A perspective on the 2015 appropriation bill (2)

The planned expenditure, projected revenue and by extension the expected fiscal deficit for 2015 depend on the budget assumptions. The oil price benchmark of $65 per barrel (pb) is lower than $77.5pb applied in 2014. Oil prices have dropped sharply and are currently trading below the budget benchmark, with OPEC estimating that Nigeria’s Bonny Light crude averaged $51pb in January 2015.

The outlook for the oil market, according to the ‘The Economist’ magazine, is not too robust for the reason that

(1) demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels;

(2) the turmoil in Iraq and Libya, two big oil producers with nearly 4m barrels a day combined, has not affected their output;

(3) America now imports much less oil;

(4) the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price.

The current supply and demand dynamics notwithstanding, it is not certain where the price of oil will be in the medium term given the volatilities associated with commodities markets in general and the oil markets in particular. What is certain is that markets go through the boom-bust cycles which make it imperative for natural resource countries like Nigeria to put in place sufficient fiscal buffers. Government should therefore consider a lower benchmark oil price in line with market realities. The reduction of the benchmark price implies lower revenue estimate, therefore necessitating corresponding cuts in planned expenditure. Given the rigidity associated with personnel costs reduction, there is need for downward review in overhead costs which accounts for N1.58 trillion or 36.2 percent of the total budget and is 2.5 times the amount set aside for capital spending.

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With respect to oil production, it is assumed that 2.2782mbpd will be produced in the fiscal year 2015 as against 2.3883mbpd last year. Although the assumed production level is lower than the previous year, there are still concerns that this target may not be met owing to continued problem of oil pipelines vandalism and theft. However, in setting the production target, consideration may have been given to the fact that broad-based efforts (including the involvement of local communities) are being taken to address the problem. Nevertheless, the concerns are not misplaced given that budget goals have been consistently lower than actual production. Nigeria’s actual oil production, according to OPEC, was on average lower than the budget targets for 2013 and 2014. Therefore, government should consider a downward review of the oil production benchmark to between 1.79mbpd and 1.91mbpd which are the average productions in 2013 and 2014, according to OPEC.

The exchange rate target for the fiscal year 2015 is N165/$ as against N160/$ in 2014. Compared with the oil price and production benchmarks which are determined by the fiscal authorities, the exchange rate assumption is usually provided by the central bank. The lower value of the exchange rate is based on current trend in the global oil market which poses risk to dollar earnings from oil and by extension exchange rate management. The direction of the exchange rate will in the short term depend on whether oil prices rebound from current levels as well as on Nigeria’s domestic oil production meeting the target for the fiscal year. Ultimately, the value of the exchange rate will be determined by how competitive the Nigerian economy is relative to the world.

In sum, a downward review of the oil price and production benchmarks should be considered in light of current realities. If oil prices rebound and production meets or surpasses the target, then the government will earn enough revenue to fund the budget and also have a lower deficit level. However, if oil price and production targets fail, the resultant deficit will be enormous and the financing mode will be challenging. To finance the deficit, the option of increasing new borrowing from the proposed N570bn, which is a decline from the previous year’s N653.72bn, may be insufficient. Besides, if borrowing is increased, total amount set aside for debt service will also increase from N943bn, which is already 21.6 percent of the total budget and 1.5 times the N627.12bn set aside for capital expenditure. This includes MDAs capital budget, share of capital spending in statutory transfers and share of capital spending in SURE-P.

At this time of unfavourable market conditions, there is need for drastic reduction in spendings that have little value addition. While personnel costs comprise salaries and other entitlements that are rigid, the overhead costs component of recurrent spending need to be slashed across the board. Salary cuts should be considered for top government officials while the legislators can show patriotism and lead by example by slashing the N150bn allocation to the National Assembly. In the medium to long-term, there is need for the establishment of a mechanism that will ensure MDAs provide detailed returns on how their budgetary allocations are expended. Emphasis must be on the quality of spending, not only during austerity periods but also during boom times.

Culled from the policy brief prepared for Preston Consults Nigeria Limited.

Maxwell Ekor