The Challenges and Prospects of Nigeria s Fiscal and Monetary Policies, ( )

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1 Euro-Asian Journal of Economics and Finance ISSN: (print) ISSN: (online) Volume: 2, Issue: 1 (January 2014), Pages: Academy of Business & Scientific Research The Challenges and Prospects of Nigeria s Fiscal and Monetary Policies, ( ) Chris O. Udoka, Ph.D 1 * and Anyingang Roland A (M.Sc) 2 1&2. Department of Banking and Finance, Faculty of Management Sciences, University of Calabar, Calabar Nigeria. The main thrust of this paper was on the challenges and prospects of Nigeria s fiscal and monetary policies framework, Specifically, issues of monetary or fiscal dominance, financing of fiscal deficits, fiscal-monetary policy conflicts and policy coordination were intimately discussed. A synopsis of the relationship between monetary and fiscal policies behaviors in Nigeria with particular attention to the pattern and changes of fiscal behavior, the incidence of fiscal dominance, and the implications of the pattern of fiscal behavior for monetary policy and its management were provided. Findings resulting from the paper revealed that performance of the economy was better under cooperation in the sense that Losses to the government and the Central bank were lower than under non-cooperation. The study suggested that all tiers of government in Nigeria should inculcate the habit of financing budgetary deficits from noninflationary sources than continuous borrowings from the financial system. Keywords: Fiscal policy; monetary policy; economic growth; budget deficits. INTRODUCTION Fiscal and monetary policies are inextricably linked in macroeconomic management. (Ailen- Ataman, 2012). Undoubtedly, fiscal policy is central to the health of any economy, as government s power to tax and spend affect the disposable income of citizens and corporations, as well as the general business climate. It is incontrovertible that an effective and efficient monetary policy is essential for economic growth and development (Ojo, 1992). This is borne out of the fact that pragmatic monetary management regulates liquidity to an optimal level to ensure macroeconomic stability which is imperative for sustained economic growth. Monetary policy management is usually carried out by the Central bank using various instruments at its disposal to regulate the availability and cost of money in consonance with the absorptive capacity of the economy. Therefore, key to all these, lie striking a balance in fiscal and monetary policies management. Unfortunately most Nigerian political leaders over the years, appear not to understand that real reform requires systematic policy initiatives, well thought-out, coordinated fiscal and monetary policy actions that could drive social and economic developments. It must be noted that there is always a positive relationship between inflation and flamboyant spending habits and the level of productivity. One of the problems with Nigeria is that there is a lot of unregulated *Corresponding author: Chris O. Udoka, Ph.D Department of Banking and Finance, Faculty of Management Sciences, University of Calabar, Calabar Nigeria. udokaco@yahoo.com 72

2 The challenges and prospects of Nigeria s fiscal and monetary policies Udoka and Roland spending life styles among the political class on frivolities. Monetary and fiscal policies should be able to play a key role in the promotion of the main objectives of promoting the welfare of its citizens, price stability, full employment as well as enducing economic growth and development. In order to achieve the objectives of this study, the paper is divided into four sections. Section one is the introduction. Section two dwells on the overview of Nigeria s fiscal and monetary policies. Section three is on the challenges and prospects in macroeconomic management. This is followed by conclusion and recommendations. AN OVERVIEW OF FISCAL AND MONETARY POLICIES Fiscal policy is the deliberate changes in the level of government expenditure, taxes and other revenue and borrowing in order to achieve such national goal or objectives such as price stability, full employment, economic growth and balance of payments equilibrium (Okunrounmu in Idowu, 2009). The stance of fiscal policy could be neutral, which implies a balanced budget, where government spending is equal to tax revenue; expansionary, where a government raises its spending or reduces taxation, or a combination of the two or contractionary, when government spending is reduced either through higher taxation or reduced spending (Wikipedia, 2010). Monetary policy is concerned with the use of changes in monetary supply and /or interest rates to influence the level of economic activity. It is anchored on the use of some or all of the following instruments. Open Market Operation (OMO); which involves the supply or withdrawal of liquidity from the economy by the Central bank through secondary market dealings in treasury securities and the issuance / purchase of Central bank securities. The reserve requirements; which specifies the proportion of a bank s total deposit liabilities that should be kept with the Central bank. The Discount Window operations; which the Central bank uses in performing the role of the lender of last resort to the deposit money banks. Sectoral credit guidelines, credit ceilings and cash reserve requirements, administrative fixing of interest rates, exchange rates and the imposition of special deposits. In most developing countries, such as Nigeria, the use of these policy instruments may be sub-optimal on account of the underdeveloped nature of the money and capital markets. The authority to carry out monetary policy is rested in the Central Bank of Nigeria through the CBN Act the law enjoins the Bank under section 2 to ensure monetary and price stability, among others. In designing monetary policy, Ezema, in Idowu, (2009) noted that the CBN reviews developments in the economy over a period, articulates the major pressures for and risk to price stability and formulates a framework which is essentially based on monetary programme which sets out future trends in macroeconomic aggregates to guide its monetary implementation. The monetary programme is reviewed on the basis of the performance of macroeconomic aggregates against the projections. He also observed that monetary management generally focused on price stability through assiduous tracking of liquidity. Fiscal policy on the other hand involves the use of taxes and changes in government expenditure to influence the level of economic activity. The undeveloped nature of money and capital markets in Nigeria means that more emphasis is placed on the use of changes in government spending. Consequently, budget deficits tend to be financed through domestic borrowings; in some developing economics, budget deficits are often financed by printing money. The monetization policy often results in inflation and engenders the dominance of fiscal over monetary policy. The main instrument of fiscal policy in Nigeria is the budget and is usually prepared by Government ministries /Departments/Agencies (MDAS) of the Federal government under the supervision and guidance of the Ministry of Finance (MOF) through the Budget Office of The Federation (BOF). Hitherto, the time horizon for the budget had been one year, until recently, when the medium Term Fiscal Framework (MTFF) was introduced, which involves the documentation of the fiscal policy objective of government as well as fiscal targets and projections (Oti, 2011) in (Mbat 2011). 73

3 Euro-Asian j. econ. financ. ISSN: (print); (online) Volume: 2, Issue: 1, Pages: The main thrusts of the Federal Government fiscal policy over the last decade has remained the pursuit of the goal of economic growth, employment generation, and the provision of infrastructure. Monetary and fiscal policies are inextricably tied, suggesting that pragmatic monetary management is important to the realization of the objectives of growth and development of an economy. Both policies are essential components of overall macroeconomic policies and they usually share similar goals of macroeconomic stability, low inflation and reduced unemployment. All these objectives, however, may not be achievable without tradeoffs and also requiring a lot of Coordination for policy effectiveness. It is important to stress that monetary policy refers to a blend of measures designed by the Central bank to regulate the value, supply and cost of money consistent with the absorptive capacity of the economy of the expected level of economic activity without necessarily generating undue pressure on domestic price and exchange rate. The objective of monetary policy can vary from one country to the other but are generally of two variants. The first focuses on single objective of price stability, while the second perspective has multiple objectives of achieving not only price stability, but other macroeconomic goals. The need for monetary instrument to regulate money supply is based on the general consensus that the quantity of money supply and the general price level are highly related and if not regulated, could result in undesirable effects such as rising inflation. In the context of the objectives of both the fiscal and monetary policies as enunciated by Oyejide, (2003) when presenting the challenge of monetary management in an environment of fiscal dominance shows that apparent conflict often arise between the CBN whose primary goal is to maintain monetary and price stability and the Federal Government whose primary pursuit are infrastructure provision, employment generation and economic growth. Therefore, the conduct of monetary policy, the fiscal environment and data availability can create uncertainty in policies macroeconomic variable transmission mechanism. In dealing with fiscal uncertainty, Uchendu (2009) stresses the need for proper coordination of monetary authority with fiscal authority as a key factor in achieving effective monetary management which is imperative in ensuring a stable macroeconomic environment. CHALLENGES AND PROSPECTS IN MACROECONOMIC MANAGEMENT The 2007 Federal budget focused on the theme: accelerate Investments in Basic Physical and Human Resource Capital. Thus, government expenditure was to be channeled towards completing on-going projects in the power, water, roads, security, education and health sub-sectors. These goals are still evident till date (2012) and are directed toward improving the quality of life of Nigerians and addressing the infrastructural deficiencies that constrained the ability of indigenous businesses to optimize their operations and generate employment. The framework for monetary policy management in 2007 and throughout the period remained that of monetary targeting. The Central Bank of Nigeria (CBN) adopted various policy measures aimed at containing the growth of monetary aggregates in order to achieve monetary and price stability. Open Market Operations (OMO) remained the major tool of liquidity management. Other policy measures included increased issuance of treasury securities in the primary market to mop-up excess liquidity; use of deposit and lending facility to encourage interbank transactions as well as special sales of foreign exchange, including swap arrangements. NTBs of various tenors (91-, 182 and 365-day) were auctioned during the period. These two conducts remained a challenge for macroeconomic management in Nigeria. Several fiscal factors have over the period hampered the efficiency and effectiveness of monetary management by CBN. These factors include the following: The financing of large fiscal deficit of the Federal Government mainly by CBN and Excessive fiscal spending by the three tiers of government due to the sustained increase in revenue flows occasioned by rising price of crude oil at the international market. 74

4 The challenges and prospects of Nigeria s fiscal and monetary policies Udoka and Roland Banking system borrowing by the sub-national governments to finance unplanned and inefficient extra budgetary activities due to unbridled fiscal expansion and un-coordinated budgetary operations of the three ties of government. Given the resolute commitment to the mandate of ensuring monetary and price stability at all times, the CBN in the period deployed un-conventional instruments including stabilization securities, CBN certificates, special treasury bills, special deposit, withdrawal of public sector deposits from deposit money banks, in addition to the conventional instruments of open market operations (OMO), rediscount rate, reserve requirements, cash/liquidity ratios including repos, open buy-back (OBB), reserve repos, swaps, special OMO auctions, occasional foreign exchange swaps, special wholesale Dutch Auction System (wdas) and standing deposit and lending facilities, among others to achieve its objectives. In 2006, the Bank re-engineered its policy framework by replacing the Minimum Rediscount Rate (MRR) which hitherto served as the nominal anchor for interest rates in the economy with the Monetary Policy Rate (MPR) in order to be more proactive in macroeconomic management. Over the years, the fiscal operations of the government both at the national and sub-national levels have essentially been characterized by continuing growth in expenditure and have persistently followed the booms and burst of earnings from the oil sector. Despite the claims by the CBN that it has achieved price stability within the system, records show that the economy is suffering from rising inflation and unemployment. Reportedly, however, inflation dropped to 11.8% close to the target of 11.2% in 2010 from 15.1 % and 13.9% in 2008 and 2009 as shown in Appendix 3. Between 2005 and 2010, the expenditure of the federal and sub-national government grew at an annual average of about 14.8 (appendix 1). The huge fiscal operations at all levels and the inflationary financing of large budget deficits of the Federal Government vitiated monetary management, particularly, as the CBN had to take up the Federal Government s fiscal deficits with the issuance of high powered money during that period as compared in (Appendix 2). Consequently, unbridled fiscal spending with the attendant fiscal deficit by all the tiers of government, over the years, engendered rapid monetary growth, accentuated inflationary pressure and other monetary targets (Appendix 3). The government has not been particularly reluctant to use domestic debt and money creation to finance their deficits especially when they are unable to deploy alternative tax handles. In such circumstances, it may be virtually impossible to separate monetary from fiscal policy. This is clearly one of the areas where conflict frequently occurs between monetary and fiscal authorities. The performance of the economy is better under cooperation in the sense that the Loose to the government and central bank as well as the economy are lower than they are under noncooperation. Between 2005 and 2010 this cooperation has become increasingly effective and evidently significant in the mechanisms in monetary policy formulation where the Ministry of Finance (MoF) becomes directly involved. The Permanent Secretary, MoF is an ex-officio member of the MPC. As shown in the appendix 4 the fiscal deficit/ GDP ratio was actually lowest during (- 1.58) as compared to -3.1, -5.9, -4.9 in period , and respectively. Furthermore, the proportion of the stock of domestic public debt which was held by the banking system lowered in period (54.5%) compared to 73.2%, 83.3%, 92% in period , , and respectively. It appears therefore, that increased cooperation and collaboration improved fiscal behavior on the part of government to induce an improved fiscal behavior of government, although the banking system has been apparently obliged to hold an increasing share of the public debt. In effect, government s fiscal behavior ultimately determined the growth of monetary aggregates over these periods. However, the 54.5% is still relatively high as it contains the productive sector access to greater credit. The implementation and institution of these reforms have so far yielded positive results. Specifically, the fiscal reforms had brought some element of prudent fiscal management particularly with respect to the size of fiscal deficit 75

5 Euro-Asian j. econ. financ. ISSN: (print); (online) Volume: 2, Issue: 1, Pages: /GDP ratio which declined asymptotically from 1.5 per cent in 2004 to 0.6 per cent 2007 and averaged 1.58% in the period Similarly, with regard to financing of fiscal deficits, the CBN zero tolerance for ways and means advances moderated the Federal Government fiscal operation as shown in Appendix 2. CONCLUSION AND RECOMMENDATIONS The paper has examined the various ways in which government fiscal operations has constrained monetary management in Nigeria. It established the fact that huge public spending by the three tiers of government, over the years, had hampered monetary management resulting in the missing (s), while induced serious pressure on the general price level. There is need therefore to ensure that the fiscal operations of government do not result in excess liquidity beyond the absorptive capacity of the economy. In this respect, it is important to pursue consistent monetary-fiscal policy mix to achieve the desired macroeconomic objectives. Thus, arrangement for sharing vital information to support the execution of both policies for effective monetary and fiscal management should be fashioned out and implemented. Uncertainty remains a major challenge in fiscal and monetary policies implementation in Nigeria. In dealing with fiscal policy uncertainty, the Central Bank s major strategy should be to continue to seek closer and more effective coordination with the fiscal authorities. Both policies authority have to continue to find ways to deal with uncertainty. The major approach has to be close collaboration as well as monitoring of key sources of uncertainty like data generating institutions and the treasury. Notwithstanding these developments, the coordination of fiscal and monetary policy calls for constant re-examination of issues with respect to the overall liquidity in the economy. Given the high degree of vulnerability of the federation revenue to the vagaries of oil prices in the international market, a sustained downward swing in prices for instance could constitute a serious threat to the fiscal operations of all levels of government and may induce government, particularly, the Federal Government, recourse to the CBN for financing of huge fiscal deficits. This may reverse the gains of the fiscal reforms and put monetary management at risk. In the light of this, monetary authority should at all time not lose sight of the inherent danger posed by revenue volatility to government fiscal operations and ultimately, the effectiveness of monetary management. It is pertinent to emphasize that monetary management remained confronted with the problems of the non-committal to the Bank s ultimate target of inflation by successive governments. This posture always create difficulty for the pursuit of a low and stable inflation by the CBN, as the short term objectives of government is inconsistent with medium to long run objective of price and monetary stability. The current reform in the nation s macroeconomic management process should be sustained. These include: Fiscal Rule Oil price based fiscal rule by applying specific oil price benchmark for budgeting and the establishment of a savings fund known as the excess crude revenue account of the Nigerian Sovereign wealth fund to warehouse excess revenue from crude oil sales above a predetermined oil price. This policy is aimed at ensuring that public expenditure is smoothed over time. Monetization of the benefit of public servants to stem the ever rising recurrent expenditure of the Federal Government, thus reducing waste and releasing more resources for the provision of social and economic infrastructure. Pension Reform Enactment of the Pension Act 2004 to free public resource from the burden of pension payments and institute fiscal affordability in public finance nationwide. Fiscal transparency: Public Sector Procurement Reform The establishment of the budget Monitoring and Price Intelligence Unit (BMPIU) Due Process. Introduction of policy based budgeting to ensure transparency and adherence to budget processes by law. Commencement of medium term fiscal framework Medium Term Fiscal Framework (MTFF) inclusive of MTEF and MTRF to drive budgetary 76

6 The challenges and prospects of Nigeria s fiscal and monetary policies Udoka and Roland processes. Entrenchment of a provision limiting the granting of advances to the Federal Government for budget support. The current effort at strengthening transparency and accountability in fiscal management should be sustained to prevent undue constrains to monetary management. In this respect, strict adherence to the fiscal responsibility laws (FRA 2007) would continue to stimulate fiscal discipline and good public expenditure management. Subnational governments should be encouraged to adapt and enact the relevant provisions of the FRA This would promote efficient public expenditure management, assist budgetary operations and ultimately foster the fiscal policy coordination nationwide. The continued observance of the Medium-Term Fiscal Framework (MTFF) and the newly introduced performance budgeting initiatives should be pursued with vigor to improve allocation and operational efficiency of government spending. The government should initiate and pursue policies /reforms that would truly diversify Nigeria s revenue base to promote predictable earnings and engender a macroeconomic environment in which resource are efficiently utilized to ensure sustainable public finance at all levels of government. The savings in the excess crude account should be strictly channeled to provision of socioeconomic infrastructure such as roads and rail, energy particularly power, health services to enhance human capital and support adaptable technological research so as to lay the foundation for industrialization and economic advancement. Idowu, A. E. (2009). Fiscal operations and the efficacy of monetary management in Nigeria. CBN Bullion (2). CBN Research Department. Oti, P. A. (2011). Fundamentals of medium term framework. In Mbat (ed). Topical issues in finance. 2 nd (Ed) University of Calabar press, Calabar. Ojo, M. O. (1992, March). Monetary policy in Nigeria in the 1980s and prospects in the 1990 s CBN Economic Review. 30 (1) Oyejide, T. A. (2003). The challenges of monetary management in an environment of fiscal dominance Issues in fiscal management: implication for monetary: implication for monetary policy in Nigeria. CBN (3 rd annual monetary policy conference). 11 th 12 th December. CBN. Statistical bulletin. (2010). 21. CBN Statistics Department. Uchendu, O. A. (2009). Monetary policy management in Nigeria in the context of uncertainty. CBN Bullion (3). CBN Research Department. Wikipedia Encyclopedia (2010). Fiscal policy. REFERENCES Blinder, C. C. (1983). Issues in the coordination of monetary and fiscal policy. NBER working paper No.982. Central Bank Act, Fiscal Responsibility Act (2007). Federal Republic of Nigeria. 77

7 Euro-Asian j. econ. financ. ISSN: (print); (online) Volume: 2, Issue: 1, Pages: APPENDIX Appendix 1: Public Expenditure (N Billion) Public Exp/Yr Average % Federal Govt 1, , , , , , State Govt 1, , , , , , L.G.A , , , Total 3, , , , , , % Growth in Total Exp.,7.7%,28.8%,39.6%,-3%,15.4%,14.8% Source: CBN Statistical Bulletin Appendix 2: Public Exp/Yr Federal Govt Deficit CBN Take up (%) Fiscal indicators (N, Billion) , Source: CBN Statistical Bulletin Appendix 3: Key Monetary Mgt Variable (%) Tgt Outc Tgt Outc Tgt Outc Tgt Outc Tgt Outc Tgt Outc M M Inflation RM n.a n.a n.a n.a Source: CBN Statistical Bulletin Appendix4: Trends in indicators of Fiscal Dominance ( ) ( ) ( ) Public ( ) Domestic Dept/GDP (%) Domestic Public Debt/Total Assets of Commercial Bank Fiscal Deficit/GDP (%) Banking System s Holding of Domestic Public Debt (%) Computed from CBN Statistical Bulletin