Developing an Indicator of Fiscal Sustainability for Africa

Abstract

The experience of extreme macroeconomic instability in Africa has its origin in the inability to control fiscal dynamics and the effect that this has had on the overall policy stance. African countries are heavily dependent on volatile revenues (from aid, oil, exports, a small tax base) to finance their relatively huge total expenditure, making their budget vulnerable to fiscal shocks. This poses a serious threat both to the sustainability of the continent’s budget and to its macroeconomic stability. Oil and commodity windfalls and aid surges induce government spending that is difficult to retrench when these sources of revenue experience negative shocks, distorting government budget allocation patterns, cohesion, and stability, and increase deficits and debt stock that has often created an unfavourable environment for monetary policy. In the presence of such a highly volatile environment, current figures for revenues, expenditures, and the fiscal balances will convey a rather misleading picture of the underlying fiscal situation. Developing fiscal indicators which may provide a more reliable picture of the underlying sustainability of current fiscal policy is of paramount important. In 2004, Nigeria introduced an oil-price-based rule to deal with the revenue volatility challenge. The aim of the rule is to smooth government expenditure. The oil-price rule is designed to benchmark overall fiscal performance and the sustainability of public finances. In this chapter, we analyse the case of Nigeria’s post-2004 data to guide the development of fiscal sustainability indicators in economies with highly uncertain fiscal revenues such as Africa. In particular, we look at whether the oil-price-based rule is able to adequately address the macroeconomic conditions that affect fiscal sustainability in Africa.