Economic Impact of Fuel Subsidy, Borrowing, Interest Rate Hike

Nume Ekeghe posits that inflationary pressure, budget deficit due to continued fuel subsidy, will have adverse effect on the Nigerian economy

Nigerian government is planning to increase its borrowing to be able to finance the over N6 trillion budget deficit in 2022. The borrowing is however expected to be beyond what was initially planned as the federal government recently announced that it would be suspending the initially intended removal of fuel subsidy.

The government has initially planned to commence the removal of fuel subsidies this month but had been shifted the plan to July 2022 with the implementation of the Petroleum Industry Act (PIA). However, last month, the government reneged on its words, shifting the finishing-line for fuel subsidy by 18 months.

The Nigeria Labour Congress (NLC) and the Trade Union Congress (TUC) had mounted pressure on the government with threats of embarking on a nationwide protest if the removal of subsidy was not suspended.

While the government had said the suspension of the removal was due to the fact that the timing was not right, the deferment is expected to further add not less than N3 trillion to the current deficit woes of the country.

Cost of Subsidy for 2022

Minister of Finance, Zainab Ahmed had noted that only N443 billion had been provided for in the 2022 budget to accommodate subsidy from January to June, but taking the prevailing economic realities, both locally and globally, into consideration, Federal Executive Council (FEC) proposed a year-long provision for the subsidy.

“The Nigerian National Petroleum Company (NNPC) has presented to the ministry a request for N3 trillion as fuel subsidy for 2022. What this means is that we have to make an incremental provision of N2.557 trillion to be able to meet the subsidy requirement, which is averaging about N270 billion per month.

“In 2021, the actual under-recovery that has been charged to the federation was N1.2 trillion, but in 2022, because of increased crude oil price per barrel in the global market, now at $80 per barrel and also because an NNPC’s assessment is that the country is consuming 65.7 million litres per day, now we’ll end up with the incremental cost of N3 trillion in 2022.” She stated whilst noting that there were plans to scale down the spending.

Meanwhile, the Senate President, Ahmad Lawan had pointed out the burden, which the suspension would put on government finances. Lawan in a statement issued by his media aide, Ezrel Tabiowo, said; “The position of everyone in government today is that admittedly, subsidy administration and management are flawed because of so many reasons. Admittedly, the burden is huge and massive and there is need at one point to do away with the subsidy.”

IMF Drive Against Subsidy

The IMF in its latest Executive Board 2021 Article IV Consultation with Nigeria had further pressed on the government to lift the suspension on removal of fuel subsidies, with compensatory measures for the poor and transparent use of saved resources. They stressed the importance of further strengthening social safety nets.

The Division Chief, Research Department, IMF, Mr. Malhar Nabar, earlier at the World Economic Outlook media briefing ad said, “In terms of subsidy, we have for long not just for Nigeria, but for many low-income countries that have these programme of subsidy schemes in place, called for scaling back of poorly targeted subsidies to create fiscal space that can then be repurposed for meeting vital health and social spending needs. That recommendation applies in the case of Nigeria.”

Increased Fiscal Deficit

Commenting on the development, Senior Research Analyst at FXTM, Lukman Otunuga, noted that, “the International Monetary Fund (IMF) has urged Nigeria on repeated occasions to drop the fuel subsidies because it remains a key driver of significant fiscal deficits and evaporating public finances.

“Indeed, Nigeria exports crude but imports all by-products of the resource, including premium motor spirit (petrol). With the country consuming more than it refines, it depends heavily on importations for its energy needs. Interestingly, rising global oil prices will enforce more pressure on Nigeria’s foreign exchange while the revenues from oil sales will be sapped by fuel subsidies.

“According to data from the Nigerian National Petroleum Corporation (NNPC), petrol subsides jumped to N1.43 trillion in 2021. This will certainly impact the government’s ability to fulfill its financial obligations in 2022.”

Speaking on the suspension of the removal of fuel subsidies, the managing director of Parthian Securities, Oluseye Olusoga said this would certainly lead to more borrowing by the government and thus affect interest rates.

“My view of 2022 is that interest rates are going to end up higher but I think that could be controlled. There was a budget and with this comes two sides, there is the cost side and the revenue side. And when you think about it, there are some components in the budget that always have to be paid. So, things like salaries, recurrent expenditure and so on.

“But when it comes to things like subsidies, the real problem is the contribution of Nigerian National Petroleum Corporation (NNPC) to Federation Account Allocation Committee (FAAC) would be significantly depressed because of the subsidy issue.

“Yes, the lack of removal of subsidy is going to lead to an increase in rates. This would mean that there would be a controlled cap on how much money NNPC can contribute meaning that the government is going to borrow more. And by borrowing more, it means rates would go up. But I’m saying that they are not going to go as high as people might actually think because government has other tools, which they can use to manage that amount of borrowing. Even though I think rates would go up, I am not that bearish that they would go significantly higher beyond 200 to 300 basis points, ”he said.

To analysts at Agusto & Co, “The rhetoric of Nigeria’s fiscal policy managers over the last decade has been one that downplays the risks around a widening fiscal deficit that has been largely funded by borrowings. Initial defence of the borrowings harped on Nigeria’s benign Debt to GDP levels albeit with less focus on debt service to revenue levels.

“At Debt to GDP ratio of 30 per cent, Nigeria seems to have what genuinely looks like a benign ratio. But with 76per cent of the Federal Government’s revenue going into debt service alone in 2021, the country genuinely has a debt sustainability crisis that should lead to new thinking.”

They added, “In 2022, we estimate that the debt to revenue ratio will cross the 80 per cent mark and hover between 85 per cent – 90 per cent as election induced spending ramps up. While we do recognise the initiatives to grow fiscal revenues, Agusto & Co is of the opinion that these efforts will not be enough without due consideration to the expenditure element of the fiscal balance equation.

“Plans to more than double the non-debt recurrent expenditure to about N6.9 trillion in 2022 from about N3.5 trillion last year, indicates an absence of fiscal discipline to rein spending largely financed by borrowings. We also believe that this administration will not pursue other deficit financing options particularly disposal of assets in 2022. In 2021, the federal government estimated revenue projections from privatisation at N205 billion but ended the year without any proceeds from divestments of state- owned enterprises. In 2022, the Federal Government has budgeted N90 billion from the same source. We believe this will also not materialise.”

On his part, the Group Managing Director, Cowry Asset Management Limited, Mr. Johnson Chukwu added, “If they achieve their budgeted revenue expectation, we are going to have N9.6 trillion deficit. Nothing has changed in the economy structurally as to enable us to generate from N6 trillion to N10 trillion.

“If we give it a benefit of doubt and increased government revenue to N7 trillion and you spent N19.7 trillion. Go and note it that Johnson Chukwu said it that we are going to end 2022 with N12.6 trillion deficit.

“So, what follows next is that we will have to borrow. The Monetary Policy Rate is 11.5 per cent and so they are giving 13.5 per cent to Central Bank of Nigeria (CBN) to be borrowing.”