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Oil, water and budget 2013

IN his 2013 budget speech proposal to the National Assembly three weeks ago, President Goodluck Jonathan had set $75 as the upper limit benchmark for oil price. The House of Representatives is pushing for $80.

The Minister of Finance and the Coordinating Minister for the Economy, Mrs. Ngozi Okonjo-Iweala, had, in defense of the government position, said the $75 oil benchmark “is based on moving averages of the world oil price and government’s simulations allowing for uncertainty in world oil price movements”.

She said this was a “standard technique commonly used by commodity-dependent countries to protect them against the volatilities of oil” and in that respect “$75/barrel price represents an upper limit from our model, if Nigeria is to maintain a stable macroeconomic environment for next year.”

The rationale for government position is obvious. A modest oil price benchmark is a vote for more diversification of revenue sources, less dependence on oil, development of other sectors and reduction in government spending, especially its recurrent expenditure.

And government seemed to be showing its intentions when President Goodluck Jonathan presented an appropriation bill of N4.9 trillion for 2013, compared with N4.697 trillion in 2012.

The share of the recurrent spending in aggregate expenditure in the 2013 budget estimate was reduced from 71.47 per cent in 2012 to 68.7 per cent, while capital expenditure as a share of aggregate spending was also increased from 28.53 per cent in 2012 to 31.3 per cent in 2013.

But a lower oil price benchmark is also a matter of economic survival. The US Wall Street Journal recently published a sober report on the Nigeria oil situation. According to the report, Nigeria may soon be looking for new buyers for its light, sweet crude as American demand tumbles.

The report said: “Changes in the destination of Nigerian crude, which contributes roughly 95 per cent of the country’s export earnings, could shift the commodity’s pricing. And it could have a knock-on effect on Brent crude, the benchmark against which a majority of the world’s oil is valued.

“Another problem for Nigeria is that as refineries across the globe become more advanced, they are able to take heavier, sour grades of crude, which are generally cheaper, and refine them into high-end products. This has lessened demand for the lighter, sweet grades that Nigeria produces.”

The 2008 experience where oil prices fell almost overnight from $147 per barrel to $38 per barrel is a sad reminder.

This threat of oil price volatility remains constant and underscores the need to rely on a robust and prudent methodology to estimate the benchmark price.

Some other watchers of the economy have expressed similar fears. Mr Razia Khan, the Regional Head of Research of Standard Chartered Bank was reported to have expressed concern to a national newspaper over the position of the lower house.

“Of greater concern is the suggestion that there might be an attempt by the House to raise this to USD 80/bbl. In our view, given global risks, and Nigeria’s ongoing fiscal and export dependency on a single commodity, the priority for Nigeria should be increasing its rate of savings,” Mr Khan said.

“Were oil prices to fall, Nigeria would currently be left very vulnerable, with no sound mechanism for being able to smooth spending, let alone provide a counter-cyclical boost to the economy.

The Sovereign Wealth Fund, while encouraging, is not yet sizeable enough to create a sound buffer against external shocks. There is, therefore, a need for much more fiscal conservatism, and the signals from the House are a considerable concern.”

Khan further noted that the fall in the share of recurrent spending to 68.7 per cent of the budget, from 71.47 per cent “is a step in the right direction and indicative of the authorities’ desire to gradually boost the share of capital expenditure. It is especially encouraging to see the funds earmarked for agriculture, as this could be a game changer for Nigeria.”

Khan is not alone in his position. Mr. Bismark Rewane, head of the Financial Derivatives Company Limited, FDA, was recently quoted as saying: “as an economist, I think it is still high at $78. Why is it a problem for them (the legislature) to reduce it? If there is a 25 per cent decline in international oil price, there will be problem.

To be on a safe side, it is necessary to adopt $75 rather than the $80.”
Question now is, why is the Lower House insisting on a higher benchmark? And how did they arrive at the $80 mark?

Like the housewife in the pure water parable, the lower house is relying on an escalation of the Middle East crisis to keep oil prices at an unsustainable high. Thus, the $80 suggestion from the House of Representatives is not based on verifiable, actual data or fundamentals.

It is overly optimistic and ignores possible reduction in global oil demand, due to recession in the Eurozone, low growth in the US, and economic slowdown in the China and India.

The legislature may also be secretly banking on a supposed excess liquidity that would sweep the economy if their $80 proposal carried the day. There would be more money for the government to throw around.

An uncontrolled increase in liquidity will however be harmful to sound macroeconomic forecasts. Inflation rates would certainly rise significantly. The exchange rate would come under severe pressure, leading to a depreciation of the Naira.

High inflation would result in higher interest rates. A combination of high inflation, interest rate and an unstable exchange rate is bad for economic planning, both for the government and for private

Mr. JOHNSON OGUNDE, a banker, wrote from Ilorin , Kwara State.


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