Oil price volatility effect on infrastructure spending in Nigeria

• Published date: 01 March 2017
• Date: 01 March 2017
• DOI: http://doi.org/10.1111/opec.12096
• Author: Simeon Oludiran Akinleye

Oil price volatility effect on infrastructure

spending in Nigeria

Simeon Oludiran Akinleye

Department of Economics, University of Lagos, 234 Akoka, Lagos, Nigeria. Email: akinleye@gmail.com,

soakinleye@unilag.edu.ng

Abstract

This study examined the effect of oil price volatility on infrastructure spending in Nigeria, using

time series data from 1960 to 2012. The data were analysed using cointegration, variance

decomposition and impulse response functions to determine the effect of oil price volatility on

infrastructure spending in Nigeria. The trend analysis shows that both oil price and government

spending on infrastructure fluctuate together. The impulse response showed that the impact of

crude oil price shock is substantial in the short run but remain stable and high in the long run which

implies that the effect of crude oil price volatility could persist into the future. From these results,

the empirical findings suggest that effort should be made by government to seek alternative means

of financing infrastructure as oil price is unpredictable.

1. Introduction

Oil represents one of the most important macroeconomic factors in the global economy,

and the crude oil market is the largest commodity market in the world. As a difference

from other commodities, oil is probably one of the few or the only production input that

can affect economic growth both positively and negatively, to an extent that it might even

lead to a recession (Gonzălez and Nabiyev, 2011). Since the 1970s, the international

crude oil price has been fluctuating with worsening volatility, creating unpredictable

consequences (Gonzălez and Nabiyev, 2011; Li and Zhao, 2011). Oil price volatility

dampens growth through different channels, from an increase in production cost to

inflation expectations. Besides, oil price increases can translate into higher transportation,

production and heating costs, which can put a drag on corporate earnings. It can also

affect price stability, firm profitability and a country’sfinancial system stability (Li and

Zhao, 2011). Oil price shocks (i.e. sudden changes) can be transmitted into the

macroeconomy via various channels. In the private sector, a positive oil price shock wi ll

increase production costs and hence restrict output with price increases at least partially

passed on to consumers. Moreover, as prices for gasoline and electricity increase,

households face higher costs of living, with the poor being particularly vulnerable.

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These impacts can have further significant knock on effects and repercussions

throughout the economy, affecting macro indicators such as employment, trade balance,

inflation and public accounts, as well as stock market prices and exchange rates.

Thereby, the nature and extent of such knock on effects depend on the structural

characteristics of an economy; for instance, the more a country engages in oil trade, the

more it is exposed to price shocks in global commodity markets. Countries that rely on a

high fossil fuel share in their energy mix, or on energy intensive industrial production,

are also vulnerable. Furthermore, oil price shocks on the international market might be

amplified in specific countries, depending on the respective dollar exchange rate and

prevailing inflationary pressures. While a given oil price increase may be perceived

positively by oil exporting countries and negatively by importers, an increase in oil price

volatility (i.e. consecutive positive and negative oil price shocks) increases perceived

price uncertainty for all countries regardless of their balance of trade.

Higher oil prices may reduce economic growth, generate stock exchange panics and

produce inflation which eventually leads to monetary and financial instability. It could

also lead to high interest rates and even a plunge into recession (McKillop, 2004). Sharp

increases in the international oil prices and the fluctuations of the exchange rate are

generally regarded as the factors limiting economic growth (Jin, 2008). Most oil

producing countries face problems in managing fiscal policy because of the high

volatility of oil prices. Some have fared better than others in delivering higher real per

capita growth. If soundly managed oil revenue can translate into sustained higher non-

inflationary growth of the non-oil economy while also cushioning the domestic economy

from sharp and unpredictable movement in oil prices and revenue (Ferderer, 2013).

Findings on the asymmetric effects of oil revenue shocks in Nigeria revealed that

positive shocks to oil revenue stimulate expansionary fiscal posture in the Nigerian

economy in the short run in line with theory, thereby creating inflationary pressure and

domestic currency depreciation. The implication of this is the need for proper

coordination of fiscal and monetary policy for sustainable macroeconomic stability to be

achieved (Akinleye and Ekpo, 2013).

Crude oil has generated great wealth for Nigeria, but its effect on the growth of the

Nigerian economy as regards returns and productivity is still questionable (Odularu,

2008). New oil wealth has led to a concurrent decline of other sectors in the economy

and has fuelled massive migration to cities and led to increasingly widespread poverty

especially in rural areas. As a result, Nigeria’s job market has witnessed very high degree

of unemployment, low wages and pitiable working environments (Adedipe, 2004 and

Odularu, 2012). Between 1970 and 2012, Nigeria’s poverty rate increased from 36 to 70

per cent (National Bureau of Statistics, 2014), and it is believed that oil revenue did not

seem to add to the standard of living at this time but actually caused it to decline (Salai-

Martin and Subramanian, 2013).

OPEC Energy Review March 2017 ©2017 Organization of the Petroleum Exporting Countries

72 Simeon Oludiran Akinleye