In her book, Reforming the Unreformable, the Nigerian Experience, Dr. Ngozi Okonjo-Iweala provided background of the reforms in Nigeria and how she became the Finance Minister under President Olusegun Obasanjo
On the morning of July 17, 2003, I sat down at my desk in Nigeria's Ministry of Finance, just after being sworn in with other ministers by President Olusegun Obasanjo as a member of the cabinet.
I was overwhelmed when I reviewed the enormity of the problems confronting the country and saw the huge mountain of files already stacked for action on my desk. I wondered where to begin, and whether I had in fact been insane, as many friends and family thought, to leave my comfortable job and recent promotion to vice president at the World Bank to accept this huge challenge.
I had spent the two months between the time President Obasanjo first approached me to serve in May 2003 and the swearing-in ceremony in July working intensely on analyzing the problems of the economy and identifying the bottlenecks.
This analysis clearly showed that if we were to make any headway in improving economic and social performance of the country, we had to begin with macroeconomic and budgetary reforms.
We had inherited an unstable macroeconomic environment characterised by volatile exchange rates, double-digit inflation (23 percent on an annual basis in 2003), a high fiscal deficit (3.5 percent GDP in 2003), low foreign-exchange reserves ($US7.5 billion in 2003), and low GDP growth (2.3 percent on average for the past decade, including negative GDP growth per capita in those years because of the increase in population).
Essentially, our analysis showed that we faced two sets of problems.
First, the economy was highly volatile, with loose fiscal policy and poor management of both the volatility and the fiscal policy. Second, there was no clear and consistent budgetary framework or budget process. The two sets of problems were strongly related-indeed, as we increasingly discovered, they were intertwined-and solutions had to be found for both.
Nigeria - one of the world's most volatile economics
Since the oil boom of the 1970s, the Nigerian economy has been highly undiversified. The overwhelming share of exports (96 percent) and government revenues (more than 75 percent) depend on oil. Oil has two important attributes that demand attention and careful treatment. First, oil prices are internationally determined, highly volatile, and unpredictable; hence oil revenues in any economy are highly volatile. Second, oil is a depleting natural resource whose benefits must be managed carefully for the good of both current and future generations.
Economic management in Nigeria over the years had paid scant attention to both attributes. Government expenditure in Nigeria was volatile and procyclical: government spending rose in tandem with oil prices and oil revenues, and dropped when prices crashed.
The wide fluctuations in government revenues and expenditures from 1971 to 2005 can be seen clearly in figure A2.1. Successive Nigerian governments had gone on a spending and borrowing spree during oil booms in the 1970s, the early 1980s, and the 1990s that often resulted in poorly planned projects of low quality, including such notable "white elephants" as the Ajaokuta steel mill, on which $US5 billion was spent and which produced virtually no usable steel. Spending sprees also encouraged corruption, the bane of Nigeria's economy throughout the years.
Oil-price volatility and revenue volatility were made much worse by Nigeria's loose fiscal policy. As oil prices increased, so did the fiscal revenues that government could collect from oil, and so could government spending; hence volatility in oil prices and oil revenues translated into volatility in public spending, along with volatility in exchange rates - with serious macroeconomic consequences.
The Nigerian economy earned the dubious distinction of being rated one of the most world's volatile. (See World Bank 2003 and table A2.1.) From 1961 to 2000, Nigeria ranked among the ten most volatile economies in the world on a range of macroeconomic variables, from terms of trade to per capita real GDP; indeed, it ranked in the top five for three of these variables. More important, Nigeria's volatility was more than twice the median volatility for almost all of these important economic variables.
Why does volatility matter? Because evidence shows that high volatility slows down productivity growth by a substantial margin, particularly in countries where the financial sector is insufficiently developed.
Failure to manage the consequences of oil-price volatility, together with poor fiscal and exchange-rate policy, can lead to Dutch Disease. Nigeria's non-oil sectors, particularly agriculture, were classic victims of Dutch Disease during the oil booms.
The high cost that volatility inflicted on the non-oil economy manifested in a precipitous decline in per capita non-oil real GDP growth from 1970 to 2003. (See figures A2.2 and A2.3.) The effect on social indicators was equally deleterious. (See table A2.2.) The effect of volatility on GDP growth is shown in table A2.3.
Despite its substantial oil earnings - estimated at US$300 billion since the 1970s - Nigeria remains mired in poverty, with high rates of adult illiteracy, maternal mortality, and infant mortality.
It is expected to be one of the sub-Saharan African countries that will not meet the Millennium Development Goals by 2015. Infrastructure is poor. In a telling example, per capita consumption of electric power is low (121 kilowatt-hours) compared even to the average of low-income countries (317 kWh) and a fraction of consumption in South Africa (3,800 kWh).
The challenge we faced - which may remain Nigeria's prime economic-management challenge - was managing oil-related volatility and ensuring that oil revenues would be spent to improve the lives of the Nigerian people.
Remember that Nigeria's oil earnings accounted for the lion's share of government revenues, and the fluctuations in those earnings were directly transmitted to the domestic economy through fluctuations in public expenditure.
The simple way of addressing this problem would have been to de-link public expenditures from current oil revenues by adopting a fiscal rule based on the price of oil. This is what we did.
The Oil Price-based Fiscal Rule (OPFR) lets Nigeria escape from the tyranny of current oil prices by using a long-run average oil price. Nigeria adopted a reference price that mimics the long-run (10-year) average oil price.
When actual prices rise above the reference price, the government can put away some of the excess revenues in the form of savings. When oil prices fall below the reference price, the government can draw on these savings to maintain its level of spending. This predictability is, in turn, imparted to the non-oil economy.
In 2004, when oil prices averaged US$33 per barrel, Nigeria adopted a reference price of US$25 per barrel to craft the budget.
This generated savings of US$8 per barrel at a time when Nigeria was pumping an average of 2.3 million barrels of crude oil per day. In 2005, when prices averaged US$55 per barrel, Nigeria adopted a US$33 per barrel reference price. In 2006, when prices averaged US$60 per barrel, Nigeria boosted the reference price to US$45.
A new Excess Crude Oil Account (ECA) was created at the central bank, and savings were held there and managed as part of the country's reserves. The savings were allocated to the three tiers of government of the Nigerian Federation (federal, state, and local), as stipulated in the constitution.
By the end of 2006, Nigeria had accumulated gross reserves of US$46 billion, of which US$8 billion were savings in the Excess Crude Oil Account in spite of utilising US$12 billion in connection with the settlement of the US$30 billion Nigeria owed to the Paris Club. The OPFR was binding on all tiers of government.
Thus it was not without controversy, as the states insisted that this was not constitutional. Some state governors declared that they did not see the need for this "rainy day fund," as I had termed it, since, given the development problems of the country and their states, they thought it was raining already - "in fact, the roof was coming down," as one governor put it.
They argued forcefully that the money should be allocated for spending right away. We did a lot of jawboning to try to explain the volatility issue, and President Obasanjo courageously demonstrated the political will to hold the states to this agreement.
Successfully implementing an oil-price-based fiscal rule requires good timing relative to the trajectory of oil prices, and we were lucky. We began implementation of the rule when oil prices were on an upward trajectory, so savings could be built up in the first place.
Nevertheless, successful implementation of an oil-price-based fiscal rule does not depend solely on building up savings. There are other factors. Let me make three observations.
First, although de-linking government spending from current oil revenues is a big step forward, it is not enough.
The composition of spending also matters. Oil revenues are generated while a national asset, the country's oil reserves, is being depleted. That national asset belongs not just to the current generation but also to future ones. Thus, oil revenues should be spent on creating a springboard for stable long-run growth that will benefit future generations.
This means spending the money wisely on long-term investments. Two types of investments are ideal: public investments in infrastructure to support diversified private investment in the non-oil sectors, and social expenditures in health and education.
Second, transferring oil revenues to the budget at the reference price must be accompanied by spending discipline. There is no point in accumulating savings when oil prices are high if government spending is out of control.
This would be akin to a driver's putting one foot on the accelerator pedal and the other on the brake pedal. Spending discipline automatically puts a lid on borrowing and on debt accumulation.
Third, a fiscal system is needed that can facilitate and monitor the process whereby oil revenues are transferred to the budget, and can follow the subsequent spending and results. As I shall discuss in detail in the next section, Nigeria lacked a clear and consistent budget process.
Nigeria badly needed a medium-term macroeconomic program and a way of enshrining the OPFR in law to avoid backsliding. We dealt with those challenges by adopting a medium-term macroeconomic program supported by a new nonfinancial instrument the International Monetary Fund had just developed: the Policy Support Instrument (PSI).
To instill fiscal discipline and tighten macroeconomic management, we designed a mix of fiscal and monetary policies in order to deliver macroeconomic stability in the medium term. We aimed at a fiscal deficit of 3 percent of GDP and a gradual reduction of the consolidated non-oil primary balance - the difference between the government's non-interest spending and non-oil revenues - from 41 percent of non-oil GDP in 2005 to 35 percent by 2006.
We aimed to boost international reserves to reach US$26 billion by the end of 2005 and US$50 billion by the end of 2006 and to adopt tight monetary policies that would achieve single-digit inflation by the end of 2006. We invited the International Monetary Fund to support this program and monitor our progress through the Policy Support Instrument.
This instrument allows the IMF to monitor a country and assist it in implementing a program without the country having to borrow any financial resources. For us, it served as an external restraint that would be an additional support in implementing a tough set of self-improved policies.
We next aimed to institutionalise the OPFR and fiscal discipline through the adoption of a Fiscal Responsibility Act. (See box 2.1.) In view of the controversy surrounding the OPFR and the lack of a budget framework and good budgetary practices at both federal and state levels, it became clear that a binding instrument would be needed to safeguard the macroeconomic reforms and lock in a good set of policies for managing volatility for the long term. A Fiscal Responsibility Act suited to a fiscally decentralised country such as Nigeria seemed to be the right instrument.
For inspiration on how to craft such a bill, we turned to another large fiscally decentralised country: Brazil. There was consensus at the federal government level that such a bill would be helpful. Nigeria's vice president at the time, Atiku Abubakar, and several lawmakers traveled to Brazil to learn about their bill.
We subsequently adapted the Brazilian bill for Nigerian purposes, locking in adherence to the OPFR by all tiers of government and adherence to a fiscal deficit of no more than 3 percent of GDP over a three-year, medium-term expenditure horizon.
We also locked in a requirement for an annual budget and for sound and transparent budgetary practices by the federal and state governments. We set limits to external borrowing for all tiers of government, including the terms for such borrowing.
Unfortunately, by the time the bill was passed and signed into law, near the end of 2007, state governments had watered down some of the provisions they found restrictive, using constitutional-related arguments.
The budget process that I encountered in the mid 2000s was ad hoc, opaque, and poorly planned. There was little coherence in budget formulation. Budgets tended to just repeat sectoral allocations from the past with some tweaking at the margin, perpetuating a legacy. Program implementation often deviated from the budget with impunity.
All this meant that the budget cycle created room for corruption and waste. To use a common Nigerian term, there were widespread leakages at various stages of the budget process. It was widely believed that one could bribe senior civil servants preparing the budget in order to get a desired project included.
Monitoring and evaluation officials could also be routinely bribed to sign off on a shoddily completed project, or even on incomplete work. For example, a contractor building a road could cut costs by not building drainage systems or sidewalks specified in the project design.
The government supervisor could simply ignore this and take his or her share of the "savings" accruing to the contractor. Moreover, because of poor record keeping between the Budget Office and the Accountant-General's office, millions of dollars could be lost when funds were being released to implement a project. addition, the poor record keeping and lack of reconciliation of accounts routinely resulted in expenditures running ahead of revenues in a cash-based budget; thus, government institutions periodically accessed the Ways and Means account or overdraft facility at the central bank.
I was shocked to find systems in disarray and a very low level of computerisation in both the Budget Office and the office of the Accountant-General of the Federation (AGF). Almost everything was handled through Excel spreadsheets. There were few links between the systems and the processes of the two offices.
The ministries, departments, and agencies (MDAs) that implemented the budget took advantage of this lack of coordination in various ways. Monies disbursed to the MDAs for operating expenses were routinely kept in accounts at various commercial banks, where favorable interest rates were negotiated by the senior civil Servants responsible for oversight of these monies. While banks traded with the monies on their own account, top civil servants shared the interest that had accrued.
There was no feeling that anything was wrong with this practice as long as the principal was untouched. As a result, monies were often kept in accounts for as long as possible to earn interest, while projects and programs went unexecuted. Sometimes ministers were unaware of what happened to the ministries' resources and complained in cabinet of a lack of resources for their programs, while the resources were lying idle in commercial bank accounts.
Execution of the capital budget consistently fell below 50 percent and was at 24 percent in 2003. By 2003, the government had also accumulated arrears to domestic contractors amounting to about 150 billion naira (US$1.17 billion at the time).
I also found that there were no proper government records of these debts; they became another source of corrupt transactions that stretched out over the years as contractors were routinely asked by some unscrupulous budget officials for bribes when they brought in their receipts for validation and payment.
Our initial attempts to audit and pay off these debts became a protracted negotiation between the Treasury and contractors as to how large the actual debts were. Over the years, pension arrears of parastatals, government agencies, and departments had also accumulated, reaching more than a trillion naira (the equivalent of US$8 billion at the time). Record keeping in this area was just as poor, and all combined to make for a fiscal nightmare.
Finally, there were structural problems with the budget - not least the fact that more than two-thirds of budget resources went for salaries and operating expenditures, leaving less than one-third for capital projects. Restructuring and reshaping a US$15-25 billion budget in the face of so many distortions and needs would prove difficult.
A book you must read
Read part one of the serialization of Reforming the Unreformable