The Implication of Subsidy Removal, Naira Devaluation, and a Single FX Window on the Nigerian Economy
In President Bola Ahmed Tinubu’s inauguration speech on Monday, he reiterated his commitment to phasing out Nigeria’s decades-long subsidy on refined petroleum products and working with the Central Bank of Nigeria (CBN) to change the country’s monetary policy approach which includes “guaranteeing” a unified exchange rate. Ensuingly, the Nigerian National Petroleum Company Limited (NNPC) adjusted the pump prices of Premium Motor Spirit (PMS), also known as fuel or petrol, across its retail outlets on Wednesday, 48 hours after the inauguration speech. The adjustment, according to the NNPC, was made in line with current market realities - which basically means that the product (PMS) is no longer subsidized by the government. This adjustment has since seen the pump prices of PMS (fuel) across Nigeria increase by an average of 193%, leaving a majority of Nigerians wincing in socio-economic anxiety amidst contradictory fuel queues and deserted fuel stations.
Figure 1: Adjusted NNPC pump price list across Nigeria for PMS, from 31, May 2023
Regarding devaluation, analysts at Absa Group, as reported by Bloomberg, are convinced that the Naira will be devalued in the early days of Tinubu’s presidency. In addition to that, rumors of a devaluation have since surged on the first day of June 2023, prompting the CBN to issue a disclaimer. Furthermore, in our recent review of Tinubu’s manifesto and inauguration speech on Monday, we highlighted his determination to push for a single foreign exchange window.
It is important to highlight the implications of these planned and early-stage implementations of the highlighted macroeconomic policy decisions on the Nigerian economy and everyday Nigerians.
The removal of subsidies on PMS (fuel) took effect on May 31, 2023. A vast majority of Nigerians have already begun to feel the underlying short-run effects, especially those at the lower and middle ends of the income spectrum. Across Nigeria, transportation costs have grown substantially and are expected to continue to do so. In many cities, the rise in transportation costs has been well over 100%. This sharp increase has severe implications for individuals, households, and the market dynamics. The increase in transportation costs will feed into the increase in both food and non-food prices. Transportation costs play a significant role in the supply chain, which transmits higher input costs, raw material costs, agricultural commodities, and consumer products. The short-run implication is that the inflation rate, which is currently at an unbearable level of 22.22%, will further rise due to the increase in the cost of transportation. Inflation expectations are also going to be on the rise as consumers and businesses anticipate higher future prices in the market, particularly for new products. As a result, immediate demand pressure for existing commodities will surge up thereby putting additional inflationary pressure. However, after inflation expectation dwindles, purchasing power and intent are expected to further reduce, forcing producers, merchants, vendors, and retailers to reduce their inventory/product stock. This transmission mechanism will likely induce a gradual reduction in national productivity, thus, adversely affecting Nigeria’s macroeconomic stability in the short and medium run. In addition, the increased socioeconomic anxiety caused by the aggregate increase in the prices and goods across Nigeria primarily caused by the fuel subsidy removal might inadvertently lead to social unrest in the form of demonstrations and industrial action led by organized labor.
For medium to long-term implications, we expect the gloomy consequences to be at a manageable rate, or in a much appreciable situation. According to the NNPC in February 2023, before the removal of subsidy in May 2023, Nigeria’s fuel subsidy bill surged up to 400 billion naira ($867 million) monthly, hemorrhaging Nigeria’s dwindling treasury. In 2022 alone, Nigeria through the NNPC spent at least 4.3 trillion naira ($10 billion) on fuel subsidy, further putting a dent in Nigeria’s earnings from its oil exports at a precarious time where the dwindling oil revenues and burgeoning budget deficits were stagnating the economy. The subsidy removal will free up more monies from its oil exports-dominated revenue base to enable Nigeria to cover its surging debt servicing costs while increasing its funding for subsequent budgets outside of debt sources. This is expected to remediate Nigeria’s already frail fiscal health. More money freed up means more government spending on non-subsidy line items especially in critical sectors needing more financial investments like infrastructure, public healthcare, education, and transportation. This also means a positive aggregate effect on the Nigerian economy in terms of jobs, better work, and health outcomes, as with a fledging economy buoyed by new infrastructure and an influx of skilled Nigerian labor. However, all of this is meaningless if the government is not spending its money efficiently and if it is still plagued by the characteristic Nigerian government practice of patronage, and corruption.
Devaluation of the Naira
There are indications that the Central Bank of Nigeria (CBN) will devalue the naira. If such a policy is implemented, it would have a significant effect on the economy. A partial devaluation can significantly cut arbitrage deals, while a total devaluation will lead to convergence, unifying the official exchange rate and the parallel market exchange rate. The devaluation of the naira can help improve Nigeria’s export competitiveness in the global market. This is largely because Nigeria’s exports become cheaper for foreign buyers, potentially boosting export earnings. Devaluing the naira can also help attract foreign investment as it becomes relatively cheaper to invest in Nigeria. However, there are negative effects associated with the Nigerian economy when a devaluation policy is implemented. Nigeria has a large preference for foreign commodities and relies significantly on imports. Data from the National Bureau of Statistics (NBS) illustrates this stance, showing that import volume stood at ₦5.7 trillion in Q3, 2022. This means that devaluing the naira will make imports expensive and contribute to inflation, reducing the purchasing power of consumers and potentially eroding living standards, as well as negatively affecting business costs and profitability.
A Single FX Window
The current parallel market exchange rate hovers around ₦745 to the United States dollar. The official exchange rate, on the other hand, is about ₦461 to a dollar. This significant discrepancy between the official exchange rate and the parallel market exchange rate has resulted in arbitrage. Individuals who have access to official rates sell the dollar in the parallel market, making arbitrage profits. However, a single FX window can significantly mitigate these types of arbitrage opportunities by promoting transparency, efficiency, and regulatory control in foreign exchange transactions. It can also simplify the process of foreign exchange transactions by providing a centralized platform for buying and selling currencies, which enhances transparency and promotes efficiency in foreign exchange operations. It can also enable the CBN to have better oversight of foreign exchange transactions and facilitate better monitoring of money laundering and illicit capital inflows. Moreover, it could foster exchange rate stability by minimizing the influence of multiple exchange rates, thereby reducing uncertainty.
It is important to highlight that a peer African country of similar economic size and importance, Egypt, carried out a similar macroeconomic decision by unifying its foreign exchange market window in 2016. We earlier delineated the positive outcomes as a result of this move by Egypt in an article imploring Nigeria’s new president and the CBN to build consensus for the creation of a single FX window. We found that the Egyptian pound had appreciated by 20% in the last five years since they enabled a transition into a single FX window. Nonetheless, a single FX window can limit market flexibility and responsiveness to demand and supply dynamics. It can limit the ability of market participants to negotiate rates and may result in less competitive pricing, hindering the efficient allocation of foreign exchange resources.
Since 1999, economic policy experts, researchers, and development finance institutions (DFIs) have long advocated for the phasing out of energy subsidies and a single FX market window that reflects the most accurate market value of the Naira. These calls have predominantly been met with indecision on the part of the government, and derision on the part of a vast majority of Nigerians. On the part of the government, it is thought that removing the subsidy on PMS (fuel) has long been a politically inexpedient policy decision. While this is not the case for the single FX market window argument, it is widely noted in academia that there are powerful forces in the country’s political economy hindering a liberalization of the foreign exchange market. On the part of a vast majority of Nigerians, the removal of fuel subsidy in particular spells dire financial consequences for their respective purchasing power and dwindling earnings. However, with what has been noted in his campaign manifesto, his inauguration speech earlier this week, and the policy decisions already taken in the past 72 hours, it is likely that Tinubu is willing to brave all the odds and follow through with the removal of fuel subsidy as well as lobbying the CBN for a single FX market window that entails a devaluation of the Naira. As we have earlier noted, these policy decisions do not come without adverse implications for Nigerians and the aggregate Nigerian economy. To add, the implications can further worsen if the policy implementation process is flawed just as the policy communication and multi-stakeholder consensus-building efforts are not effective.
Ideally, it is thought that the removal of fuel subsidy is expected to free up more finances for the federal government to spend on capital projects. But this amounts to nothing if the characteristic corruption, misappropriation of government funds meant for the projects, and inefficiency in overseeing the capital projects in the Nigerian public governance space come to the fore.
While these are still early days, we also note considerable flaws on the part of the newly sworn-in Tinubu-led federal government concerning the subsidy removal process. While this wasn’t a decision of theirs—as budgetary spending for 2023 did not include a fuel subsidy bill for the months preceding June 2023, the policy communication and stakeholder engagement currently carried out by the incumbent has left a lot to be desired. We believe that this leaves room for disorienting organized labor activity that might derail the policy implementation, especially if consensus has not been cordially built. In the medium run, this might precipitate social unrest.
To conclude, we reiterate that these policy decisions are gravely important for Nigeria’s macroeconomic stability and fiscal health in the medium-term to long-term run. However, the devil is in the detail and in implementation. Earlier this year, prior to the 2023 general elections, we implored whoever was the eventual victor of the presidential election to remove fuel subsidy and work with the CBN to institute a single FX window in a way that reflected the true market value of the naira, thus, devaluing it. It is important that these steps are carried out in the most pragmatic way possible in a way that accounts for the peculiarities of the Nigerian economy as with the civic space. For instance, enabling the ease of market entry for refined petroleum products importation and domestic refining of petroleum can help make PMS (fuel) pricing competitive in Nigeria’s downstream sector—for further clarity, this can help ease the prices to more affordable rates in the medium-term. Furthermore, shrewdly engaging with organized labor to forestall a looming halt in economic activity due to mass industrial action, and winning the support of the general public by vastly cutting the cost of governance are other steps to take to douse the propensity for economic decline and social unrest and anxiety.
“The herd is not infallible. It makes mistakes. It overreacts & overshoots. But if your fundamentals are sound, the herd will eventually recognize this & come back. The herd is never stupid for too long. In the end, it always responds to good governance & good economic management.” - Thomas L. Friedmann, The Lexus, and the Olive Tree