The International Monetary Fund (IMF) has advised the Federal Government to remove subsidies in petrol and electricity to save the economy from significant risks.
The IMF disclosed this in its annual Article IV Consultations following its Executive Board’s concluding visit to Nigeria.
The Fund said the emergence of fuel subsidies and slow progress on revenue mobilization has put the fiscal outlook into significant risks.
The multilateral institution therefore called for major reforms in fiscal, exchange rate, trade and governance to alter the long-running lackluster growth path.
On the immediate front, it advised that fiscal and external imbalances require removal of regressive fuel and electricity subsidies, tax administration reforms and installing a fully unified market-clearing exchange rate.
It said continued reliance on administrative measures to address persistent foreign exchange shortages is negatively impacting confidence adding that without urgent fiscal and exchange rate reforms, the medium-term outlook faces sub-par growth.
The Fund said Nigeria’s economy is recovering from a historic downturn. “Helped by government policy support, rebounding oil prices and international financial aid, Nigeria exited the recession in 2020 fourth quarter, earlier than expected. Output rose by 5.4 per cent (y-o-y) in the second quarter, mainly reflecting base effects from transport and trade sectors and continued strong growth in the IT sector,” it said.
However, manufacturing and oil sectors remain weak, reflecting continued foreign exchange shortages, and security and technical challenges.
The report said headline inflation rose sharply during the pandemic reaching a peak of 18.2 percent y-o-y in March 2021 but has since declined helped by the new harvest season and opening of the land borders.
On the management of Civid-19, it said the authorities’ proactive actions, including a robust infection tracking system and a national strategy for vaccine procurement and rollout, have helped keep infection rates and fatalities lower than in many other countries.
However, the economic and social impacts of the pandemic have been more daunting with rising food insecurity and an increase in the already-high levels of poverty.
On economic recovery, the Fund said that while real Gross Domestic Product (GDP) is projected to grow by 2.6 per cent this year and continue in the range of 2.6-2.7 per cent per annum over the medium term, this is just above the population growth rate implying stagnant per capita income in the medium term.
“In the medium term, there are upside risks from faster-than-expected reaching of the Dangote refinery’s production capacity along with effective implementation of the 2021 Petroleum Industry Act in terms of higher manufacturing production and investment in the oil sector,” it said.
It added that over the medium term, moving away from inward-looking policies through trade, monetary and foreign exchange reforms, enhancing public trust through governance and fiscal transparency reforms, and improving welfare through job creation and agricultural reforms are priorities.
Despite much higher oil prices, the general government fiscal deficit is projected to widen in 2021 to 6.3 percent of GDP, reflecting implicit fuel subsidies and higher security spending, and remain at that level in 2022.
The Fund therefore recommended complete removal of regressive fuel and electricity subsidies a near-term, combined with adequate compensatory measures for the poor . The mission stressed the need to fully remove fuel subsidies and move to a market-based pricing mechanism in early 2022 as stipulated in the 2021 Petroleum Industry Act.
In addition, the implementation of cost-reflective electricity tariffs as of January 2022 should not be delayed. Well-targeted social assistance will be needed to cushion any negative impacts on the poor particularly in light of still elevated inflation. Nigeria’s past experiences with fuel subsidy removal, which have all been short-lived and reversed, underscore the importance of building a consensus and improving public trust regarding the protection of the poor and efficient and transparent use of the saved resources.
Significant additional domestic revenue mobilization is critical to put the public debt and debt-servicing capacity on a sustainable path . The near-term priorities are to implement e-customs reforms including efficient procedures and controls, developing a VAT Compliance Improvement Program, improving compliance across large, medium, and micro/small taxpayers and rationalizing tax incentives and customs duty waivers.
As the recovery gains strength and compliance improves, Nigeria will have to adopt tax rates comparable to its peers in the Economic Community of West African States (ECOWAS) to raise revenues to levels targeted in the 2021-25 National Development Plan. The cumulative net savings from the recommended measures, after making room for additional social assistance to cushion impacts of reforms, could amount to 5.1 percent of GDP over 2022-26. Such a consolidation would keep public debt below 40 percent of GDP and reduce dependence on central bank financing of the deficit.
The mission welcomed the recent passage of the Petroleum Industry Act (PIA) and stressed its timely implementation. The PIA aims to improve administration and governance in the petroleum sector, introduce market-based fuel pricing and attract higher investment. Preliminary assessments by the IMF and the World Bank suggest that the approved fiscal terms will provide greater incentives to invest in the oil and gas industry but will reduce the fiscal take from new and converted fields.
Exchange Rate policy: Reduce administrative measures and allow for a market-clearing unified exchange rate
The mission welcomed steps taken toward unification of the exchange rate and stressed the need for further actions. The discontinuation of the official exchange rate is a step in the right direction but continued dependence on administrative measures to address FX shortages sustains uncertainties and increases the risks of a sudden and large adjustment in the exchange rate. Taking advantage of the favorable global conditions, improving current account and robust oil prices, the mission advised a move to a unified and market-clearing exchange rate without further delays. To preserve competitiveness, any exchange rate adjustment should be accompanied by clear communications regarding exchange rate policy going forward, macroeconomic policies to contain inflation and structural policies to facilitate new investment.
A further move toward a market-clearing exchange rate will also help build foreign exchange buffers through higher capital inflows. Despite the recent SDR allocation and a successful Eurobond issuance, gross reserves remain significantly below the IMF’s recommended adequacy levels. Slow FX reforms and uncertainties regarding the ability to repatriate foreign funds have discouraged new capital inflows. With an external position that is assessed to be weaker than implied by Nigeria’s economic fundamentals and desired policies, a narrow export base, and limited capital inflows, the mission recommended preserving foreign exchange reserves through sustainable policies. The mission assessed Nigeria’s capacity to repay the outstanding credit from the 2020 Rapid Financing Instrument (RFI) to be adequate.
A more open trade regime is needed to unleash the growth potential brought by the African Continental Free Trade Agreement (AfCFTA). The authorities are committed to implementing the AfCFTA and are working to enhance trade facilitation through increased use of technology. However, overall trade regime continues to be protectionist and restrictive with numerous products prohibited from FX access for imports, including basic necessities and food items, high tariff and non-tariff barriers, and difficult trade logistics. Building on current efforts to improve port infrastructure and reduce the burden of customs administration, the mission recommended decisive actions to reduce barriers to trade and reliance on import substitution.
Monetary and Financial Sector Policies: Support the recovery but remain vigilant against inflationary and stability risks
12. Monetary policy should remain supportive of the nascent recovery but warrants close monitoring . With the recovery yet to be broad-based, inflation projected to decline, and limited fiscal policy space, monetary policy should remain supportive unless exchange rate pressures intensify, or inflationary pressures resurface. The mission advised vigilance to prevent possible adverse feedback loops between persistent high inflation and periodic exchange rate adjustments if monetary policy were to become excessively loose. The out-of-cycle and discretionary use of the cash reserve requirement (CRR) continues to pose regulatory and operational uncertainties for the banking system.
In the medium term, the monetary operational framework should be strengthened to establish the primacy of price stability. Long-term high inflation in Nigeria is associated with the lack of a well-functioning monetary policy operational framework along with the presence of multiple policy goals. The mission reiterated its previous advice to (i) modernize the 2007 CBN act to establish the primacy of price stability and (ii) strengthen the monetary transmission mechanism by integrating the interbank and debt markets and using central bank or government bills of short maturity as the main liquidity management tool. As the recovery firms up, the CBN also needs to scale back its credit intervention programs as part of a broader monetary structural reform.
The banking sector has been resilient thanks to ample pre-crisis buffers. The systemwide NPL ratio has improved, and profitability has been resilient, resulting in capital buffers above the regulatory minimum. However, stress tests conducted by the authorities show that a severe shock requiring loan reclassification could erode the system’s buffers and there are risks that a part of the restructured loans, which represent less than a quarter of the overall loan portfolio, may eventually become delinquent. Tighter market liquidity due to CRR debits and restricted access to the CBN discount window may raise bank funding costs going forward and possibly restrict credit growth at individual banks.
Financial inclusion continued to improve despite the pandemic but remains considerably below Nigeria’s ambitious inclusion targets. The share of the financially excluded population remains large overall, particularly in rural areas and among women and youth. The mission recommended prioritizing provision of financial access points in remote areas and leverage the new technologies to close the inclusion gap more quickly. The launching of eNaira bodes strong promises and, over time, could significantly increase financial inclusion and delivery of social assistance if coverage is extended to those with a mobile phone.
The mission supported the time-bound debt relief measures currently in place and recommended vigilance to guard against financial stability risks . The authorities are in the process of implementing a suite of Basel II/III instruments in addition to last year’s passage of the new banking law BOFIA.
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