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Deconstructing Nigeria development update

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2 years ago

The World Bank recently unveiled the Nigeria Development Update (NDU), a document, which presents the country with policy options to choose from in its quest to address the long-standing macro-economic imbalances. If judiciously handled, it has the potential to establish a solid foundation for sustainable and inclusive growth, writes JOSEPH INOKOTONG.

The prevailing economic situation in Nigeria has thrown up many issues in the management of the economy by present and past leaders. Although some gains appear to have been made recently in strengthening the macroeconomic fundamentals, much still remains undone.

Consequently, an appropriate safety net to protect the most vulnerable in the society seems to emerge as the missing link amidst a number of economic reforms that have been carried out by President Bola Tinubu’s administration. The government keeps calling on the masses to sacrifice for a better tomorrow without putting in place adequate palliatives to cushion the effects of the reforms, albeit temporarily.

It is on this premise that an attempt is being made to deconstruct last week’s release of the Nigeria Development Update (NDU) by the World Bank.

The NDU, a biannual World Bank report series assesses recent economic and social developments and prospects in Nigeria and places these in a longer-term and global context. It also provides an in-depth examination of selected economic and policy issues and an analysis of Nigeria’s medium-term development challenges. The Bank said the report is intended for a wide audience, including policymakers, business leaders, financial market participants, and the community of analysts and professionals engaged in Nigeria’s evolving economy. A cursory look at happenings in the country so far does not depict a firm grasp of the import of the NDU, especially by the policymakers. However, it may not be too late if a new leaf can be turned tomorrow.

The World Bank’s NDU periscopes Nigeria’s economic performance, which it aptly stated was weakened in the first part of 2023 amid a challenging global context and domestic economic distortions. Starting from the prevailing global economic conditions, which continue to pose challenges for Nigeria’s economy, the Bank said the global economy, still grappling with the compounded effects of the COVID-19 pandemic, Russia’s invasion of Ukraine, and the sharp tightening of monetary policy to curb high inflation, remains in a precarious position while external financing conditions have broadly stabilised over the past six months, and remain challenging, especially for “frontier markets” like Nigeria.

Emerging and developing economies, according to the World Bank, face deteriorating growth prospects due to the higher cost of borrowing, limited access to international capital markets, high inflation, and record debt levels. Despite the steepest global interest-rate hiking cycle in four decades, inflation remains high; even by the end of 2024, and it is projected to remain above most central banks’ target ranges.

According to the NDU, “Nigeria’s chronically high inflation has worsened”, as inflation in the country has been high on a structural basis, but has escalated in recent years, to the point where consumer prices are now increasing at their fastest pace in 17 years. The most recent pattern of chronically high and increasing inflation, it observed has been in place since October 2019, when Nigeria’s land borders were closed. Headline inflation rose sharply from 15.6 percent in January 2022 to 21.8 percent in January 2023 and further to 22.41 percent in May 2023.

The Bank rightly pointed out that the recent spike in inflation was primarily driven by surging food and energy prices caused by Russia’s invasion of Ukraine. Food prices rose by 24.6 percent (y-o-y) in April, resulting from higher prices of major staples such as bread, cereals, rice, yam, and other tubers. Energy prices remained elevated at 20.8 percent (y-o-y) in May, as kerosene and diesel prices hit new record highs. Core inflation, which excludes volatile energy and food prices to provide an indication of underlying inflation pressures, increased to 20.0 percent in April, led by rising prices for medical services, transportation, clothing, footwear, housing, and education services.

The NDU reports that in the midst of rising inflation, the effectiveness of monetary policy to reduce it was undermined by monetisation of the budget deficit and other inconsistent policies, contributing to inflation. The CBN, it noted implemented measures to control rising inflation, including raising the monetary policy rate by 700 basis points (bps) and the cash reserve ratio by 500 bps since May 2022.

However, the monetisation of the fiscal deficit through expensive Ways and Means advances, and the CBN’s provision of development finance at subsidised rates, weakened the effectiveness of the monetary policy, increased the money supply, and contributed to high inflation. Exchange rate distortions resulting from the high premium between the official and parallel rates and multiple exchange rates have also contributed to high inflation. The limited effectiveness of monetary policy translated into unanchored inflation expectations. Economic agents believed that despite the CBN policy actions inflation increased.

Indeed, consumer price inflation surged and is currently one of the highest globally, which the NDU said is related to Nigeria’s fiscal imbalance and points to the urgency of reform efforts. Inflation in Nigeria has been high for many years due to structural factors, but it escalated in 2022, to the point where consumer prices increased at their fastest pace for 17 years. “The CBN implemented measures to control rising inflation proved ineffective and monetary policy remained loose overall in the first half of the year. The loss of purchasing power from high inflation has increased poverty in the short-term, pushing an estimated 4 million Nigerians into poverty between January and May 2023.”

Still laying the foundation for its report, the Bank noted that in the months following the previous Nigeria Development Update (NDU), published in December 2022 under the title: Nigeria’s Choice, economic growth weakened further. Real gross domestic product (GDP) growth fell from 3.3 percent in 2022 to 2.4 percent year-on-year (y-o-y) in Q1 2023. This slowdown was largely due to the sustained contraction in oil production, as well as the demonetization of the Naira, causing a scarcity of cash that severely disrupted the economy in February and March. The World Bank projects real GDP to grow by 3.3 percent in 2023, although the outcome could vary significantly from this base case depending on the policy choices and their implementation by the new administration.

Delving deeper into the Naira redesign policy and its impact on growth, the NDU says, “The CBN policy to redesign the Nigerian naira led to a scarcity of cash due to its timing and short transition period. The CBN announced on October 26, 2022, that it planned to redesign, produce, and circulate new series of Nigeria Naira banknotes in the denominations of N200, N500, and N1,000 (equivalent to roughly US$0.5, US$1, and US$2 at the official rate)”. Stated goals for the policy included reducing the amount of currency in circulation outside of banks, reducing inflation and demand for foreign currency, addressing shortages of clean notes, reducing counterfeiting, and accelerating the transition to a cashless economy.

According to the CBN’s original timeline, the new currency notes were to be circulated from December 15, 2022, with both the new and existing notes considered legal tender until January 31, 2023. “The short transition period was not enough for the CBN to replace the demonetized old notes with new notes and this resulted in cash scarcity. Moreover, digital and financial infrastructure and processes were not in place to support the rapid transition to a cashless economy, with only 40 percent of adults having a bank account. The shortage of cash led to the creation of a black market for new notes, increasing overall transaction costs. The adverse shock to economic activity was further exacerbated by reversals in policy decisions and conflicting positions between state and federal governments, the CBN, and the Supreme Court. Although the Supreme Court extended the deadline to accept old notes until the end of 2023 on March 2, it was only a month later that the old notes were effectively back in circulation. Disruptive cash shortages and uncertainty negatively impacted consumer and business sentiment”, the Bank explained.

According to the report, international experience suggests that rapid demonetisations can generate significant short-term costs, with small-scale businesses, and poor and vulnerable households, potentially being particularly affected due to being liquidity-constrained and heavily reliant on day-to-day cash transactions. Nigeria was not an exception. In February 2023, Nigeria’s Purchasing Managers’ Index (PMI) fell sharply to 44.7 index points, a decline from 53.5 index points in January, and entered negative territory (below 50 index points) for the first time since the COVID-19 pandemic began. This trend continued in March 2023. As industrial and services activities were affected, non-oil-non-agriculture GDP weakened sharply from an average quarterly growth rate of 6.0 percent in 2022 to 3.9 percent y-o-y in Q1 2023. According to firms, the inability to secure regular funding and operating cash to commit to spending, combined with increasing prices and fuel shortages, led to a decline in demand.

The Bank commended the new administration of President Tinubu, which took office at the end of May for initiating critical reforms to address macroeconomic imbalances. The challenging global context, it noted has been a headwind for the economy through imported inflation and increased external borrowing costs. However, domestic policies have played a more significant role in impeding Nigeria’s recent economic performance and have increased vulnerabilities to further shocks, the report further noted, stressing that the previous mix of fiscal, monetary, and exchange rates, as well as structural (e.g., trade), policy settings failed to deliver. The new government, it added, “has recognised the need to chart a new course and has already made a start on critical reforms, such as the elimination of the petrol subsidy and reforms in the foreign exchange (FX) market. There is now scope for Nigeria to seize the opportunity of having a new government to lift its economic trajectory and achieve inclusive, sustainable growth if it chooses to sustain these reforms while protecting the poor and vulnerable.”

The NDU amplified the need for comprehensive, ongoing reform as urgent, as fiscal pressures remain intense despite elevated global oil prices. Global oil price booms have historically supported the Nigerian economy, but this has not been the case since 2021. The average price of crude oil increased by over 150 percent from 2020 to 2022, and yet Nigeria’s fiscal space shrunk, with the general government fiscal deficit at or above 5.0 percent of GDP since 2021. The major cause of higher global energy prices causing Nigeria’s fiscal situation to weaken was the Premium Motor Spirit (PMS) (also known as petrol) subsidy, deducted directly from oil revenues. “This implied forgone fiscal revenues of N4.5 trillion or 2.2 percent of GDP in 2022 – almost half the fiscal deficit. The subsidy deductions, combined with the protracted decline in oil production, resulted in the lowest levels of net oil revenues (as a share of GDP) being transferred to the government in over a decade. Large primary deficits, rising global and domestic interest rates, and the continuous reliance on expensive, inflationary financing from the CBN to meet in-year cash shortfalls, increased debt-servicing costs. Interest payments on the public debt increased from 2.6 percent of GDP in 2021 to about 3.4 percent of GDP in 2022, or over one-quarter of total general government expenditure”, the Bank stated.

The NDU highlighted that currency market distortions contributed to weak growth, fragile fiscal position, and high inflation, noting that before the major FX reforms implemented on June 14, the CBN only allowed a slow depreciation of the official exchange rate, which was insufficient to bring the supply and demand of foreign currency into balance, placing increasing pressure on the exchange rate in the parallel market. The official rate, it pointed out, depreciated by 11 percent from January 2022 through May 2023, while the parallel market rate depreciated by 30 percent, with the parallel market rate premium widening from 37 percent in January 2022 to 63 percent in May 2023. “During this period, the CBN, the largest single supplier of FX to the Nigerian economy, continued to suppress FX demand. The use of FX remained banned for the importation of 43 product categories, and the CBN also limited the size of its interventions in the FX market, and thus, the FX supply for imports of those goods and services that are not banned. Nigeria’s previous exchange rate management stifled business activity, investment, and growth weakening the fiscal position, and boosting inflationary pressures. Despite higher oil exports and reduced CBN interventions, external reserves fell from their recent high of US$41.8 billion in October 2021 (helped by official sector inflows) to US$34.9 billion in June 2023”, NDU further stated.

The report urges Nigeria to seize the opportunity for more growth through increased and more diversified trade because oil has represented the majority of Nigeria’s exports since the 1970s, indicating that the country’s efforts to achieve diversification have not yielded substantial results thus far.

Over the past five decades, hydrocarbon products have made up approximately 90 percent of Nigeria’s total exports. Successive economic strategies such as the 2004–07 National Economic Empowerment and Development Strategy (NEEDS), the 2017–20 Economic Recovery and Growth Plan (EGRP) as well as the current 2021–25 Medium Term National Development Plan (NDP), stressed the need for export diversification, but have been met with limited success while the post-2021 increase in oil prices strengthened the country’s current account balance, an oil windfall did not materialise.

The NDU stressed that diversifying away from extractive industries such as oil, and supporting the development of other sectors with greater scope for productivity gains, can accelerate employment creation and income growth, pointing out that the African Continental Free Trade Area (AfCFTA) is a significant avenue for promoting non-oil exports.

The report reckons with the decision to remove the petrol subsidy as the first step towards restoring macroeconomic stability and creating more fiscal space, stressing that for years, Nigeria had maintained an opaque, fiscally unsustainable, and socially unfair petrol subsidy. It noted that with the “removal of the subsidy and the implementation of FX reforms, the Government is projected to achieve estimated fiscal gains of about N3.9 trillion in 2023, equivalent to 1.6 percent of GDP. These gains are expected to reach over N21 trillion between 2023 and 2025, compared with a scenario in which the fuel subsidy had persisted.”

The report states that the removal of the petrol subsidy is anticipated to cause a temporary increase in inflation in the upcoming months before contributing to disinflation in the medium term, and that the price increases resulting from the subsidy removal will have a one-time impact on prices, primarily affecting petrol purchases for transportation, power generation, and other services.

To limit the risk of so-called second-round effects, where one-off price increases trigger more generalized inflation including through wage-price spirals, the NDU suggests that it will be important to adopt macro-fiscal policy settings that are conducive to price stability. “Compensating transfers will be essential in helping to shield Nigerian households from the initial price impacts of the subsidy reform. Without compensation, many households could be pushed into poverty by higher petrol prices and forced to resort to coping mechanisms with long-term adverse consequences, such as not sending children to school, or not going to health facilities to seek preventative healthcare”, the NDU said.

In addition to providing immediate cash compensation, the report stated that the “Government could also elaborate on the use of the freed-up resources in a new compact with the Nigerian people, outlining support in the immediate as well as medium and long term, at the federal, state, and local government levels. The recent proposal to implement a set of measures to alleviate the impact of the subsidy removal, led by the National Economic Council, should clearly identify priority areas for government investment and effectively communicate these to the public to garner support. A public commitment to identifying development (including infrastructure) spending priorities, pro-poor service delivery, and a role for social protection programmes to help households cope with shocks could guide such a compact. The compact should also be anchored in a clear commitment to fiscal realism, as a large expansion in spending could have fiscal implications, potentially leading to increased fiscal deficits over the medium-term”.

The Government, to a large extent, has not articulated clear palliative measures to cushion the unintended consequences of the reforms it has thus far implemented, apart from incessant appeals for endless sacrifices by the masses. To shield the poor and most vulnerable from increases in living costs, temporary and targeted cash transfers should be considered, as part of a new social compact to sustainably redirect resources towards addressing Nigeria’s most urgent development priorities.

The recent removal of the petrol subsidy and the foreign exchange (FX) management reforms are critical steps to address long-standing macroeconomic imbalances and have the potential to establish a solid foundation for sustainable and inclusive growth. Nigeria can seize this window of opportunity to further implement a comprehensive reform package that encompasses a range of complementary fiscal, monetary, trade, and structural policy measures to maximize the collective impact on growth, job creation, and poverty reduction.

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