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FG’s therapy for oil shock attracts divergent views from experts

By on November 24, 2014

As the price of Bonny Light, Nigeria’s crude oil grade hovered around $78 last week amidst a cocktail of austerity measures unveiled by the Coordinating Minister of the Economy and Minister of Finance, Dr. Ngozi Okonjo-Iweala, a week ago, economic affairs commentators have continued to weigh the pros and cons of the measures, with most commentators agreeing that Nigeria will survive the global oil shock.

A Cocktail of Measures
With the price of oil in the international market continuing its downward spiral, the federal government on Sunday announced a number of measures to cushion the economy from exogenous shocks.  Okonjo-Iweala had outlined some austerity measures as part of the government’s fiscal policy adjustments to mitigate the implications of lower oil prices on the fiscal and external balance of the Nigerian economy. These belt- tightening measures form the first tranche of a series of fiscal policy adjustments to be implemented if oil prices continue to fall.

Some of the measures include: six per cent downward revision in the 2015 budget benchmark oil price to $73pb from $78pb; upward revision in the collection target for Federal Inland Revenue Services; reduction in international travel and training within the public service, and surcharge on luxury items such as private jets and alcoholic beverages.

Appropriate Benchmark
Head, Research and Intelligence, BGL Plc, Mr. Olufemi Ademola, in his evaluation of the process adopted by the Federal Government, said the $73 benchmark per barrel of crude oil settled for by the Federal Government was inadequate.

However, sources disclosed that the Finance Minister had a hectic time with the National Assembly members before the new budget benchmark of $73 was approved. THISDAY checks also showed that the minister had pressed for lower benchmark but the legislators were not in the mood to accept her explanations for a lower benchmark.
According to sources, the minister had warned that the tumbling price of oil could worsen in the months ahead, thus the need for much lower oil benchmark.

Interestingly, the Federal Government have been under attack by the Nigeria’s Governors Forum which demanded the distribution of the funds in the Excess Crude Account although Okonjo-Iweala has continued to stress the need to save for the raining days.
In his opinion, Ademola said, “If we look at the current oil price, $73/barrel cannot be a comfortable benchmark to adopt. However, the outlook for next year is not yet very clear.

“While some analysts are predicting a continuous decline in oil price, others are forecasting a reversal in the near term. What appears to be clear now is that the possibility of consistent oil price above $100 mark may not be achievable in the near term. If I were to plan, I will take the worst-case scenario which is that oil price will decline further to below $70 to determine my benchmark.”

Managing Director, Financial Derivatives Company Limited, Mr. Bismarck Rewane said a six per cent reduction in the 2015 budget benchmark oil price to $73pb at a time when oil prices are trading between $77- $78pb is cutting it too close; it is also under the assumption that oil prices may not fall below $70pb in 2014.

According to him, not only have oil prices fallen below the 2014 benchmark of $75pb but there is a high possibility that they would fall further, below the proposed 2015 target of $73pb. If this happens, Nigeria has no savings. In addition, the government might require a supplementary budget for 2014 if revenues decline sharply.

“The benchmark price is set to determine the level at which savings accrue to an economy. Any price above the target price is considered as savings or used to build up the external buffers. So far, Nigeria has been unable to build up its external buffers even when crude prices were as high as $120pb.

Therefore a $5 (6%) reduction in the benchmark when compared to the 30 percent decline in oil prices is like a drop in the ocean and although necessary, may not be sufficient to plug the leakages. The government’s suggestion to increase taxes in an economy wherein tax compliance is low may be an exercise in futility as it is highly unlikely that the government will be able to generate enough revenue to fund the budget deficit.

The other measures outlined by the Minister of Finance are more academic than practical and are unlikely to have any significant impact,” he said.

He maintained that the federal government has taken the first step in the right direction, saying a blend of fiscal, structural and monetary policy adjustments are required to effectively mitigate the dire effects on the Nigerian macro-economy.
Is Tighter Monetary Policy Underway?
The government’s move to mitigate the impact of lower oil prices is a step in the right direction. But how adequate and effective are these measures?
Market watchers are of the opinion that further tightening should be expected at the Monetary Policy Committee meeting holding on Tuesday and Wednesday to reflect the austerity measures announced by the Federal Government. Ademola said there are various options available to the MPC including further tightening to help the exchange rate,  adjustment to the exchange rate mid-point or the official band, or do nothing. He said, “Further tightening would increase yield on investment and may attract more foreign investors but it would be against the policy direction of the current CBN regime and may also disappoint investors that expect adjustment to exchange rate.

“Adjustment to exchange rate mid-point or policy band is a pseudo-depreciation that the CBN is also not willing to do. While this action may stem the pressure on the exchange rate, it may also send a signal of panic by the monetary authority. Doing nothing (or Hold) would show a signal of being in control and quench the idea of panic. However it has the tendency of being interpreted as recklessness on the part of the MPC. Therefore it is a very knotty situation for the MPC. While I may subscribe to tightening using other policies but adjustment of MPR, I will also support an announcement of planned programme of floating the naira over the next 3-5 years.”

On the new target set on tax revenue, the BGL chief said it is an opportunity for the Federal Government to shore up its revenue base.
“According to the Minister of Finance and CME, the FIRS has collected N65 billion out of the target of N75 billion so far in 2014. This is a good development as it means that the target is achievable by year end. With all the processes put in place by the government to make it easier to assess and make tax payments and the expanding net of tax payers, including the newly introduced taxes on luxury goods, I think the target is achievable.

“I think any amount of revenue into the federal purse at the moment will make so much difference. With falling oil revenue and potentially falling revenue from duties due to the new policies on importation, the income from the tax on luxury goods will be important. In addition, it appears that like the US, Nigeria also has the top one per cent that controls more than 90 per cent of the country’s total wealth. Therefore, the tax on luxury goods, if implemented could be substantial. Finally, it would be more informative if the Ministry of Finance can put an estimate on the expected revenue from this new policy.”
He believes current austerity measure is not expected to directly affect the average Nigerians, warning, however that if the decline in oil prices continues, the government may introduce tighter measures including complete removal of oil subsidies and increase in levies and taxes on some other more commonly used goods. I don’t expect anything of such to happen until after the general elections in 2015.”

A Stitch in Time…
Confirming that the Federal Government, like other affected oil-reliant nations, has been making efforts to make the impact of the current volatility in oil market less severe Rewane, recalled that when global oil prices started to decline sharply in September, the markets and investors were taken by surprise.
Dissecting the new policy measures in the FDC’s Economic Bulleting for the month of November released last week, Rewane recalled that some governments started implementing austerity measures such as budget cuts, while others tarried to see how far prices will fall.

Within this period, he noted, Brent crude price has fallen 32.76 per cent from its peak of $116pb in June to $78pb and may have further to fall before rebounding towards the sub $80 levels.
“The Nigerian economy relies heavily on oil revenue; therefore a decline in oil prices poses significant risks to the fiscal and external balance of the economy. In the meantime, the CBN has commenced initial implementation of some monetary adjustments, while others will be announced at the next MPC meeting on November 24/25.”

Oil proceeds account for approximately 70 per cent of Nigeria’s fiscal revenue. However, the FDC chief said in the report that with the relative stability in Nigeria’s oil production of 1.9mbpd, which is 17.39 per cent below the 2014 benchmark of 2.3mbpd, a 32.76 per cent decrease in oil prices will result in a further deterioration of the fiscal imbalance.
“Nigeria has a fiscal deficit of approximately one per cent of GDP, a resultant effect of a rebased GDP. This is projected to widen beyond the fiscal target of three per cent of GDP as revenue shortfalls intensify.

“In Q2’14, the government’s retained revenue decreased to N864bn from N912bn in Q1, while September FAAC disbursements declined by four per cent year to date; these events occurred when oil prices were still above $110pb. With oil prices fluctuating between a band of $75 and $79pb, government allocations will reduce further as revenues decline,” Rewane said.

And The External Gap
Approximately 94 per cent of Nigeria’s exports are from oil and gas receipts. Over the years, Nigeria has maintained a surplus balance of trade position, currently estimated at $41.4bn.
Rewane therefore submitted that “A sustained decline in oil prices could result in a 70 per cent reduction in the balance of trade surplus and completely erode the current account balance. This is because typically when exports fall; imports remain stubbornly static, thus creating a trade gap. The level of Nigeria’s external reserves, of which a significant amount is from portfolio funds and hot money, has depleted approximately 14 percent year to date. Portfolio inflows have reduced since the start of 2014 and are expected to decline further with the end of the US Fed tapering. The excess crude account is down to $4bn and may be drawn down by 50 percent, according to the Minister of Finance.
“The combination of lower oil revenues and portfolio funds could push the balance of payments into negative territory.”

Saving the Naira
On the ability of the naira to survive the current pressure, Head, Research & Investment Advisory at Sterling Capital Limited, Mr. Sewa Wusu, said already, we have seen an implicit devaluation of the naira by the recent CBN policy action directed towards the inter-bank. The Official window had also responded speedily with the naira depreciating by about 72 kobo to N156.59/$. I think, the naira will still remain under intense pressure, given the reduction in Foreign Reserves and the predictions by IEA that oil prices at the international markets will continue to decline. In the face of these emerging realities, the CBN can only confront exchange rate stability endogenously. The vagaries of price decline at the international markets are exogenously determined by factors beyond the CBN control. That is why we have seen various policies within the last couple of days to ensure Naira stability. The forthcoming OPEC`s meeting  slated for 27th of November may proffer solution to oil price decline by the possibility of production cut. The policy direction of MPC meeting will also give direction for the Naira. But, we should expect further tightening of monetary policy.”

Can  Tax on Luxury Items Make any Difference?
Wusu said  under the current circumstances, the ideal thing for government to do is to commence the implementation of the announced austerity measures by the Ministry of Finance very quickly. “In as much as we are not saying that our country`s economic condition is that bad, but there is need to insulate the economy by adopting fiscal prudence before the full manifestation comes to reality. By then some savings would have been done to cushion the effect of revenue shortfall. The additional taxes to be levied on luxury items such as automobile, wine, jewelries, private jets, yachts and other high-end items bought for their value or status by the wealthy are also essential. However, there is need to carry the austerity measures beyond taxes on these luxury items to other areas where huge frivolous government expenditure will be curtailed to have meaningful impact in terms of savings. All the ancillary political office holders with huge expense heads should be cut off. The Minister of Finance had said that the salaries of public servants will not be affected. This is because you cannot compare the level of luxury enjoyed by public servants to political office holders. So at this time of anticipated austerity measures, they should shed the heavy weight of their emoluments.”

A fiscal strategy analyst, Eze Onyekpere, who spoke on a Channels Television programme last week, said there was need for the federal government to tackle the issue of waste by cutting the emoluments of National Assembly members as well as reducing the expenses of the executive arm of government.

According to him, there is no sense in keeping about 10 aircraft for the president at a period when revenue was going down.
Another financial expert, Paschal Odigbo, who expressed the fear that the austerity measures announced by the federal government was bound to trigger panic in money and capital market, said a long term measure is to diversify the economy.

Will Fuel Pump Price Reduce?
Speaking on the expectations over reduction in pump price of fuel in view of the reduction in crude oil price, Ademola said there is no reason why Nigerians should not enjoy a cut in fuel pump price. He said, “In the US, the current pump price of fuel is $2.76/gallon (about N110.4/litre), down from about $3.49/gallon few months ago. This is in reaction to the fall in oil prices. Hence, it should be expected that the landing cost of fuel in Nigeria too would have declined quite significantly. However, the question is whether the landing cost is not below the subsidised pump price. According to some analysts, the landing cost of petrol is currently about N125; down from N141.50. Since this amount is still above the pump price, no reduction in fuel price should be expected. However, the country is expected to see savings from fuel subsidy costs. This has also been estimated at about N600 billion in 2014. Therefore, except the oil price continues to go down until landing cost gets to below the current N97/litre, Nigerians should not expect any reduction in fuel pump price.”

In his analysis, Wusu, said, “The decline in crude oil prices, all things being equal, should translate into a reduction in pump prices, but that depends on the level of price decline. But the reduction in pump price is unlikely in the Nigerian scenario at this time. One has to look at the dynamics of fuel pricing at this moment to ascertain the landing cost from the decline in oil prices at the international markets vis-à-vis the subsidy gap paid by the government. I think the pricing template should be adjusted to reflect the current price reality. If that is implemented which I think the PPPRA would have adjusted, we may then see a drop in the amount of subsidy paid by the government.

“So, I think the decline in crude oil prices in the short run is a big positive for countries that depends largely on oil imports for their oil consumption. But for Nigeria, the situation is a dilemma. We earn less during a price decline as a producer, which reduces our revenue base and on the other hand, we are better off as an importer of refined crude oil, which reduces our import bill and also lowers the subsidy burden for the government which should even make it easier for the government to provide a case for deregulation of pump prices. But the current scenario may not be tenable because of the anticipated public outcry that may follow, particularly as election year approaches. Just recently, the government of Rwanda announced a reduction in fuel pump prices by about 4.95% mainly due to reduction in oil prices at the international market.

“Again, this is where the need to fix our refineries or get more private investors to invest in building more refineries in the country just like that of Dangote that is billed to come up by 2018.”

 

[ThisDay]