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Deregulate, diversify, develop

September 22, 2009

From all indications President Yar’Adua is bent on deregulating the downstream oil sector. Hopefully it will finally unfetter the country from enslavement by a powerful few. Yes, issuing more licenses for the importation of more petroleum products will increase competition.  But complementary actions are required.

Since plans to build new refineries aren’t on governments’ to-do list; equal access to infrastructure: pipelines, jetties and terminals will hopefully follow soon. This will convince investors to build refineries and ensure petroleum products are competitively priced.  But, once free from this burden, will government now squarely face its responsibility of providing decent public services? Does it have the capacity and capital to sustain growth?

Betting on oil income, at least for the short to medium term – thanks to the global meltdown and the continued unrest in the Niger Delta – is out of the question. With a 30 percent shortfall, revenues to finance its expenses and stimulate the economy, has taken a hit. Nigeria’s foreign reserve and excess crude account, saved for a rainy day through fiscal prudence, now need to be spent efficiently. Transparency and plugging leakages eg, by propping the capacity of ministries, departments and agencies to ensure value for every naira spent on critical infrastructure must now take precedence.

Spend or save

Paul Collier and Anthony Venables, economic professors at Oxford, in their research: Managing resource revenues: lessons for low income countries, offer striking ways for tackling the issue. According to them, an oil-rich country’s decision to accumulate foreign assets to smooth volatility of oil income (as Nigeria has) is justified. However, it must decide how to best invest these savings.

They argue for using “revenues to promote growth and investment in the domestic economy and thereby put consumption on a rapid growth path”, rather than outright consumption or accumulation of foreign assets. They note, however, that consumption makes sense; so long as the return on investment – measured by the social wellbeing of citizens, is greater than either of the two investment options: foreign or domestic. In other words, consuming oil income today trumps foreign or domestic investment if the number of people living on $1 per day can be significantly reduced.

Neither lender nor borrower be

Foreign investment could be either as a borrower or lender. A lending country accumulates foreign exchange reserves or builds up a sovereign wealth fund (SWF). The borrowing country on the other hand will use its resource revenues to pay down its debt – not a good option given that indebtedness raises the interest paid by countries. Besides, Nigeria’s past is replete with lessons about the consequences of borrowing based on unrealised and uncertain oil income.

Yet Nigeria is characterised by capital scarcity with high interest rates and limited access to international capital markets – propounded by her sovereign rating downgrade. Alternatively, the government is mulling over a concessionary loan from the World Bank to fund priority projects. An undersupply of public infrastructure and an uncertain investment climate is depressing private investment.

The role of complementary public inputs, particularly electricity generation, to reduce the cost of private investments is now clear as noon. If not, under-investment in public and private assets will remain the norm. Thus, to yield high returns, domestic investment of resource revenues is inevitable.

This is the potential. That unrealised opportunity, recently alluded to by President Yar ‘Adua. Yet realising this potential is hinged on determining the investment opportunities that give the best return. These increase domestic spending (consumption and investment); further growing the economy and increasing future consumption. But there’s a snag. Technical capacity – more pronounced in the public sector, is in short supply.

How to spend it

For instance, selection and operation of projects that give best return on investment are hampered by limited information on the timing of oil windfalls and technical capacity eg, social cost-benefit analysis of projects. Misaligned incentives – what’s in it for me – also encourage socially sub-optimal decisions.

Oil windfalls, abrupt and volatile by nature, coupled with technical incapacity result in inefficient resource allocation. Expenditures need to match the scale and timing of the income. Otherwise a plethora of white elephant projects – as in the past, fritter the savings from the recent oil boom.

To address the snags of technical capacity and oil shocks, Profs Collier and Venables make a case for incremental spending and capacity building eg, public expenditure management, project appraisals and procurement techniques, to spend revenues efficiently on domestic investment that benefit current and future generations (beyond the period of the windfall).

They also contend that increasing transparency and accountability, as regards resource revenues and procurements, is a disincentive to misappropriate funds. Monthly publication of allocations to the three tiers of government, for example, should be continued.

However the disequilibrium in the allocation of funds and crowding out of the private sector must be avoided. Assuming the financial sector commands investors’ confidence.  News and rumours about share manipulation don’t wash with local and foreign investors; delayed action by regulators further stokes uncertainty. More so, it hinders the markets’ much needed development of breadth and depth.

So far, government bonds eg, FGN and Lagos State are the brides to court. Then again, with dwindling revenues the three tiers of government will turn to banks to raise funds. Symptomatic of how past windfalls, better still budgets, have been inefficiently executed.

Can legislation of fiscal prudence be replicated in the states and local governments? Thankfully, the debt management office (DMO) has placed a cap on borrowable funds. Piling debt, in anticipation of either rising oil prices or on the assumption of debt repayment by another government, must be discouraged. It is an incentive for sub-optimal expenditure.

Yet there are underemployed resources which can be exploited to generate demand and in turn increase income and wages. Growth sectors such as Nigeria’s vast arable lands and the infrastructure to support them will attract investments. Barriers, regulatory or otherwise, for doing business must be minimised. In addition to incremental expenditure on public services, an investment-friendly climate counts. So does the political environment.

Politics and economics

Resource-rich economies are known for their paradoxes. For instance after a commodity boom, GDP increases for the first few years. Two decades down the line a resource extracting economy produces less than it would have done. One key issue is that resource rents – huge profits from extracting the resource less the cost – don’t mix well with democracy. Without checks and balances embedded in a constitution, with institutions to enforce compliance, reform or economic diversification become difficult. Legislative reform like the fiscal responsibility act has so far spared the Nigerian economy from the throes of the global meltdown.

Quality governance plays an important role in arresting decreasing GDP (the norm in resource-rich countries) and harnessing the gains of booms to sustain output. Profs Collier and Venbales say: “The governance challenge for resource-rich Africa is to strengthen checks and balances in the face of pressures to weaken them.” Examples of checks and balances are independent courts, provision of public goods via taxes and electoral reforms – that ensure heroes, not villains, get into power. A Sisyphean feat, if the rerun in Ekiti State is anything to go by.

Nonetheless Nigeria’s foreign reserves have to be invested. Saving excess revenues have helped smoothen oil income volatility. But the rate of return is lower compared to domestic investment. Bridging the gap between Nigeria’s economic potential and actual output needs a stimulus. The CBN cannot plan to use the reserve to support the naira forever. A sequence of incremental investment, reforms and capacity building, to improve the economy’s absorptive capacity, are compatible with saving for a rainy day.

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