Khan: Nigeria’s Fuel Subsidy Policy is Regressive

Head of Research/Chief Economist, Africa, with Standard Chartered Bank, Razia Khan, who was in Lagos recently spoke extensively on the outlook for Nigeria’s financial market as well as the economy. Obinna Chima presents the excerpts:

Do you foresee a problem of debt overhang in the light of increased borrowing by the federal government considering the country’s weak fiscal position?

There are two parts to that. One is the attractiveness of Nigeria’s yields to foreign investors. At current interest rate, yields are very attractive. But investors may be reluctant to come in if they think there is still a big adjustment that the exchange rate needs to do and until they see a more market driven mechanism of bringing about that forex rate, they wouldn’t know about the sustainability of these levels or not and that may be discouraging foreign investors from coming in and being able to finance the deficits the way Nigeria expects given its yields advantage. Another thing is that Nigeria’s debt ratio and the likelihood of a debt overhang. The problem really stems from the low level of revenue collection as a percentage of Gross Domestic Product (GDP), factoring oil price or even Boko Haram, if you take the oil out. If you look at the debt commitments of Nigeria relative to the revenue that it earns, if you look at it as a percentage of GDP, 12 per cent, anyone can shrug it off. But when you look at the difference between the actual stock and the flow, there is a big difference in terms of how much the Nigerian government is collecting as revenue and its ability to finance that debt. So, it isn’t yet a concern for market. I think for now the market has accepted the fact that yields in Nigeria are higher for structural reasons. It is not yet driving perception of there being an over indebtedness. The risk will come if time moves on and having rebased its GDP, Nigeria isn’t able to show the dramatic improvement in the pace of non-oil revenue mobilisation. I think that would focus investors mind much more sharply on the fact that you do have potentially a more serious problem developing. For now, the consensus seems to be that Nigeria has room to borrow. It has room to borrow because of the domestic investor base, which is still considerably if you think of the $23 billion assets under management from the local pension funds, it has room to borrow in terms of the willingness of foreign investors to potentially put more money in Nigeria and given the extent of issuance we have seen internationally, it’s got room to borrow there. What we don’t want is to see zero progress in term of the revenue mobilisation efforts, which then makes investors focus more on the amount of debt service commitments relative to the revenue coming in, which is afairly high ratio.

Do you foresee the country borrowing from the international market before the end of this year?

I think it is possible given the willingness not to crowd out the domestic market so much with excessive domestic borrowing. We have obviously seen the passage of the budget and it is unlikely that any of the assumptions are going to change very dramatically. If we are right in thinking that oil prices will bounce back by the second half of the year that will certainly provide a certain element of reprieve in terms of acting as a buffer and there may not need be as much as borrowing as envisaged. But I think anyone looking at Nigeria’s situation would say there is likely going to be a case for external borrowing. What we don’t know yet is how open and favourable the external debt market is given what might happen at the Federal Reserve.

Still considering the country’s weak fiscal buffers, what do you think should be done to the controversial issue of fuel subsidy. Do you support its removal so as enhance the country’s fiscal position?

Absolutely, I think it should be removed. If you look at the reasons for the fuel subsidy and its economic effect, that subsidy is very regressive because it a cost on the whole economy. It takes away resources especially from the poor and rewards those who consume more fuel, which are mostly wealthy Nigerians. So, just from a perspective of having a tax regime that isn’t as regressive, there are very serious reasons to consider the modification or eradication of that subsidy. The other element to it, is how does the Nigerian economy actually benefits from it. There is a lot of positivity and I think part of the long-term foreign account forecast we see is not just the assumption that food import would fall dramatically, but the imported fuel products, the hope is that by 2017, we would start to see some difference in terms of the amount of products that Nigeria needs to import simply because of the construction of refineries. But for that to be economically feasible, we do believe market forces need to start playing a greater role in Nigeria and that is another argument that is needed to consider getting rid of the subsidy regime which is a great distortion. But the third element as we know, is just how the subsidy has operated. In other countries, you might thinking of that as something that adjusts itself to market prices. But in Nigeria, the subsidy has been put in place as a cap. That doesn’t make too much economic sense. It means when the country is perhaps least likely to afford it, it might be making larger and larger pay out of the subsidy. So, the economic rationale for the subsidy can be called to question. It is an incredible regressive policy intervention and I think if that