Managing Natural Resources Revenue: Lessons from Nigeria’s Experience

Ngozi Okonjo–Iweala
Managing Director, The World Bank

Introduction

Your Excellency the Minister of Foreign Affairs, Honorable Ministers, distinguished guests.

Before I begin, I would like to extend my deepest sympathies to the people of Indonesia for the recent loss of President Suharto.

The topic today is one that is all too familiar to us: How should governments manage commodity windfalls? I am much honored that you have asked me here today to share with you Nigeria’s experience on this issue.

Windfalls have occurred many times in history, with mixed results. Many countries, developed and developing, such as Norway, South Africa, Nigeria, and the Netherlands, have struggled with this issue. Commodity windfalls are a potential blessing to any country; managing these windfalls, on the other hand, is a formidable challenge with enormous consequences for both present and future generations.

This is a good time to be discussing these issues, since the price of many commodities is up again, and likely to remain high for a long while. Countries are therefore revisiting their commodity management strategies and analyzing their previous experiences, both good and bad. As we are all aware, Indonesia’s good macro-economic management puts it in the category of countries with good experiences! Nigeria too, after a rocky start, is part of this group. For both countries, the challenge is now to put in place sustainable institutional mechanisms to ensure that previous gains are protected and that future resources are well utilized.

My speech today will focus mostly on Nigeria’s experience good and bad as a natural resource rich country, and what we can learn from it. To paraphrase Aldous Huxley, experience is not what happens to a country, it’s what a country does with what happens to it. I’ll therefore talk about Nigeria’s past challenges, successes and future prospects.

Nigeria ’s Experience

The two oil booms of 1973-74 and 1979-80 transferred a great deal of wealth to Nigeria. As one might expect, public expenditure went up, as well as public debt due to increased access to external borrowing. However, when in 1982, oil prices fell, accompanied by a large increase in interest rates, inflation went up, and Nigeria entered into a prolonged period of economic stagnation, rising poverty levels and declining public institutions. If Nigeria had done nothing more than place the $300 billion it earned from oil between 1970 and 2001 in the bank, it would have had over $600 billion by 2001, or some 12 times the 2001 GDP. Instead, per capita GDP fell from $264 to $256 in constant 1995 US dollars, infrastructure deteriorated, infant mortality rose to 101 per 1000 live births in 2003 compared to 79 in Low Income Countries and 54 in South Africa. Never was Oscar Wilde’s saying, “Experience is the name everyone gives to their mistakes”, more painfully true.

How could this happen to Africa’s most populous country, with a GDP second only to that of South Africa? Nigeria should be an engine of growth for Africa! A great deal of the answer can be traced to mismanagement of the commodity windfalls, which only highlights how the consequences of mismanagement can continue over decades.

3. Brief comparison of Nigeria’s and Indonesia’s experiences.

It’s appropriate to be delivering this lecture in Jakarta, as Indonesia and Nigeria present an interesting contrast on how the oil price boom of the 1970s and 80s was handled. Much of the focus in the economics literature at that time was on avoiding Dutch Disease. Indonesia did the right things on a number of fronts: fiscal, exchange rate, agricultural and external debt policies, and reaped substantial benefits. This is all the more creditable because Indonesia was in this a step ahead of the way the world understanding of these issues.

A number of macro fiscal policy decisions highlight the main differences in approach between Nigeria and Indonesia over this period. On the fiscal front, Nigeria’s fiscal policy had two problematic features:

• First, public expenditure was closely linked to current oil revenues and thereby the current oil price, making it highly volatile.
• Second, since Nigeria consistently ran sizable fiscal deficits after 1974, in spite of the revenue bonanza from oil, fiscal policy was procyclical and actually amplifying oil price volatility! Not only were there no saving, large fiscal deficits were incurred, averaging over 8 percent of GDP for the period 1981-84.

These in turn fed into current account deficits and rising external debt. In contrast, the fiscal deficit in Indonesia in this period was always small, less than 5 percent of GDP, with surpluses in two years.

On the public expenditure front, the bulk of Nigeria’s increased public expenditure over 1974-84 went into transportation, primary education, and large scale infrastructure. Nigeria, unlike Indonesia, failed to improve agricultural investment and protect the capital intensive industry. The share of agricultural imports in total imports more than doubled from less than 3 percent in the 1960s to 7 percent in the early 1980s. By the mid-1980s, cocoa was virtually all that was left of agricultural exports, and for the first time, Nigeria became a net food importer.

Indonesia on the other hand adopted measures to protect and increase investments in the agricultural and capital intensive sectors. In contrast to Nigeria, the share of agriculture in total imports stayed at about 1 percent between 1965 and 1983. The Indonesian economy remained diversified in terms of its employment, tax and export base. This acted as an insurance policy against subsequent oil price busts.

A major factor helping the Indonesian agricultural sector was the exchange rate policy pursued by the government. The contrast is remarkable: in Nigeria, the real exchange rate appreciated by a huge 55 percent over 1974-1980, whereas in Indonesia, it actually depreciated by 12 percent over the same period. This reflected the assumption that oil revenues would dwindle over time, possibly vanishing in a few decades. Thus, the goal of maintaining a diversified economy was given top priority. This was not the case in Nigeria. By 1981, oil had become the key determinant of real income, the terms of trade, foreign exchange earnings, government revenues and external creditworthiness; the agriculture sector had become negligible. For the first time, in 1982 and 1983, Nigeria accumulated trade payment arrears.

In 1976, Nigeria’s total external debt outstanding and disbursed was US$ 1.3 billion; at the end of 1983 it was about US$12 billion; by 1985-86, Nigeria was having difficulty rescheduling a relatively paltry US$2 billion in insured trade credits. Given Nigeria’s vast oil and gas reserves, rescheduling should have been a straightforward issue. Indonesia, on the other hand, in spite of debt burden indicators that were comparable to or even exceeded those of Nigeria, did not face a debt problem.

By the late 1990s, a major challenge for the Nigerian economy was its macroeconomic volatility driven largely by external terms of trade shocks and the country’s large reliance on oil exports earnings. By both measures, Nigeria’s economy ranked among the most volatile in the world for the period 1960 to 2000 ( World Bank 2003). Public expenditures also followed current revenues, implying that fluctuations in oil earnings were directly transferred into the domestic economy. Public expenditure patterns reflected an over reliance on oil as well as a lack of fiscal discipline. Similarly, the volatile fiscal spending patterns translated by extension to exchange rate volatility. The economic performance of Nigeria over this period was one of a series of boom and bust episodes.

Figure 1: Nigeria: Volatility and Growth 1970-2005

The New Commodity Boom – a second chance

By the turn of the millennium, it was clear that the many years of oil money in Nigeria had not only failed to alleviate poverty, they had landed the country in deep indebtedness and shrunk the country’s production base.

By early 2000, there was consensus among key reformers in Nigeria that the main path out of the low-growth/high-debt situation was to adopt a two-pronged strategy of reducing macroeconomic volatility and strengthening the governance environment. Nigeria would have to improve its budget planning and execution process, and also confront its legacy of poor governance and corruption. Corruption, rent-seeking and vested interests—the “political economy of oil”— were recognized as barriers to the transparent accounting for the receipt and use of oil revenues. To put it simply: the volatility of the economy had to stop and achieving good governance became a prerequisite for using oil revenues effectively.

The first Obasanjo administration (1999-2003) focused on ensuring political stability. The second Obasanjo administration (2003-2007) embarked on the implementation of a comprehensive economic reform program with a focus on four areas: macroeconomic, structural, public sector and institutional and governance. The overall goal was to promote private sector development as a vehicle for wealth creation and poverty reduction. This resolve to change the course of the Nigerian economy coincided with rising oil prices; the new fiscal response to this latest boom enabled Nigeria to break out of the natural resource trap.

The Reform Program

On the macro front, a major challenge was to de-link public expenditures from oil revenue earnings by introducing a fiscal rule. Similar to fiscal rules in other countries such as Brazil, it was hoped that the adoption of a fiscal rule would also assist the government in its efforts to accumulate savings, smooth public expenditures, and ensure intergenerational transfers.

What was the nature of the fiscal rule? An oil price-based fiscal rule was introduced in which government expenditure was based on more conservative oil price projections. Any excess revenue accumulated above the reference price was saved in a special excess crude account. In 2004, 2005, and 2006, for example, government budgeting was based on conservative oil prices of US$25 per barrel, US$30 per barrel and US$35 per barrel respectively despite realized prices of US$38, US$54.2 and an estimated average price of US$68 in 2006. On average, the budget price was 75 percent lower than the actual end of year average prices. Adoption of this rule has ensured that government expenditures are delinked from oil revenue earnings. The main effect of this has been to limit any transmission of external shocks into the domestic economy.

The outcome has been remarkable. The fiscal deficit improved from 3.5 percent of GDP in 2003 to a surplus of about 10 percent of GDP in 2004 and 11 percent of GDP in 2005. The adoption of the fiscal rule also resulted in significant public savings. Gross excess crude savings totaled about US$6.3 billion at the end of 2004 and about US$17.7 billion by end 2005. Over the period 2003 to 2006, foreign reserves increased fivefold, from US$7.5 billion at the end of 2003 to about US$38 billion in July 2006. Today foreign reserves stand at US$54 billion.

To institutionalize the fiscal rule, we put in place a Fiscal Responsibility Bill finally passed by the National Assembly in 2007.

While most of its provisions apply only to the federal government, the FRB authorizes the President to set a ceiling on the consolidated debt of all tiers of government, and also sets some principles on debt management which are binding for the states. As of now, 12 of the 36 states in Nigeria have also passed their own fiscal responsibility laws.

As part of the improvements in fiscal policy, the government took measures to strengthen the budget preparation and execution process. A fiscal strategy paper laying out options and trade-offs for budgetary spending, as well as improved management of government finances by a Cash Management committee chaired by the finance minister were put in place. In addition a medium term expenditure framework and a medium term sector strategy were introduced to ensure that sectoral spending programs reflected government development priorities ,and most importantly, remain within the fiscal framework envelop. The government also introduced the practice of preparing an annual implementation report which reviews the strengths and weaknesses in the execution year. Implementation reports have been prepared for the 2004 and 2005 budgets.

The improved implementation of fiscal policy helped provide a stable and predictable macroeconomic environment which is crowding in private sector participation in the domestic economy. Credit to the private sector, for example, grew by 30.8 percent in 2005, exceeding the target growth rate of 22.5 percent. In addition, net credit to the government declined by 37 percent. This decline is attributed mainly to a decline in the central bank’s holding of treasury securities.

The implementation of monetary policy was also fairly disciplined, with the central bank adhering to various monetary policy targets and reducing inflation. End-year inflation declined from 21.8 percent in 2003 to 11.6 percent in 2005 and is in single digits today. Similarly, interest rates, though high, gradually declined: prime lending rates went from about 21.3 percent at the end of 1999 to 17.6 percent at the end of 2005.

As you are well aware, the attainment of macroeconomic stability is vital for growth. The growth rates in Nigeria have averaged 6.5 percent annually for the period 2003 to 2006, compared to average growth rates of 2.3 percent the decade before. The de-linking of the economy from oil revenues has also led to renewed growth in non oil sectors. Growth in the non-oil sectors for 2003, 2004 and 2005 was 4.4, 7.4 and 8.2 percent respectively.

Structural reforms:

In addition to prudent and disciplined macroeconomic and fiscal policy, a broad range of complementary structural reforms were adopted. These included the privatization of some state owned enterprises as well as the deregulation of government activities in key sectors. Between 1999 and 2006, about 116 enterprises were privatized including various loss-making enterprises operating in industries such as aluminum, telecommunications, petrochemicals, and hotels. Privatization was also accompanied by deregulation in a number of sectors to encourage private sector participation. In the telecomm sector for example, over US$ 1 billion a year in investments over the past four years. The number of telephone lines in the country went from about 500,000 lines in 2001 to over 32 million GSM lines in 2007.

Governance:

Improving transparency and tackling corruption under the recent economic reform program required two elements: first, embedding anti-corruption measures in a comprehensive economic reform program, and second, conducting diagnostic studies to identify specific areas where corruption was undermining public sector performance and growth. By embedding anti-corruption activities in the overall reform agenda, the battle against corruption was more visible and had a direct link to growth.

As an example of the government’s corruption efforts, public procurement in Nigeria was reviewed to determine the costs of corruption in government contracts. Although procurement fraud tends to be one of the most common avenues of corruption in most countries, its incidence in Nigeria was particularly severe. A federal government survey noted that prior to 1999 the government had lost an average of about US$300 million each year from corrupt practices in public procurement. Procurement fraud took on many facets: inflation of contract costs, award of contracts for non-existent projects, over –invoicing, diversion of public funds to foreign banks, and low project quality because of inexperienced contractors. Moreover, procurement costs in Nigeria were significantly higher compared with costs for similar projects in neighboring countries.

Following an extensive review of the public procurement systems, the government introduced a Value-for-Money audit, or Due Process mechanism, in public contracts. The Due Process mechanism has promoted an open tender process with competitive bidding for government contracts. Any project exceeding US$400,000 requires approval. To ensure competitive costing of contracts, a database of international prices was developed to serve as a guide during the bidding process. The government also published all public tenders as a means of reducing patronage in the award of contracts. Finally, certification of completed government projects was also required before final payments of contracts were made.

With the introduction of the Due Process mechanism, there has been a notable improvement in the efficiency of capital spending. The federal government has saved about US$ 1.5 billion since 2001.

On the budget resource management front, the main thrust of the governance reform program was to improve transparency in the allocation and use of resources. To this end, a monthly publication of federal, state and local government shares of revenues from the country’s federation account was introduced in 2004. The publication provides details of revenue allocations to all 36 states and the Federal Capital territory, as well as 774 local governments. The publication has increased transparency, particularly of sub-national finances, and opened up dialogue on public revenues and expenditures at all tiers of government.

A very important instrument for increasing transparency, the Extractive Industries Transparency Initiative (EITI), was announced in 2002 at the Johannesburg World Summit for Sustainable Development. EITI is a voluntary global initiative consisting of a set of standards to promote revenue transparency and accountability in resource-rich countries. The standards require companies to publish what they pay and governments to disclose revenues from oil, gas and mining. The EITI Board and the international secretariat are responsible for maintaining the global standards while participating countries are responsible for implementation. In 2003, Nigeria became one of the first countries to adopt the EITI . The Nigeria Extractive Industries Transparency Initiative (NEITI) Bill was approved in May 2007.

The NEITI has to be seen in the broader context of Nigeria’s fight against corruption.

NEITI functions through the National Stakeholders Working Group (NSWG) which has representatives from the government, civil society, private sector companies and extractive industry experts. One of the main activities of NEITI was the financial, physical and process audit of the domestic petroleum sector from 1999-2004. The audit results identified some of the key shortcomings in the sector and the results were widely disseminated to all stakeholders.

Doing financial and physical audits puts Nigeria in the EITI+ camp—as “core” EITI only requires transparent disclosure of revenues handed over by companies and received by the government. Very importantly the Physical audit pointed to the loss of crude oil between the oil wellhead and the export metering terminals. The poor metering infrastructure also prevented accurate collection of data on output volumes.

In addition, Nigeria conducts a processaudit, a Nigerian innovation in the application of the EITI. The process audits revealed deficiencies in management leading to a capacity utilization of only 47 percent in refineries for example. The combination of these audits has led to the Nigerian initiative being labeled as EITI++.

The NEITI has been operational for close to three years and has made remarkable progress. There is now greater transparency in the oil and gas sector and global stakeholders are taking notice of the national commitment to EITI. More importantly it has lifted Nigeria’s profile in the eyes of investors and helped lead to significant increases in FDI not only in the oil sector (about US$ 6 billion a year) but also in the other non-oil sectors US$3 billion. As I alluded to earlier, a critical success factor has been the commitment from the top leadership – President Olusegun Obasanjo took it up as a top priority [and I am happy to say that our new president Umaru Musa Yar’Adua is determined to continue its institutionalization. The process has not been without challenges: lack of knowledge and the personal agendas of the members of the National Stakeholders Working Group (NSWG) were some of the biggest hurdles. Most of these were resolved through extensive training and capacity building within the NSWG.

Anti-corruption

Prosecuting Corrupt Practices. Another element in the government’s fight against corruption was the prosecution of high level officials. The government created two institutions to tackle corruption in the domestic business environment: the Economic and Financial Crimes Commission (EFCC) and the Independent Corrupt Practices and other Related Offenses Commission (ICPC). There have been a number of high profile convictions; many advance fee fraud ( “419”) kingpins have been detained, two judges have been sacked and two others suspended, several legislators including a past senate president have lost their posts and are being prosecuted, three ministers have been dismissed and three former state governors have been impeached. An inspector General of Police, the highest ranking Police officer in the country was arrested on corruption charges tried and jailed.

The EFCC investigations have made excellent use of the monthly revenue share publications mentioned above, highlighting the importance of information and transparency in the fight against corruption.

Overall, despite continued challenges, the governance reforms put in place appear to be bearing fruit. Recent survey data from Kaufman et al (2005), indicate that there has been a reduction in the perception of corruption by Nigerian firms in obtaining trade permits, in paying taxes, in procurement and in money laundering, to name a few.

Debt Reduction

The credibility obtained by Nigeria’s reform efforts enabled it to negotiate its debt cancellation with the Paris Club. Nigeria’s Paris Club debt at the end of 2004 amounted to US$30 billion out of a total external debt of US$35 billion. In October 2005, Nigeria and the Paris Club announced a final agreement regarding the treatment of this debt. Nigeria paid back US$ 6billion in arrears as required by the Paris Club treatments. Nigeria then received Naples terms treatment or a write-off of 6.7 percent of the US$ 24 billion outstanding. Nigeria was then allowed to buy back the remaining US$8 billion after Naples terms treatment resulting at a 25percent discount resulting in a further US$ 2 billion debt relief.

In total Nigeria received a cancellation of US$18 billion or 60 percent of its US$ 30 billion debt. With the buyback included Nigeria managed to wipe out the entire US$30 billion Paris Club debt, bringing our national debt down from US$35billion to US$5 billion. Today our debt to GDP stands at 15 percent and external debt to GDP is less than 5 percent.

the buyback of this debt at an overall price of 40 cents on the dollar, i.e., for approximately $12 billion. By April 2006, Nigeria had made its final payment to the Paris Club.

Financial Market Reaction

As a result of the credible macroeconomic and structural policy reforms and the treatment of the debt, financial markets began to reward Nigeria. S& P and Fitch Ratings assigned Nigeria a sovereign credit rating of BB- for 2007, affirming the country’s previous results from 2006. Consequently, Nigeria’s rating peers include countries such as Indonesia, Turkey, Ukraine, Venezuela and Vietnam.

A point worth making is that while the current oil boom has been a necessary condition for eliminating Nigeria’s debt overhang—because it provided the necessary liquidity—it was by no means sufficient. If the lessons from the 1970s had not been learnt, it is likely that the opportunity presented by this new boom would have been squandered. It is the combination of high oil prices, improving governance, new political will and leadership and improved fiscal management that has delivered the goods. The challenge is to maintain this momentum.

Defining Goals for the Future

Notwithstanding the real progress made in the past few years, Nigeria is still substantially dependent upon oil (the share of oil and gas rose to over 95 percent of exports in 2007 and oil and gas continue to account for 85 percent of revenues) and will have to continue to remain vigilant to ensure that mistakes from the past are not repeated.

So what are the challenges for the future?

• Maintaining hard won macroeconomic stability sustaining fiscal discipline and maintaining debt to GDP at satisfactory levels.
• Facilitating economic diversification by focusing on sectoral investments and job creation in the areas of the main sources of growth such as agriculture, non-oil mining, services sector construction and real estate.
• Dramatically improving service delivery to poor people especially of basic services such as water, rural electricity, rural roads as well as human infrastructure such as education and health.
• Getting economic reform adopted and implemented at the decentralized levels of government.
• Continuing the fight against corruption.

Vested Interests

I have talked about these reforms in a very clinical manner as if everything worked smoothly and seamlessly with backing from everyone and anyone within and outside government. The truth is that this was far from being the case. Almost every reform was fought (contested) by vested interests who did not want to see the country leave its old ways. How did we deal with such interests? We dealt with our detractors with strong resolve and steadfast determination not to be sidetracked and by trying to build grassroots and popular support for the reforms. The more results we obtained the more support we got for future reforms.

Concluding thoughts and an invitation

Let me conclude. Someone once said “Good judgment comes from experience; experience comes from bad judgment”. Rarely does a nation get a second chance to redeem itself and alter the course of its economy for the betterment of all its citizens. There are many reasons Nigeria did not manage the oil windfall of the 1970s well. But after all the accumulated experience since 1974, oil-rich developing countries can no longer plead either innocence or ignorance. Let me underline our three major lessons:

• Mismanagement of a commodity price windfall which might last for just a few years can have adverse consequences for the economy which might persist for decades and penalize future generations. Countries should use commodity windfalls as a way of helping them finance faster and better diversification of their economy. This allows for macro-economic stability, faster and more inclusive growth.
• While the current oil boom has provided the means to eliminate the debt overhang and even build reserves, the government needs to be cautious about getting over-exuberant about the continuing rise in oil prices. Commodity prices are volatile and expectations can change very rapidly. Commodity rich countries must adopt conservative approaches to fiscal management.
• Introducing transparency in the way commodity booms are managed helps enormously to win public trust. The transparent, efficient, honest and prudent management of all public finances to ensure both that commodity wealth is used for the good of the country now and in the future and to create a better environment for economic diversification.

Permit me to end with an invitation: Over the past 10 years, there has been a remarkable transformation in the way public resources are managed and allocated in Indonesia. This shows especially in the outstanding way in which it has recovered from the East Asian crisis. Without a doubt Indonesia has done well.

The I leave you with today is, is Indonesia performing to its full potential? Can Indonesia spur that potential with some added kick to boost growth focusing on increased infrastructure development, stronger governance reforms, and an even friendlier investment climate which will deliver even faster and more inclusive growth? I invite you to consider adopting some of the measures we have discussed here today. We hope we can continue to learn from you and you from us.

It has been a pleasure to be here with you today; once again, thank you for inviting me.