Of all the policy options at the disposal of the Federal Government in response to the recent slump in the price of crude oil, fiscal austerity is the most morally justified. It is also the least risky option. But as with all economic policies, there are countervailing arguments. So, we can decide to maintain fiscal deficit at the same level. Or find some reasons to widen the gap between Government’s revenue and expenditure. This would be in the hope of financing the fiscal deficit by issuing bonds (debt capital) or increasing money supply through quantitative easing (printing money).
Raising the level of debt at a time of dwindling revenue is both unrealistic and problematic. The debt finance would be more expensive. Investors would be swayed to buy the bonds only if they offer higher risk premiums. But then the higher cost of raising the financing also comes with two additional problems. One involves the reputational damage to the Government as the market would perceive the pricey issuances as junk bonds. The other problem is that such bonds, being sovereign issuances, would invariably set very high benchmarks for corporate bonds. Nigerian banks and other private sector issuers would have to pay higher costs for raising debt capital in the international capital market. In the end, this option would be too costly; not only for Government, but also for the private sector.
If the Government therefore ditches debt capital financing for quantitative easing, as has been suggested in some quarters, the implications would also be dire. There would be no escape from the consequences; the inflationary expectations that would greet the policy would be self-fulfilling. Out through the window would go price stability which has been achieved by this Administration through monetary policy. Not only would this affect affordability by the citizens, the ensuing inflationary outlook would deter private capital flows and investment in the country.
Quantitative easing might have become very appealing because of its effect in stimulating the U.S. economy to growth since the global financial crisis of 2007 to 2009. But there is a fundamental difference in the structural composition of the Nigerian economy and that of the United States. Besides, while the U.S. Federal Reserve’s QE diffused volatility risks around the world, similar policy in Nigeria would mainly localize the risks as we don’t have the reach of the U.S. economy. To underscore the fact that the success of quantitative easing is not beyond question, the policy has produced in Japan the very opposite of its accomplishment in the United States. The Japanese economy has returned into a recession, making a monkey out of the Abenomics mantra.
The reason why Nigeria would pursue either of the two policies of raising debt capital or printing money, as opposed to fiscal retrenchment, is to create a false impression that no serious adjustment is necessary in response to lower revenue by the Government on account of the fallen oil prices. This is completely out of nature with the Administration of President Goodluck Jonathan. In the past five years, the Government has been very pragmatic and honest in implementing needed reforms in the country. The Administration has backed the necessary tough choices that policymakers have made in maintaining healthy macroeconomic variables. Examples include tight monetary policy, reforms in the banking industry and tighter regulation of the capital market.
The Administration has also made a shift with regard to public debt. At the time of above-$100-a-barrel oil price, the fiscal regime had opted for consolidation, to slow down the rate of growth of public debt. External borrowing was tied to infrastructural projects, an example being the $1 billion Eurobond that was successfully issued in 2013. While the Coordinating Minister of the Economy (CME) and Honourable Finance Minister, Dr. Ngozi Okonjo-Iweala has assured of government’s commitments to development of infrastructure, the strategy is not and cannot be to fuel public debt at an inauspicious time as we are in. Instead of that, and rightly so, Dr. Okonjo-Iweala has announced spending cuts in the areas that will not hurt the economy – international travels and consolidation of some government agencies whose functions seem to overlap as recommended by the Stephen Oronsaye Report. This will be complemented by raising more tax revenue.
The best scenario of raising public debt to fund infrastructural projects under the ensuing fiscal head wind is that future generation of Nigerians will have the benefits of the infrastructure and also the burden of repayment of the loans. However, a different proposition that is morally unassailable is to fund infrastructure without also bequeathing a debt overhang on the future generation.
Yes, whereas the response of the U.S. economy to quantitative easing has been positive so far, fiscal austerity in much of the Eurozone has perpetuated weak economic performance. While the U.S. economy is now growing at above 3 per cent annualized, Europe continues to have a combination of mediocre growth and economic contraction. Italy has just fallen into triple-deep recession. As a result of these, fiscal austerity has become an orphan. But the jury is out on what the outcome of QE in the Eurozone would be, and whether the U.S. will face a painful adjustment with the end of QE3.
Even then, there are fundamental differences between Europe — where austerity measures have proved to make matters worse before possible improvement — and Nigeria — where austerity measures are expected to help in managing external shock and also help intensify structural transformation of the economy. Europe introduced fiscal austerity when and where public debt had reached unsustainable levels, almost equal to or exceeding the GDP. But the level of Nigeria’s public debt is sustainable, well under 40 percent of GDP ceiling. As a result of the financial crisis and the public debt crisis, southern Europe especially had plunged into a recession. But GDP growth has been very solid in Nigeria. Even with the cuts in the GDP growth projections as a result of the fallen oil prices, Nigeria will grow at above 5 per cent this 2014 and in 2015. Again, because austerity measures in troubled Southern European countries were imposed by their senior partners in the Eurozone and the IMF, the standard conditionalities for the financing left policymakers in the countries no legroom for manoeuver. But the austerity measures that have recently been declared in Nigeria are not an external imposition. The Government has a lot of headroom in applying the policy. Therefore, spending cuts have been applied to areas that are in the least likely to constrain growth.
Nigeria’s austerity measures are not just a belt-tightening framework. It is an opportunity to improve fiscal management and widen the tax net. Following the recent rebasing of the Nigerian GDP, the economy became 89 per cent bigger than the previous size. But as a result, Nigeria’s tax-to-GDP ratio became much smaller, magnifying the problem of low tax base. Right away, tax on luxury goods has been announced. In that one stroke, the tax will help government to generate additional revenue and at the same time help in redistributing income. When the new tax on luxury properties are viewed alongside the areas that the Government wants to cut expenditures, it becomes apparent that the initial responses of the Administration are decidedly pro-poor; the cuts are unlikely to hurt the middle class and less fortunate Nigerians. These initial steps should assure the generality of Nigerians that the Government is very mindful of protecting our economic interests if and when additional measures touch areas that are likely to have wider reach.
As has been acknowledged, every crisis presents an opportunity. Lower oil prices may not change in a hurry. Indeed, the CME, Dr. Okonjo-Iweala, has said the Government takes the view that lower oil prices are most likely to remain permanent. In that case, the structural transformation that has gained pace under this Administration, as attested by the GDP rebasing, will now intensify. The main reason why very adverse conditions are not immediately expected in Nigeria (and may never become a reality) is because the Nigerian GDP growth is led by the non-oil sectors. Oil revenue will hurt government revenue. But the economy can adjust and cope with that. Growth in services, agriculture and manufacturing will remain on track and will help create jobs.
Even within the oil and gas sector, we are seeing a structural transformation at play. The implementation of the power sector reform has suddenly increased domestic demand for gas. The thermal power stations – existing and those coming on stream – have made gas a local commodity. Similarly, I foresee the situation whereby the Nigerian oil will essentially serve the domestic market. Industrial activities have begun to grow and will likely reach a tipping point in a few years, transforming Nigeria into an industrial hub. At that time, the price of oil will matter very little for Nigeria. Indeed, higher oil price at that time would hurt us because most of Nigeria’s oil would be sold locally. The country would be more concerned about increasing the oil reserves so that Nigeria’s oil would continue to be available to fuel its economic growth. At such a time, we would look back to this Administration and appreciate the Transformation Agenda of President Goodluck Jonathan as being well-appointed. Implementation of non-oil growth dimension of the Transformation Agenda has been the pre-occupation of NEXIM Bank in the last five years. It will remain so.
Roberts Orya is Managing Director / Chief Executive Officer, Nigerian Export-Import Bank.