ABSTRACT
The objective of this work is to investigate the twin deficit hypothesis in Nigeria from 1981-2015. The study made use of secondary data sourced from the Central Bank of Nigeria statistical bulletin. The variable used for the study is Current Account Deficit (CAD) being the dependent variables are Budget Deficit(BD), Real Gross Domestic Product(RGDP) .Manufacturing Output Product(MOP) and Real exchange rate (RER) Using Ordinary Least Square Method (OLS) multiple regression techniques, the study revealed that there is no causal relationship between current account deficit and budget deficit in Nigeria. The study also reveals that there is a positive relationship between budget deficit and current account deficit in Nigeria such that an increase in the budget deficit will trigger a worsening of current account position thereby reaffirming the twin deficit phenomenon in Nigeria. Persistent budget deficit may lead to chronic current account disequilibrium which may further hinder economic growth. Government must in that pursue fiscal policy that aligns expenditure with revenue. Government should also keep budget deficit within manageable limit and encourage the development of viable manufacturing sector so as to improve the current account position of the economy.
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The “Twin deficit” debate was a common policy issue during the 1980s and the early 1990s and the term was initially invented to describe the co-movement between the budget deficit and the current account deficit (Chang and Hsu, 2009). A twin deficit otherwise known as “double deficit” occurs when a nation has both a current account deficit and a fiscal deficit (Tonia, 2007). Twin deficits hypothesis asserts that an increase in budget deficit will cause a similar increase in current account deficit. That is, there exist a co-movement between fiscal deficits and the current account deficits. (Ogbonna, 2014).A fiscal deficit otherwise known as budget deficit occurs when government spending exceeds government revenues. It represents a significant portion of federal spending that must be financed through the issuance of debt (Neaime, 2008).
The current account deficit, or “trade deficit” as it is sometimes called, is the measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the goods and services it exports. This is generally financed by a net capital inflow into the country from abroad. Such an imbalance is generally viewed as undesirable as consumer demand is being met increasingly by foreign goods produced by foreign workers to the detriment of the domestic workforce (Njoroge, Kosimbei and Korir, 2014).
Yanik (2006) was of the opinion that the relationship between current account deficits and budget deficits (BD) are now at the center of international macroeconomics literature. It is believed that the two deficits move together, at least in the long-run (Yanik, 2006). Having a foundation in international macroeconomics, the twin deficit hypothesis posits that changes in the budget deficit of a country can translate to a change in the current account balance of the country or could be the other way round. This relationship, however, is said to take place through the channel of real interest rate, real income and real exchange rate (Neaime, 2008).
Kim et al., (2007) observed that fiscal deficits tend to occur jointly with current account deficits. Giarcarloet al., (2006) is of the view that fiscal shocks will cause a deterioration of the government’s budget and also worsen the country’s current account balance. Thus, the main thrust of the twin deficit hypothesis, however, is that current account deficits of most countries is caused by government’s budget deficits phenomenon and the most suitable way to solve this problem and stabilize internal and external deficits is reducing the government’s budget deficit (Zamanzadeh and Mehrara, 2011).
Ogbonna (2014) observed that a large budget deficit is a source of economic instability and in the same vein, a significant current account deficit, increases the rate of interest, reduces aggregate demand, leading to a reduction in investment and subsequent increase in unemployment, which in all, will hurt the long-term economic growth by increasing national indebtedness.
1.2 Statement of The problem
The recent fiscal expansion due to the global financial crisis in 2008 has made it timely to revisit the twin deficit phenomenon for Nigeria and examine the direction of causality. The apparent similar movement in both the budget and current account deficits gave rise to the idea that there might be a relationship between the two deficits (Egwaikhide et al, 2002). It has also been established in economic theory and empirical observation that there exists a link between the two deficits. For Nigeria, there have been persistent and rising budget deficits most especially from the 1970s. The country has also been having current account deficits, even though there has been a surplus in the last 12years. So, it is evident that the Nigerian economy has been experiencing the twin deficit phenomenon. In the same vein, Nigeria as an oil-exporting country where revenue from oil production contributes more than 95% of its foreign exchange, 40 percent of GDP and 80 percent of fiscal revenues makes the economy susceptible to fluctuations in government revenues as a result of volatility in oil revenue (Onafowokan and Owoye, 2006).
As it has been argued in empirical literature that large budget deficits can have negative implications for the stability of the current account, countries that run budget deficits are believed to most likely have a current account deficit. According to Harshemzadeh and Wilson (2006), growing budget deficits are reflected in growing current account deficits. This makes it important to know to what extent fiscal balances can be used to achieve adjustment in the current account balance. Despite the detrimental economic and social effects of large budget deficits on an economy, it is believed that running a budget deficit over a period of time is not necessarily bad for an economy, likewise a current account deficit, in as much as the deficit is used to finance developmental project for the country to bring about growth. According to Fleegler (2006), governments often incur fiscal deficits to grow their economies and provide certain services to the population. So, at some points, an economy incurs deficit in its budget balance.
Thus, the issue is not whether the country is running a budget deficit or current account deficits in as much as the deficits is being incurred for developmental purposes, the problem lies in a country running the two deficits simultaneously known as having a twin deficit. This have important implications for the economy as it can affect the country’s external rating in the global economy and foreign direct investment into the country. The importance of the policy implication is that if the basic reason for rising current account deficits is the escalating budget deficits, then policy makers may have to focus on curtailing the budget deficits to resolve the current account deficits. On the other hand, if the reverse is the case, then the reductions in the budget deficits will not resolve the current account problem (Onafowokan and Owoye, 2006). This will also help make fiscal policy more prudent especially in the case when an unbalanced budget causes predicted changes in current account.
As it is believed in open economy macroeconomics that budget deficit leads to deterioration of the current account balance (Jayaraman et al, 2008), it therefore becomes imperative to find out if the resulting current account balance experienced by the Nigerian economy is as a result of the substantial increase in its budget deficit over the years has been argued by the twin deficit hypothesis or it is the other way round. In other words, this study investigates the direction of causality between the two deficits. Also, as it has been advocated in empirical literature that domestic fiscal consolidation can be used as a necessary measure to correct current account deficits, it becomes important to ascertain the direction of causality as the causality may flow from current account deficit to budget deficit for an oil-based economy like Nigeria. On the above notes, this study intends to investigate the causal relationship between budget deficit and current account imbalance in Nigeria from 1980 – 2015.
1.3 Research Questions
- What is the direction of causality between the budget deficit and the current account deficit?
- Is there a long run relationship between budget deficits and the current account deficits?
1.4 Objectives of the study
The main objective of this study is to investigate the “twin deficit” hypothesis in Nigerian economy. Specifically, the study intends to:
- To investigate the direction of causality that exists between the budget deficits and the current account deficit in Nigeria
- To examine the long run relationship between budget deficits and the current account deficits.
1.5 Research Hypotheses
The study intends to test the following research hypotheses;
H01: There is no significant long run relationship between budget deficit and current account deficit.
H02: Budget deficit does not significantly cause current account deficit.
1.6 Significance of the Study
The study will contribute immensely in aiding the government, policy makers, economic planners, researchers and the academia generally. This will provide an insight and understanding to the government on how to be prudent in spending public funds that would bring about economic growth and development. It is also of immense help in providing an insight and knowledge to the general public, policy makers and economic planners on the impact of twin deficit hypothesis on Nigerian economy.
To the academia, the findings of the study will contribute to the available literature on twin deficit hypothesis in Nigerian economy.
Finally, this work will be of immense benefit to the policy makers and economic planners in terms of using its findings in formulating and implementing appropriate policy measures towards accelerating economic growth through the manufacturing sector.
1.7 Scope of Study
This study examines the twin deficit hypothesis in Nigerian economy by applying theoretical considerations of the twin deficit hypothesis using annual data covering the period 1981 through to 2015, which is a period of 35 years. The data for this study will be sourced from the Central Bank of Nigeria (CBN) Statistical Bulletin (2016 edition) and the World Bank Development Indicators (WDI) Database for 2016.
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