Analysis of the Relationship between Fiscal Deficits and External Sector Performance in Nigeria

Abstract

The study examined the effects of and the causation between fiscal deficits and the external sector performance of Nigeria between 1961 and 2011. Data collected from various issues of Central Bank bulletin were analyzed by a bi-variate granger causality technique and the error correlation modeling techniques. Results showed a long run relationship among the variables. There also existed a bi-directional causality between budget deficit and external sector performance in the long run while a one – way causation existed from external sector performance to budget deficit in the short run with no feedback from fiscal deficit. Results also showed that fiscal deficit did not significantly affect external sector performance in the short run. Furthermore, the cross correlation coefficient indicated that fiscal deficits would lead to long run deterioration in external reserves accumulation and exchange rate. The study therefore recommends a minimization of the current size of fiscal deficits in order to avoid the long run negative effect on the external sector.

Key words: fiscal deficit, real exchange rate, external reserves.