Nigeria’s reform progress: a stock take - Capital Economics
Africa Economics

Nigeria’s reform progress: a stock take

Africa Economics Update
Written by Virag Forizs

Policymakers in Nigeria are taking steps in the right direction with recent market-friendly reforms, from liberalizing petrol prices to moves towards exchange rate unification. But the government hasn’t shed its unorthodox and protectionist tendencies, which may prevent the release of World Bank funding and will almost certainly stifle investment and growth.

  • Policymakers in Nigeria are taking steps in the right direction with recent market-friendly reforms, from liberalizing petrol prices to moves towards exchange rate unification. But the government hasn’t shed its unorthodox and protectionist tendencies, which may prevent the release of World Bank funding and will almost certainly stifle investment and growth.
  • The World Bank has held off providing $1.5bn of funds to Nigeria, reportedly over the lack of progress on reforms. While concrete demands were not presented by the institution, it appears that areas of disagreement include fuel subsidies, electricity tariffs, and the country’s multiple exchange rates propped up by the Central Bank of Nigeria (CBN). Table 1 outlines the key reforms in question.
  • The Nigerian government has taken several steps in recent months to address these demands. The CBN allowed the naira to weaken against the US dollar in two rounds of devaluations, nearly closing the gap between the official exchange rate and the more widely used Nafex rate. (See Chart 1.) And the central bank has resumed FX sales to small and medium enterprises, bureaux-de-changes, corporates and investors.
  • In addition to moves towards a unified naira, petrol price controls were scrapped in September and, in the same month, the government gave the green light to an increase in electricity tariffs to bring them closer to cost-recovery levels. A renewed push to pass a petroleum industry reform bill, which has been in the works for twenty years, is also likely to help Nigeria’s case in unlocking multilateral financing.
  • These reforms are steps in the right direction even if, at least to some degree, they probably reflect economic necessity. Lower oil prices have slashed Nigeria’s foreign exchange earnings and shrunk government revenues. The devaluation of the currency will give a boost to the naira value of the government’s oil revenues. At the same time, the removal of petrol subsidies will reduce government expenditure by an estimated N1trn per year (equivalent to 10% of total spending in 2019).
  • That said, while these policies will have positive implications for Nigeria’s fiscal position, there will be some negative ramifications for the economy more generally. In particular, headline inflation will rise further, from 13.2% y/y in August, due to an increase in the price of imported goods and higher transport and electricity inflation. (See Chart 2.).
  • There is still a major risk that political pushback could result in reforms being watered down or even reversed. Labour unions threatening to strike over energy price rises led to the temporary suspension of a planned electricity tariff hike in September. And in 2011, widespread protests forced President Goodluck Jonathan’s administration to abandon plans to scrap fuel subsidies.
  • What’s more, there are clear signs that the government hasn’t dispensed with its unorthodox and protectionist tendencies. While the multiple exchange rate system has been simplified, and largely unified around the Nafex rate (at 386/$), policymakers seem reluctant to let the currency float freely. The gap with the black market rate (at 458/$), which we think is closer to the fair value, remains large at around 16%.
  • Moreover, the fragmented and rationed resumption of dollar sales suggests that the CBN is clinging to its grip on the currency wherever it can. Measures aimed at clamping down on foreign currency transactions, including a ban on imports via third parties and requiring banks to report exporters that fail to repatriate foreign currency earnings, point in the same direction. President Muhammadu Buhari even instructed the central bank to stop providing FX to food and fertilizer importers, threatening shortages of goods.
  • Currency reforms appear to be a key sticking point in negotiations with the World Bank over Nigeria’s loan request. Further delays in approving the loan could put renewed pressure on the country’s public finances. The IMF estimated that Nigeria’s fiscal financing gap will reach $8bn this year, of which about $2bn was expected to be covered by multilateral institutions other than the Fund, including the World Bank. Combined with weak debt servicing capabilities (see Chart 3), the central bank may be pressured into financial repression policies or even outright deficit monetization to finance the budget shortfall.
  • More broadly, hanging onto unorthodox FX policies will deter investment and hold back the economy. Lack of access to foreign currency has reportedly pushed a World Bank-backed power plant close to default. And South Africa-based food retailer ShopRite has already announced its exit from the Nigerian market, quoting currency shortages as one of the key reasons behind the decision. Weak foreign investment inflows under President Buhari are set to continue (see Chart 4), stifling economic growth.

Table 1: List of Reforms Reportedly Demanded

Economic Impact

Progress

Energy market

Removal of fuel subsidies

Annual government saving of N1trn (+)

Higher inflation (–)

Completed: Petrol prices deregulated. (Sep. ‘20)

Ease curbs on electricity tariff rises

Reducing government subsidies (+)

Higher inflation (–)

Uncertain: Electricity tariffs allowed to rise, later suspended. (Sep. ‘20)

Foreign exchange market

More unified exchange rate regime

Boost naira value of oil revenues (+)

Improve external competitiveness (+)

Improve attractiveness of Nigerian assets to foreign investors (+)

Limit shortages of imported goods (+)

Higher inflation (–)

Completed: Devaluation of official exchange rate within 2% of Nafex rate in two steps. (Jul. ‘20)

More flexible exchange rate regime

Incomplete

Clearing of FX backlog

In Progress: Gradual resumption of FX sales to SMEs, bureaux-de-changes, corporates and investors at lower volumes & frequencies.

Sources: Reuters, Bloomberg, Faye & Fraser Briefings, Capital Economics

Chart 1: Nigerian Naira (vs. $, Inverted)

Chart 2: Consumer Prices (% y/y)

Chart 3: Debt Servicing Costs (% of Federal Revenue)

Chart 4: Direct Investment into Nigeria

Sources: NBS, CBN, Budget Office, Refinitiv, Capital Economics


Virág Fórizs, Africa Economist, virag.forizs@capitaleconomics.com