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1.1 Background to the Study:

The relationships between government budget deficits and macroeconomic performance have received tremendous attention amongst researchers and policy makers around the globe. Persistent increases in budget deficits have assumed greater height in many emerging economies like Nigeria (Oladipo and Akingbola, 2011). However, evidence has shown that government budget deficit has been an issue of discuss in Nigeria because of the persistent increase recorded since 2000 till date as shown on the figure 1 below. For example, budget deficit was about N 2 billion and N 3.9 billion in 1980 and 1981 respectively. In 1986, it rose to N8.2 billion and later fell to N5.8 billion in 1987. Notwithstanding the significant recorded fall from 1987 to 1999, between 2000 and 2004, there was an amazing increase which led to a record of about N 101 and N 609.2 billion in 2006 and 2007 respectively. However, considering the international financial crisis that eroded world economy in 2008, its ugly consequence which result to a sharp fall in demand for the nation’s crude oil, witnessed N0.56 trillion increases which stand to be over 2.5% of GDP. In addition, during the 2009 and 2010 fiscal years, Nigeria recorded about N249 billion and N1.1trillion respectively. Thus, in 2011 and 2012, it rose from N9, 152.5 billion to N9, 905.6 billion respectively (NBS, 2012). However, according to Keynesian theory on budget deficit, there is nothing wrong in government borrowing if it is properly channeled to boast economic performance of a country (Olusoji and Oderinde, 2011).

The development of deficit financing is often traced to adoption of the Keynesian inspired public expenditure which Nigeria adopted to motivate economic performance. Keynes recommended deficit spending to moderate or end a recession. To him, when an economy is recording high unemployment, an increase in government purchases will help a market for business output thereby creating income which through multiplier effect encourages the demand for business output. The policy of deficit spending has however posed challenges to the Nigeria economy with regard to its effectiveness and the accumulation of debt, the justification of growth notwithstanding (Anyanwu and Oaikhenan, 1995; Ogboru, 2006).


Persistent deficits were perceived to have adverse effects on the macroeconomic indicators. Various governments having the power to exercise a lot of influence over economic activities and budget deficit being their prominent instrument felt that the deficits have to continue to stimulate the economy. In 1986, the government introduced SAP with the hope that with restructuring of the economy, there would be reduction in the deficit spending. But this appears not to have been achieved as the deficits continue to escalate on yearly basis. The consequences of such deficit spending on many macroeconomic variables cannot be underestimated (Oladipo and Akinbobola, 2011). Over the years expansionary monetary policy has been pursued together with rise in private and public consumption and growth of the internal and external debts. All these have acted to exacerbate the annual government deficits. Hence, statistics in Nigeria showed that, the gross federally collected revenue registered barely N633million in 1970 surged through N4.5billion in 1974 to slightly above N15billion in 1980. The disparity between government revenue and expenditure generated enlarged deficit in Nigeria. And this has made budget deficit to oscillate between 3% and 9% in the period (NBS, 2012).

Attempts to grow the Nigerian economy has created a situation where the nation has become frequently used to large deficit, which has over the years resulted to sale of government bonds and borrowing (domestic and foreign) in order to meet up with the required expenditure. The magnitude of nominal expenditure of the government which recorded N839 million in 1970 leapt dramatically to about N5 billion in the same 1970; and this further rose to over N14 billion. Indeed, expenditure grew annually at the rate of about 70% during 1970-1980, and since then till the present year, the deficit spending has been identified in Nigerian economy. The federal government of Nigeria total expenditure was N4.7 trillion in 2012 and the 2013 total expenditure was N4.92 trillion. (i.e. about 5% rise over the 4.70 trillion in 2012). These rapid growths have been observed to be enhanced by the huge increase in oil revenue (MTEF and FSP, 2010).

This increase in oil revenue has effect on the recurrent expenditure. Evidence has shown that Nigeria’s recurrent expenditure is more than what it should be. This suggests that there is need to cut down on recurrent expenditure: the over-head cost of running Ministries, Department and Agencies (MDAs), to reduce the budget deficit to a manageable level of 3 percent of GDP, while boosting infrastructure investment to create jobs. Sanusi (2011) stated that, it will be historically difficult to stabilize the macroeconomic variables in Nigeria, if large proportion of the money


borrowed to finance deficit is spent on consumption instead of investment. Furthermore, the current situation where recurrent budget takes on entire 75 percent of total budget could not support the type of aggressive capital development that Nigeria yearn for. (Iwuala, 2011). The 2013 recurrent expenditure is over N2.41 trillion, amounting to over 68.7% of total expenditure. Although, recurrent (non debt) expenditure fell from 71.4% in 2012 to 68.7% in 2013, the ratio of capital to recurrent over the years has not been encouraging. Busari and Omoke (2007) opined that the extent, to which the economy can be stabilized particularly in the short to medium term, will depend largely on the fiscal behaviour of the government.

Be that as it may, lack of fiscal discipline poses a threat to macroeconomic stability in Nigeria. Thus, large budget deficits overtime are mostly explained as a consequence of corruption ranging from planned political decision order than the resultant external shock or reactions on prevailing internal economic situation as stipulated by Sheneko, 1993; Olomola, 2000 and Obadan, 2003. In view of the above, the understanding of the effect of budget deficit on economic performance in Nigeria becomes paramount.

1.2 Statement of the Problem:

The rapid development of an economy requires industrialization and for a country to be industrialized there must be reasonable level of investment to boast production. That is why the industrialized nations appear to be most developed in the world. However, to tap from the benefit inherent in economic growth, there must be increase in level of investment and the production. Therefore, for a country to promote production activities there is the needs for a substantial injection of capital which may be probably earn through taxations and borrowings. It is on this ground that Keynesian perceived government borrowing reasonable and argues that it does not have any harm on economic performance.

The aim of government borrowing as one of the instruments of deficit financing is channel towards achieving growth and development. Overtime, this borrowing has always been in excess compared to the generated revenue. The consistent increase in government budget deficits in recent time has rekindled debates about the effects of budget deficit on economic performance. While the effects of budget deficit on the economy can operate through a number of different channels such as exchange rate, interest rate, national savings and gross capital formation among


others, many of the recent concerns about government borrowing have focused on the potential interest rate effect which trickle dawn to other macroeconomic indicators. Higher interest rates caused by expanding government debt may reduce investment, inhibit interest-sensitive durable consumption expenditure, and decrease the value of assets held by households, thus indirectly dampening consumption expenditure through a wealth effect (Glenn, 2012).

In addition, rise in government borrowing may cause problem of rise in bond yields and inflation if governments fund deficits by printing money. If the government sells more bonds, it is likely to cause interest rates to increase. This is because the authority may need to increase interest rates in order to attract investors to buy the extra debt. Therefore, increased government borrowing may cause a decrease in the size of the private sector which may crowd out investment. Also, the likelihood of higher taxes and spending cuts may reduce the incentives to work. In extreme circumstances government may increase the money supply to pay the debt. But if government decides to sells short term gilts to the banking sector then there will be an increase in the money supply. This is because banks see gilts as near money, therefore they can maintain their lending to customers. Thus, rapid rise in government borrowing may lead to not just a rise in real debt but a rise in debt to GDP. This means debt burdens are a bigger percentage of aggregate output.

In view of the above, the ever rising budget deficit has attracted the attention of economists and policy makers and brings the need for formulation and implementation of macroeconomic policies with the hope of improving the management of the economy. Such policies are expected to address fiscal deficit management particularly the size and financing patterns of government deficits, the structure of taxation and the level of the composition of public expenditure. Some of the policies of Nigerian government in her effort to reduce the high budget deficits include the establishment of the Fiscal Responsibility Commission in 2007 which was meant to help to raise the level of fiscal prudence. The commission was backed by an Act in 2007 which expected the Federal Government not to exceed the threshold of 3% of GDP in its budget deficit. Another one is the Medium Term Expenditure Framework (MTEF) and Fiscal Strategy Paper (FSP) of 2012 - 2015. Their aim according to MTEFFSP (2012-2015) is to help in reducing government spending from the height reached in previous years as a result of majorly fiscal stimulus extended during the peak of global economic crisis. When the deficit is reduced, opportunity for


greater private sector participation and the growth of the economy will be enhanced. In the 2013 budget termed ‘’Fiscal Consolidation with Inclusive Growth’’ the present Nigeria government mapped out supportive fiscal measures to reduce deficit and encourage private sector investment just to step up the economic activiti

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