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A new budgetary framework for Nigeria

By Ejeviome Eloho Otobo
25 June 2020   |   3:21 am
Nigeria needs a new budgetary framework. To appreciate why a new budgetary framework is required, it is important to explain how the current budgetary framework works. Since oil earnings became the dominant source of government revenue, federal budgets have been prepared on the basis of prevailing or projected oil prices. ln other words, the federal…

Nigeria needs a new budgetary framework. To appreciate why a new budgetary framework is required, it is important to explain how the current budgetary framework works. Since oil earnings became the dominant source of government revenue, federal budgets have been prepared on the basis of prevailing or projected oil prices.

ln other words, the federal budgets were benchmarked to the prevailing or projected oil prices. ln 2004, this approach was modified with the introduction of the “oil-based fiscal rule”, under which the estimated earnings from oil were based on a bit less than the prevailing or projected oil prices. This fiscal rule was designed both to avoid wild swings in expenditure but more importantly to save the earnings above the benchmarked oil price. The Excess Crude [oil] Account (ECA) was born out of this approach. The ECA was meant to serve as a stabilisation fund to be used as a last resort on “rainy days”. In practice, the weak fiscal situation of most states meant the ECA has been used on “partly cloudy days”. ECA has, however, been the most significant innovation to the budgetary framework since Nigeria made the transition from agriculture-led economy in the 1960s to oil-led economy in the early 1970s. Nigeria’s journey to an oil-dominated political economy can be traced to 1974, when oil prices quadrupled in the aftermath of the October, 1973 Middle East War.

Every budgetary framework aggregates the political decisions on fiscal arrangements. ln Nigeria, these decisions are reflected in the derivation formula and revenue allocation formula. The financial resources allocated for the budgets of governments at the federal and sub-national levels have been based on both the derivation and revenue allocation formulae. From independence till after the civil war, the budgetary framework strictly adhered to section 134(1) of the 1960 Constitution and sections 140 and 141 of the 1963 Constitution which stipulated a derivation formula that allocated 50 percent of revenue from export earnings to the regions/states where the commodity was produced, and 50 percent to the federal government. Amending the derivation formula, through military decrees, began in 1970/1971 fiscal year.

By then oil accounted for 48 percent of Nigeria’s export income and 26 percent of government revenue. In that year, Decree 13 of 1970 reduced the derivation formula to 45 percent. The process of continually revising downwards the derivation formula, to the disadvantage of oil-producing states, persisted till the end of the first military rule in 1979; when the derivation formula was abolished on the eve of the hand over to the elected leaders of the second Republic. The restoration of derivation formula during the second Republic was the outcome of a Supreme Court verdict on the basis of a suit filed by some oil producing states during the second Republic. The current 13 percent derivation formula is enshrined in section 162 of the 1999 Constitution (as amended). Meanwhile, the revenue allocation formula in force since 2004 shares the revenue in the federation account as follows: 52.68 percent for the federal government; 26.72 percent for the states; and 20.60 percent for the local governments, using a number of criteria. Three considerations provide the impetus for adopting a new budgetary framework. First, Nigeria needs to anticipate and prepare for its transition to a post-oil economy. This does not mean that Nigeria will no longer produce and export oil. Rather, it is that Nigeria would be less reliant on oil as a source of government revenue and, probably, of foreign exchange.

Second, a new budgetary framework would be predicated on, and benefit from, the growing diversification of the economy. Third, a new budgetary framework will help wean the states from “feeding bottle” federalism and move them to fiscal federalism. Concerning the last point, fiscal federalism will be a mirage, if the federal government does not devolve more sources of revenue to the states. These should be priority issues for political deliberations and constitutional negotiations. Here is the broad outline of the new budgetary framework. Its most important feature is that it will be driven by overall economic growth rather than high dependence on the oil-sector specific growth.

As the diversification of the economy deepens, the sources of government revenue and export earnings would multiply. Consequently, the government will benchmark its revenue stream on the overall growth of the economy. The higher the economic growth, and the greater the share of particular sectors in the growth rate, the more revenue that the government should garner from such sectors. Under this new framework, garnering revenue from non-oil sectors assumes great significance, in as much as the government will assign revenue targets for each sector. This is the approach that prevails in many advanced and emerging economies that are not reliant on one commodity for fiscal revenue and export earnings. An important consequence of the new budgetary framework is that it will compel all tiers of governments to show greater interest in the development and growth of various sectors of the economy.

How will revenue from oil be used during the transition period and how long should the transition last?  After the derivation portion has been deducted according to extant constitutional provisions, the earnings from oil should be split into three equal parts. A third should go to budgetary allocations for economic and social infrastructure development of both the federal and state governments. Another third should be used to tackle Nigeria’s environmental challenges: clean-up of oil-related environmental despoilation in the Niger Delta; desertification in the North; erosion in the South-East; and industrial-related pollution and waste in the South-West.

The final third will be devoted to debt servicing and to the payment of foreign investors dividends, because an immediate substitute for oil as a major source of foreign exchange is not on the horizon. Under the new budgetary framework, the federal and state governments will meet their recurrent expenditures from the revenue garnered from the relevant taxes, duties, levies and charges, and interests in investments. The transition should last for seven years to allow for significant progress on the environmental issues and enough lead time for adjustment by the federal and states’ governments. At the end of the transition period, earnings from oil will be treated like any other revenue, after making allowance for the derivation formula in the constitution. Many forces are propelling the world towards the transition from fossil fuels to other sources of energy. These include the need to reduce the deleterious impact of fossil fuels on climate change; the production of battery electric vehicles; the use of ethanol in transportation; and the growing adoption of diverse sources of renewable energy for electricity generation in many industrialised countries. These trends call to mind the famous remarks, by Sheik Ahmed Zaki Yamani, during his tenure as the Oil Minister of the Kingdom of Saudi Arabia in the 1970s, that “The Stone Age did not end for lack of stones and the Oil Age will end long before the world runs out of oil”. Whether the oil prices recover over the long run, as optimists hope; or remain depressed, as pessimists fear; Nigeria has had many warning signs, especially since 2014, to firmly launch itself on path of a post-oil economy. A new budgetary framework should be an integral part of that transition.

Otobo is a non-resident senior fellow at the Global Governance Institute, Brussels, Belgium.