Macroeconomic Policies and Smuggling: An Analysis of Illegal Oil Trade in Nigeria

WP/94/115-EA
Macroeconomic Policies and Smuggling: An Analysis of Illegal Oil Trade in
Nigeria by Jian-Ye Wang

This paper examines the relations between macroeconomic policies and
smuggling. The study is based on observations of unofficial cross-border
trade in petroleum products between Nigeria and neighboring countries in
West Africa. Such trade has long been noted to have adverse effects on
price and output structures, exchange rates, and public finances in the
region.

Available statistical evidence indicates that despite the periodic
upward adjustment in the domestic sale prices of petroleum products and
substantial trade liberalization in Nigeria under the country's Structural
Adjustment Program, the main incentive for smuggling--the price
differentials of petroleum products between Nigeria and its neighbors--rose
in 1986-93. Oil smuggling from Nigeria to neighboring countries persisted
or even grew over the period.

To explain this pattern, the paper develops a simple model focusing on
the links among smuggling, public finances, and the Government's monetary,
exchange rate, and oil pricing policies. The model shows that a vicious
circle emerges. Inappropriate domestic oil pricing policy gives rise to
implicit oil subsidies, which provide the incentive for smuggling. The
smuggling worsens the Government's financial position, and monetary
financing of the fiscal deficit accelerates domestic inflation and currency
depreciation. The Government's attempt to fix the prices of petroleum
products is tantamount to indexing the implicit oil subsidy to the exchange
rate, which pushes up the cross-border oil price differentials. Smuggling
then increases, exacerbating the fiscal imbalances. This process eventually
forces the Government to abandon the previous oil prices. In the absence of
a fundamental fiscal correction and reform of the oil pricing policy, the
vicious circle continues. Macroeconomic indicators of Nigeria in 1986-93
support this analysis.

The model is also used to shed light on the impact of the devaluation
of the CFA franc on cross-border oil trade. The paper concludes with policy
implications for financial stabilization and adjustment in Nigeria.