with regard to its effectiveness and the accumulation of debt, the justification for growth notwithstanding. The relationship between budget deficits and macroeconomic performance through variables (such as growth, money supply, private investment via interest rates, trade deficit, exchange rate, among others) represents one of the most widely debated topics among economists and policy makers in both developed and developing countries (Saleh, 2003). This relationship can either be negative, positive or a no positive or negative relationship. The differences on the nature of the relationship between budget deficits and these macroeconomic variables as found in economic literatures could be explained by the methodology, the country and the nature of the data used by the different researchers.

Fischer(1989) in a finding maintained that Large budget deficits pose real threats to macroeconomic stability and therefore to growth and development. Large deficits will, perhaps after some time, lead to inflation via money supply, exchange crises, external debt crises, and high real interest rates. In a developing open economy like Nigeria, with weak production capacity, government budget deficits increases inflation through money supply, create debt over hang, raise real interest rates, crowd out domestic investment, and cause the other currencies to appreciate vis-à-vis the domestic currency and further deteriorate the trade deficit. The consideration of macroeconomics of the government budget deficit points to the dangers that arise from excessive budget deficits as mentioned above with implications for the real exchange rate, trade account, and for investment. Fischer (1989) states that none of the links are automatic, for there are choices in the sources of financing, and lags in the effects of money printing and borrowing on inflation and interest rates. Busari and Omoke (2007) assert that the extent, to which the economy can be stabilized particularly in the short to medium term, will depend largely on the fiscal behavior of the government.

According to the authors, since 1986, when the reform measures started, Nigeria has witnessed various fiscal reforms all aimed at stabilizing the macro economy and ensuring sustained growth. However, two decades into the reform, there is considerable debate over the conduct of fiscal policy and its relation to economic stability. Behaviour of key macroeconomic aggregates suggests that the economy is far from being stable. In Nigeria, an attempt to grow the economy has created a situation where the nation has become frequently used to large budget deficits that have over the years resulted to sale of government bonds and borrowing (both internal and external) in order to meet up with the required expenditures. Anyanwu (1998), opined that since the inception of structural Adjustment Programme (SAP) in Nigeria in 1986, the fiscal operation of the federal government have been resulting in overall deficit. The resultant effects of this are persistent decline in real output caused by lower foreign exchange and reliance on borrowing to finance the deficits with it’s
attendant macroeconomic imbalance/ volatility.

Fiscal deficit in Nigeria has therefore become an issue of concern. An attempt to finance fiscal deficit has made Nigeria seriously indebted to some International financial Institutions like the Paris Club. The nature of the debt was alarming, until 2005 when the Club granted debt relief to
Nigeria. As at fourth Quarter of 2011, the nation’s external debts stood at about $ 5.3 billion, while domestic debts is about # 5.2 trillion, making a total debt of $ 39.7 billion (dollar), which is about 20 percent of Nigeria’s Gross Domestic Product (GDP). This occurred mainly as a result of high budget deficit.
Evidence from Sanisi and Okonjo-Iweala,(2011),has shown that Nigeria’s recurrent expenditure is more than 70% of the total budget. This suggest that there is need to cut down recurrent expenditures: ie, the over – head cost of running government ministries, Departments and Agencies (MDAs), to reduce the budget deficit to a manageable level of three percent of output, while boosting Infrastructure Investments to create jobs. The current situation where recurrent budget takes an entire 75 percent of total budget could not support the type of aggressive capital development that Nigerians yearn for,(Okonjo- Iweal 2011). Sanusi (2011) pointed out that it will be historically difficult to stabilize macroeconomic variables in Nigeria, if larger proportion
of the money borrowed to finance deficit is spend on consumption instead of Investments.

One Implication of this uncontrolled budget expenditure is that it affect macroeconomic performance negatively. Thus, the critical issue confronting the government is how to adequately control budget deficit in order to ensure stability of macroeconomic variables. Shonekon (1993), Olomola (2000,2006), Obadan (2003) and Anyanwu (1998), opined that lack of fiscal discipline possess threat to macroeconomic stability in Nigeria, because excessive
budget deficits are mostly linked with planned political decision, and not as a result of external shocks or reactions on prevailing internal economic situation.
For most of the past three decades or so, net budget balance of the Federal government has been generally on the negative side. Between 1970 and 1995, the ratio was on the increase peaking in  1995 at above 12 percent. The ratio then declined till 1996 before starting another round of downward journey till 1999. From the year 2000, the ratio took an upward swing and it continues to fluctuate since then(see figure1 below).

It is obvious that there exist some series of swings in the behaviour of this ratio. Financing of the ratio were classified into three, namely; domestic,
foreign and other funds (this classification is also used by the Central bank of Nigeria)(Busari and omoke,2007). ‘Other funds’ include: Public, Special and Trust Funds, Treasury Clearance Funds, excess reserves, etc. The domestic source comprises the central bank and the non bank public. Other funds (mainly excess reserves) and domestic source were mainly used in financing the deficit. Though there was a rise in the use of foreign source. Over the two years 1989 and 1990, ‘other funds’ were particularly used while since 1990, domestic source have became the major source of financing the deficit (Busari and omoke, 2007).).Figure1 below shows the trends in the fiscal deficit to the gross domestic product (GDP) for Nigeria from 1970 to 2010 From the graph above, it could be seen that government deficit had been on the increase from 1970 to 1995. It took an upward swing from 1996 to 1999 and thereafter  ontinued rapid increase since then.

This therefore calls for investigation to verify the cause and effect of such swing in deficit on macroeconomic variables. Has such persistent deficit financing been able to achieve it’s associated objective? If yes, to what extent?

MACROECONOMIC EFFECT OF GOVERNMENT A BUDGET DEFICIT IN NIGERIA 1970-2011

 

 

1.2 Statement of problem

In the Keynesian point of view, budget deficit is seen as an important instrument of national resources mobilization, allocation and economic management through which domestic output, aggregate demand and macro-stabilization can be promoted, especially when resources are not fully utilized as in the case of Nigeria. In this perspective therefore, budget deficit serves as a medium for growth and stabilization of macroeconomic variables (inflation, debt crisis, private investment via interest rate and exchange crises, unemployment,etc) which collectively develops the economy in a sustained manner. Nigeria embarked on the journey of budget deficit operation since 1960s to enhance and sustain macroeconomic performance. The deficit continued and became worst from 1980s after the oil boom as the revenue associated with the boom could not be sustained. Budget deficit was N93.1million in 1960; and was raised to N473.1million in 1970; N1975.2million in 1980; N22116.7million in 1990; declined to N6752.6million in 1995; and rose to N103,777.3million in 2000; N202,724.7million in 2003(CBN,1970-2003).

The rapid increase has been continuous since then till now. Government was able to sustain these high level of public expenditures between 1970s and 1980s because of the windfall gains from oil during the period. Between 1960s and 80s, the economy was better managed through effective fiscal discipline; leading to stability in macroeconomic activities which is a key objective of fiscal deficit operation. This can be explained by lower inflation rate, exchange rate stability and low debt level during the period. .However, over three decades into Nigeria’s budget deficit with stabilization reform, there is
considerable debate over the conduct of fiscal policy and it’s relation to economic stability, macroeconomic stabilization as a policy objective is far from being achieved (Busari and Omoke, 2007). In this regard, there have been persistent unfavorable balance of payment, Increased public debt, Increased inflationary pressure, High rate of unemployment and continuous dependence on external economy.

All these are indicators of negative growth which is in contrast with budget deficit objectives; and could be attributed to fiscal irresponsibility of the
government. Instead of employing fiscal deficits to finance investment that is self-sustaining, government over the years has devoted very large quantum of the deficits to the financing of consumption expenses which seems to have a dampening effect on the growth rate of the real Gross Domestic Product; price level, debt crises, exchange crises, and thus, have not efficiently stabilized important macro economic variables: giving credence to the monetarist position that budget deficits are counter-productive to economic growth and stabilization. Thus macroeconomic volatility in terms of high variability in non-oil output growth, inflation, interest rate, exchange rate, and so on have renewed the attention of scholars and policy analysts in the issue of fiscal policy and macroeconomic stabilization in Nigeria.

Nigeria has been ruled by military and civilian regimes and operated various policy regimes. Under these regimes, budget deficit has been employed with positive expectations of growth. Unfortunately, it still seems as if target objectives of such policies have not been achieved. Therefore, the dominance of government in economic activity in terms of national expenditure and persistent macroeconomic volatility in key aggregate variable today, calls for a thorough examination to verify the impact of budget deficit on macroeconomic stabilization. One then ask if budget deficit no longer stimulate economic growth. Do researchers believe the Keynesians economists that budget deficit grows the economy through it’s effects on macroeconomic variable or the neo-classical economists that it is counter productive or even the Ricardian economists that it has no positive or negative impacts on the economy? Which side to belong is what this research work is meant to address.

It is increasingly recognized that sustained economic growth is possible only within a sound macroeconomic framework, and that in such framework, fiscal policy plays an important role (fisher and Easterly 1990). It is therefore, suggested that if budget deficits are to generate a positive result, such deficit, must have target investments that are self-sustaining with sound and prudent management of national resources, free from corruption. Hence, this call for a
comprehensive study.

MACROECONOMIC EFFECT OF GOVERNMENT A BUDGET DEFICIT IN NIGERIA 1970-2011

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