Thursday, June 02, 2016 5:07PM /Afrinvest Research
One year into the transition from President Jonathan to the Buhari led administration, the burden on Government remained the need to rejuvenate the Nigerian economy which has suffered from the declining global oil prices, poor governance structure, sub-optimal fiscal crisis and monetary policy actions.
Recent domestic macroeconomic numbers have suffered from both global and domestic shocks which currently threaten the economic fundamentals of the country. The recent data published by the National Bureau of Statistics (NBS) reflects the impact of the delayed budget passage as well as the weak monetary policy response on macroeconomic aggregates.
The significant drop in government revenue and lower allocation to Sub-Nationals bites harder, pushing many States to the edge of a fiscal crisis with most unable to pay workers’ salaries for more than 3 months. However, many view the implementation of the 2016 budget as a catalyst for reflating the economy and resetting it on a growth pedestal.
According to the NBS, Real GDP contracted 0.36% in Q1:2016 dragged by declines in the manufacturing and key services sector components. Similarly, unemployment rate in Q1:2016 worsened to 12.4% from 10.1% in Q4:2015 as total number of people in full time employment decreased by 528,148 within the quarter and about 1.5m people joined the labour force.
Inflationary pressures continued unabated rising to 13.7% in April 2016 (from the 12.8% in March 2016) due to cost push factors which impacted on most components of the Consumer Price Index (CPI).
Thus, Nigeria’s mystery index also rose to 24.9% in Q1:2016 from 20.0% in Q4:2015. Pressure on external reserves (declined 8.6% YTD) continued relentlessly despite controls introduced by the CBN. Parallel market FX rate has depreciated 24.0%YTD due to control measures in the official market.
Thankfully, the Monetary Policy Committee (MPC) took a major move during the week in voting for the adoption of a flexible FX rate regime, though with a “small window” to cater for critical transactions. Nonetheless, the lack of economic impulse from the fiscal space for most of H1:2016 signals that the economy already nears a recession.
The Buhari led administration sought to employ a new approach to budget formation and implementation in a bid to hasten infrastructural development and reflate the economy. The 2016 Budget adopted a zero-based budgeting system, a move from incremental budgeting system. Hence, the 2016 Appropriation Bill tagged “the Budget of Change” was characterized with cocktail of controversies leading to late passage and signing by the President.
Nonetheless, the structure of the 2016 budget is a significant deviation from the previous years as the anticipated revenue was less tilted towards oil receipts (21.2%) and more skewed towards tax revenue as well as intensified efforts to reduce leakages across Ministries, Departments and Agencies (MDAs).
On the back of the huge infrastructure deficit which has hampered growth and constrained business activities, the government increased allocation for capital expenditure from 11.0% in 2015 to 28.8% in 2016. Worthy of note is the special intervention programme on social safety nets (N500.0bn or 8.0% of total expenditure) to ensure an inclusive growth in 2016.
Whilst we hold the view that the 2016 budget has the potentials to reflate the economy if properly implemented, the required funding of the budget for optimal performance could be a drag. We note that the specific provisions for capital spending will boost infrastructure projects and investments while the recurrent expenditure would have a multiplier effect on private consumption expenditure component of the GDP.
We think the fiscal deficit may exceed the 2.2% level projected for 2016 owing to pipeline vandalism which has lately hampered production. We see the recent liberalization of the downstream petroleum sector and the interbank foreign exchange market as a seeming synergy of fiscal-monetary policy synchronization, but amidst the various macroeconomic constraints, we ask; how much can the “budget of change” achieve?
The Zero Based Budgeting System: How Effective?
A significant deviation from past trends of traditional or incremental budgeting, the Federal Government adopted a Zero Based Budgeting (ZBB) System as this system allows for efficient allocation of resources based on needs and benefits rather than history.
The ZBB system ensures that all expenses for the New Year are estimated on the basis of actual expenses that will be incurred and not on the incremental basis which involves just increasing the expenses incurred in the previous year at some fixed rate.
In addition, the ZBB helps to eliminate unproductive activities by identifying more cost effective ways to channel available and limited resources. On the back of the need to justify every line item, ZBB incapacitates budget inflation. Also, it will enhance co-ordination and communication within the MDAs by involving them in decision-making.
On the flip side, it is time consuming as the budget is evaluated afresh on a yearly basis. Moreover, it requires high manpower and frequent training of the workers as every line needs to be explained and justified.
Overall, we view the adoption of the ZBB as a positive development which will increase the effectiveness of the budget. Against this backdrop, we expect improved budget implementation to snowball into a very positive results for the populace.
In a bid to reflate and reposition the economy, the FGN has based the 2016 Budget on these six pillars; Economic Reforms, Infrastructure, Social Development, Governance, Environment, as well as States & Regional development.
Economic Reforms: As Nigeria heads towards recession in H1:2016, there is an urgent need to come up with a well coordinate policy to avert a negative real growth rate at the end of 2016. Despite a well-diversified economic structure, Nigeria’s foreign earnings remain skewed to crude oil proceeds, hence creating significant distortion in the economy when oil prices wane.
That said, further efforts are required to resuscitate the non-oil sector to stabilize foreign earnings. Moreover, both the fiscal and monetary policy actions need to sync which would improve the effectiveness of the 2016 budget.
With the current stance of the CBN to adopt a flexible FX policy, we expect the manufacturing sector to rebound in H2:2016 as foreign currency liquidity improves. Also, we expect the government to increase its tax base as well as adopt more efficient revenue collection to assist in the financing of the budget.
Infrastructure: Huge infrastructure deficit has continued to hamper growth in Nigeria. Interestingly, approximately 28.8% (N1.7tn) of the total expenditure was allocated to capital expenditure in 2016 relative to 12.0% in the approved 2015 budget and 5.0% at the end of 2015. Actually, the National Integrated Infrastructure Master Plan (NIIMP) has noted that Nigeria will need to spend US$25.0bn annually for the next 3 years in order to make material impact in developing its infrastructure. We however expect more effectiveness in the disbursement of funds to capital projects on the back of the newly set up efficiency unit. This is required to ease business bottlenecks as results from investments in power and transport begin to yield results. We also expect more Public Private Partnership in 2016 to support the funding gap for infrastructure. As part of the effort of the Ministry of Budget and National Planning (MBNP) to improve the effectiveness of the budget, it has revised the National Monitoring and Evaluation (M & E) framework to institutionalize the process of carrying out physical inspections and other verification exercises, as well as the impact assessment of policies, projects and programmes on a regular basis at the national level.
Social Development: The Social Progress Index as at 2015 - measures the capacity of a society to meet the basic human needs of its citizens- Nigeria ranks 125 with 43.3 points. This obviously buttresses the need for social welfare package for the citizenries. In the 2016 budget, approximately N500.0bn has been earmarked to reflate the economy. This will cut across teachers, school children, students and market women as well as conditional cash transfer programme for 1million beneficiaries.
Governance: After 55 years of political independence, Nigeria continues to contend with the challenges of good governance. However, hope was rekindled after the election of President Buhari last year to chart the course of the nation. Though his good intentions can hardly be questioned, Nigerians are yet to witness the anticipated improvement in the Nigerian economy. The full implementation of the Treasury Single Account (TSA) as well as Biometric Verification Number (BVN) for workers is bringing some sanity in the system and blocking the leakages. We suggest this should be taken a step further by legislating some of this steps, so it will be difficult for any new government to unwind these policies.
Environment: Based on the 2016 Survey by the World Bank, Nigeria ranked 169 out of 189 countries attributable to significant hurdle experienced in starting a business, low access to credit, low tax efficiency and low trade across borders. The Government has set a 2016 target to move 20 places up in the Ease of Doing Business Rankings, by implementing fast track measures for business approvals and acquisition of land titles in addition to improvement in visa application and issuance process.
State and Regional Development: Given the heavy dependence of states on federal allocation, the need for states to explore available opportunities and improve their Internally Generated Revenue (IGR) cannot be over emphasized. We expect to see more regional collaboration for joint projects that would be of utmost benefits to the states. This will help attract more investments into these states hence increase their ability to earn more IGR through tax. State should also identify products they have absolute comparative advantage and make huge investment by adding value to these products as well as create incentives for investors.
Major Highlights of the 2016 Budget of Change
Revenue projections for the 2016 fiscal year budget signals a deviation from high dependence on oil revenues which has been the case for years, to a regime where independent and other non-oil sources account for a greater proportion of government revenue. The projected revenue for 2015 budget stood at N3.5tn. Oil revenue was projected to account for about 47.4% of the revenue, while nonoil revenue estimated at or N1.2tn with tax returns representing 35.2%, independent revenues (14.2%) and others (3.2%).
However, looking at the actual performance of the budget, only 80.0% (N2.7tn) of the total projected revenue was realised due to distortions in daily oil production, which averaged 2.1mb/d as against an earlier assumption of 2.3mb/d, on account of pipeline vandalisation as well as diversion and theft of oil.
Total revenue in the 2016 budget is projected at N3.9tn, an 11.8% uptick from N3.5tn in 2015. There is a clear shift from the usual practise in which Oil revenue accounts for a greater portion of revenue as only 21.2% of the total revenue for 2016 is projected to be realised from oil sources.
This is unsurprising given volatility in the global oil market. Surprisingly, Independent revenue is projected to account for 39.0% (N1.5tn) of total revenue from 14.0% (N489.0bn) in 2015.
The 2016 budget has been dubbed “the largest budget” in the fiscal history of the country. The budget is projected at N6.1tn, up 20.0% compared to N5.1tn (inclusive of supplementary budget) in 2015.
Also, there was a massive improvement in the proportion of expenditure allotted to capital spending, compared to 28.4% and 12.4% allocation in 2014 and 2015, 28.8% (N1.8tn) of total expenditure is anticipated to be devoted to investment in roads, transportation, power projects amongst others.
A sector by sector listing of the specific projects and the planned spending is presented in the Appendix Section of this report; we stored the information as the checklist to appraise the budget performance. Recurrent expenditure, is projected to account for about 43.7% (N2.7tn) of the total expenditure.
One key development in relation to recurrent expenditure is the removal of subsidy payments and the previously used funds can be channeled towards other productive sectors of the economy.
The budget also provisioned for a Special Intervention fund worth N500.0bn, 40.0% (N200.0bn) of which will be channeled towards capital projects while the N300.0bn balance will be channeled towards reflationary spending that will stimulate private consumption.
2016 Budget Implementation and Fiscal Viabilities
Following the passage of the 2016 appropriation Act which came about 5 months into the fiscal year, the critical question to ask is the extent to which the budget can be executed. Is 100% execution late and if late how late, more importantly are the revenue proposals of the budget realistic.
To critically assess the fiscal feasibilities of the Budget we situate the key assumptions and provisions of the budget in the context of current macroeconomic realities. For instance, revenue projection is based on a benchmark price of crude of US$38.0bp, average daily production of 2.2mbpd, projected GDP growth of 4.3%, inflation rate of 9.8% and exchange rate of N197.00/US$1.00.
Oil revenue is thus expected to contribute N820bn (21.2% to total revenue estimate of N3.9tn) compared to N1.6tn assumed for 2015 budget, while Non-oil revenues (including revenue from independent sources) will account for the balance.
However, a critical assessment of key macroeconomic variable indicated that apart from global price of crude oil which has improved significantly, currently trading at US$48.8pb relative to less than US$35.0pb in 2015, all other key assumptions of the budget are largely at variance with current data.
GDP contracted 0.36% in Q1:2016, inflation rate jumped to 13.7% in April 2016, the CBN is planning to realign its stance on FX rate to a more realistic level even as production disruption in the Niger-Delta continue to keep crude oil production below target. Hence we reassess the viability of the 2016 budget below.
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