Nigeria’s six to nine percent inflation target since 2013 has remained unattainable to date. It spiked to a new 28-year high in April, hitting 33.69 percent, year-on-year, and requiring new thinking and approach. CHIMA NWOKOJI, in this report, shares the optimism that suspending import duties and value-added tax on certain goods will be more effective than the interest rate approach.
IT is no longer in doubt that Nigeria has been at the crossroads of monetary policy drift and fiscal policy indecisiveness in the last nine years.
However, since June 2023, President Bola Tinubu seems to have decided that old things have passed and new dealings are on the horizon. The public policy rethinking was captured in an initial eight-point public policy initiative that took a fresh look at monetary and fiscal policy management.
Analysts and industry experts wanted a policy on transforming the manufacturing subsector, a key driver among the 46 sectors of the Gross Domestic Product (GDP), to realise the ambitious target.
While manufacturing has contributed around 10 percent to the country’s GDP over the last half a century, it is considered a growth driver whose share of output needs to be increased to at least 30 percent.
This shift requires a productive economic structure that facilitates sustained growth.
However, structural hurdles to a strong productive economy are present as they are in Nigeria today, the immediate and new approach proposed by the Presidential Tax and Fiscal Policy Reforms Committee (PTFPRC) promises to be the silver bullet. Nigeria imports nearly everything but exports almost nothing and with imports at a historical 16-year high, it is hard to imagine a strong Naira. What is however possible is a reduced cost of imported goods and services.
The Chairman of the Presidential Tax and Fiscal Policy Reforms Committee, Taiwo Oyedele, recently hit the nail on the head. Moving away from the current Central Bank of Nigeria’s (CBN) textbook economics, the committee recommended that food, education, medical services and accommodation should carry zero percent Value Added Tax (VAT) in order to reduce the cost of products affecting headline inflation.
Oyedele said, “Nigeria’s major contributors to inflation account for 82 percent of why there is inflation and why we think our recommendation will reduce inflation and not increase it. If we don’t allow this to work, we will lose out on the opportunity to make things better for ourselves.
“The solution to VAT is a political solution and not legal, so we have recommended that VAT collection should be in the constitution and we have recommended to the National Assembly to put VAT under the Exclusive Legislative List so that it can be collected centrally but 90 percent goes to the state and 10 to the central government, and we think that would resolve some of the problems, particularly the percentage of derivation that they would get.
“VAT is very sensitive because people immediately feel it when paying for goods and services. What we have today is the collection of VAT on so many things, including things that should not attract VAT like food, education and health and many of those things have what we call tax exemption.
“There is another regime called zero-rated VAT, which says that if you put VAT at zero percent, all the VAT incurred to produce the items will be paid back by the government. They have a choice between excise and zero-rated food items.”
According to the National Bureau of Statistics (NBS), Nigeria’s food inflation rate in April quickened to 40.53 percent on a year-on-year basis, which was 15.92 percent points higher compared to the rate recorded in April 2023 (24.61 percent).The impact of food inflation was even corroborated by the CBN governor, Olayemi Cardoso.
In his personal statement at the last Monetary Policy Committee (MPC) meeting, the CBN governor said, “Huge purchases by the government for distribution as palliatives to vulnerable citizenry are adding another dimension to the food price inflation, with seasonal factors of food price increases during religious fasting and festive periods, adding price cyclicality. Some of these new sources of inflation are better addressed by the fiscal authorities to complement the efforts of monetary policy in achieving all-round price stability.”
Oyedele said, “We are saying that we need to take a second look at our VAT rate and focus on the things our people spend the most money on: food, transport and accommodation. On those items, we want to remove the VAT as much as possible.
“That is where more than 90 percent of our population spends more than 80 percent of their income, but once we do that, government revenue will drop by at least 60 percent and we are very practical to know that nobody will approve that recommendation.
“So for them to approve, we would approve the VAT rate upward on anything other than rent, food, transport and essential items. Businesses can also claim input credit on services and assets and this will enhance their ability to start new businesses and grow existing ones. And this is why we recommended higher rates and shares for states.”
The committee wants some rich Nigerians to start paying taxes that they hitherto avoided by status symbol.
Oyedele continued: “Some rich Nigerians don’t pay tax and that is correct. We have the data to support that. If you look at the rich Nigerians who pay the right amount of tax, they are less than 10 percent and that is where the money is and not in the informal sector.”
According to him, steps have been identified to increase the compliance rate from 30 percent to more than 90 percent.
The truth and sanctity of this latest theory prompted the quick action being taken by the presidency on the “inflation reduction and price stability (fiscal policy measures, etc.) order, May 2024.
The order read in part: “In exercise of the powers conferred on me by section 5 of the Constitution of the Federal Republic of Nigeria (as amended), Section 38 of the Value Added Tax Act, Cap, V1, Laws of the Federation of Nigeria, 2004 (as amended) and all other powers enabling me in that behalf, I, Bola Ahmed Tinubu, President, Federal Republic of Nigeria, make the following Order:
“As from the commencement of this Order, the following measures and reliefs shall apply. The import duty and other tariffs on the following items are hereby suspended for a period of six months: staple food items, raw materials and other direct inputs used for manufacturing, inputs for agricultural production, including fertilisers, seedlings and chemicals, pharmaceutical products, poultry feeds, flour and grains.
“Authorised millers are to import paddy rice at zero import duty and Value Added Tax for a period of six months in the first instance in order to improve local supply and capacity utilisation of rice millers. Value Added Tax, where applicable, is hereby suspended on the following items for the rest of the year 2024: basic food items and semi-processed staple food items such as noodles and pasta, raw material inputs for the manufacturing of food items, electricity and public transportation.”
Again, Nigeria’s Cash Reserve Ratio (CRR) is one of the highest in the world. The CRR is money that banks are required to keep with their regulator and which is available for use in the event of a run on banks. It is one of the ways the CBN regulates the country’s money supply, inflation level and liquidity in the country. The higher the rate, the lower the liquidity with the banks.
The problem here is that with a hawkish Central Bank bent on containing inflation, a lower CRR may be difficult to stomach.
The tax and fiscal policy committee, therefore, among others, recommends the use of some portion of banks’ CRR to provide concessionary interest rates at single digit for manufacturers.
“We have created exemptions for manufacturers. So, if you are manufacturing anything, do not worry about withholding tax.
“We have put measures to curb evasion. These are part of the reforms that we have introduced in withholding tax regulation that has just been approved.”
This is different from the fixated monetarist’s approach of the CBN governor. Cardoso, in his speech at the 2023 end-of-the-year event of the Chartered Institute of Bankers (CIBN), made it clear that the CBN, under the new dispensation, would concentrate more on traditional monetary policy goals, such as inflation-targeting, rather than quasi-fiscal economic interventions.
It sounded promising, but just as every kid on the block loves lollipops, it comes with unhealthy teeth. The candy bag of policies Cardoso desires are nice but cannot be achieved immediately because of other countervailing forces.
Yes, the prescribed antidote to spiraling inflation by monetary economics is an increase in interest rates to rein in the money supply. This is exactly what Nigeria’s CBN governor, is doing and has vowed to continue to do. The MPC is already fixed on the monetarist ideology.
Economic policy trilemma suggests that reducing inflation and stabilising the exchange rate may conflict with lowering interest rates. As a prominent analyst puts it, “These aggressive tightening measures will end up turbo-charging interest rates, thereby shrinking credit to the real sectors of the economy and are therefore inconsistent with his expectation of an increase in the GDP growth rate.”
Faced with a sharp Naira slump since mid-April and 28-year high inflation of 33.69 percent, the MPC had little choice but to increase the Monetary Policy Rate (MPR) by 150 basis points, bringing it to 26.25 percent in a move to help restore price stability and positive real rates.
Analysts are worried that as the economy steps into the second half (H2) of the year, the end may not be in sight for the rising cost of goods and services as the authorities seem to have lost control of the bloating money supply.
Cardoso’s monetarist ideology is apparently not working in the Nigerian situation because the quantity of money released into the economy simply depicts the monetary and fiscal authorities as literally covering a running pipe with an open basket.
Despite the 750 basis points (bps) cumulative increase in interest rates by the CBN since the beginning of 2024, there is no evidence of respite in sight from inflation amidst continuing rise in money supply, already above N96.96 trillion in April 2024. In April 2024, money supply (M2), also known as the quantity of money, hit a record high of N96.96 trillion in one year and may have crossed the figure with further additions from the fiscal authorities despite monetary tightening by the CBN.
In describing the quantity theory of money, monetary economists explained that if the amount of money in an economy doubles, all else equal, price levels will also double. This means that the consumer will pay twice as much for the same amount of goods and services. This increase in price levels will eventually result in a rising inflation level, inflation being a measure of the rate of rising prices of goods and services in an economy. It is also important to agree that even if food is surplus, you can’t print N23 trillion without any productive venture and not see the currency inflated.
Groping in the dark with textbook monetary economics
All seem to forget that driving local productivity and promoting exports are keys to price stability. A major lesson learned over the last five quarters of rising inflation in 2023/2024 is that inflation is not “always and everywhere a monetary phenomenon,” as the economist, Milton Friedman, claimed, even though the famous economist later clarified that he was referring to its implications in the short run.
Inflation represents a structural failure and productivity challenge, or what economists call a supply-side problem. Analysts note that inflation in Nigeria is linked to policy ineffectiveness. Why does policy tend to stumble in the face of cold, hard statistics? The answer partly relates to the unique structure of the Nigerian economy and the weak impact of conventional policy prescriptions.
The peculiar Nigerian situation
In economic theory, higher interest rates typically lead to increased borrowing costs, which in turn reduces consumer spending and business investments, leading to lower inflation.
But the transmission mechanism of monetary policy in Nigeria may be impaired by structural issues within the financial sector, such as limited access to credit for small and medium enterprises (SMEs) and a significant informal economy.
By raising interest rates, Nigeria aims to attract foreign investment, which can increase the demand for the Naira, thereby strengthening the currency. A stronger Naira can make imports cheaper, potentially reducing imported inflation. Additionally, the recent interest rate hike is expected to stimulate activity in the fixed-income market by making new securities more attractive.
New bonds will be issued with higher yields to reflect the increased policy rate. Investors will demand higher returns to compensate for the elevated interest rate environment. As a result, long-duration bonds, which are more sensitive to interest rate changes, are likely to experience greater price declines compared to short-duration bonds as rates rise.
However, reducing imported inflation is contingent on stable global commodity prices and effective foreign exchange management. The authorities should not forget that Nigeria is susceptible to fluctuations in global food prices. Supply chain disruptions, whether due to geopolitical tensions or global economic shifts, can worsen inflation irrespective of domestic interest rate adjustments.
Enhancing local production and reducing dependency on imports could mitigate the impact of external price shocks, but this requires long-term investments in infrastructure and capacity building and a total overhaul of the country’s security architecture. The effects of interest rate changes on inflation are not immediate. It often takes several months for monetary policy adjustments to permeate through the economy.
As it stands, the results of Cardoso’s textbook economics are that businesses and individuals are struggling to service loans, potentially leading to an increase in non-performing loans for banks. The risk is that these rate hikes are slowing economic growth without effectively controlling inflation, leading to stagflation (stagnant growth with high inflation). The economy, already grappling with numerous social and economic challenges, may face further destabilisation.
The corporate sector is being slowed down, potentially leading to a decline in the stock market. During the week that ended on June 1, both volume and value of trades in the Nigerian Exchange witnessed a downturn, decreasing by 10.59 percent and 14.25 percent to 388.02 million units and N7.35 billion, respectively.
Furthermore, this policy could exacerbate the unemployment issue facing the Nigerian economy. The emphasis is on the general opinion that “inflation will continue to rise higher than expected until a new approach is applied to the Nigerian situation because high food prices are driven by low food productivity, energy costs and insecurity.”
Despite raising the policy rate several times, the CBN’s return to what is seen as monetary policy “orthodoxy” has been ineffective in curtailing inflation rate growth. Analysts at Proshare have called for a rethink of the rate-raising policy as it may not meaningfully reduce the inflation rate even if the policy rate increased to 50 percent.
“The critical challenge is Nigeria’s relatively low foreign reserve position. Nigeria must increase its foreign reserve size to sustainably bring down the inflation rate. The country needs to achieve a foreign reserve that covers at least two years of import to generate the confidence investors need to bring in foreign direct investment (FDI) rather than foreign portfolio investments (FPIs), which is typically concerned with short-term speculative capital flows,” Proshare stated in its analytical commentary.
Experts speak
The Chief Executive Officer of CFG Advisory, Tilewa Adebajo, said in a telephone chat with Nigerian Tribune, “We cannot continue to look at inflation in isolation. We have to take a look at the impact of inflation on interest rates and we have to take a look at the impact of inflation on GDP growth.”
According to him, as part of the reforms of the present administration, removing or reducing VAT on imported food items is a step in the right direction because it will bring the cost of goods down and complement the efforts of the monetary and fiscal authorities towards inflation gauging.
He added that for Nigeria to tackle its current inflation problem, the government must diversify its revenue base in order to bring in more funds for it to grow the economy.
A former Director of the Central Bank of Nigeria and the West African Institute for Financial and Economic Management, Professor Akpan Ekpo, argued that “An economy may have double-digit inflation, yet economic performance may be satisfactory. It depends on other economic fundamentals. Inflation targeting is not necessary. Ghana and South Africa have been on inflation targeting, yet there is no significant impact on their economies. This questions the universal applicability of the strategy.”
On his part, Dr Abiodun Adedipe, Chief Consultant, BAA Consult, noted that the key to dealing with the implied vulnerability is to strengthen and deepen manufacturing value-added, whereby the volume of imports (absolutely and relative to the GDP) will not matter as much as the volume that is value-converted to exports.
The crux of addressing the vulnerability induced by a strong US dollar is strengthening and expanding manufacturing value-added capabilities for trade. This shifts the emphasis from mere trade balances to creating value within the country’s borders and insulates the economy from the fluctuations of global currencies.
China’s dominance in basic manufacturing provides it with a certain level of insulation from the volatility of the US dollar. Similarly, countries like Ukraine, Indonesia, India and the UAE have identified and anchored their economies to specific sectors – wheat, palm oil, non-basmati rice, and tourism, respectively.
These “anchors” act as buffers that ensure a more stable external sector driving valuable exports. Countries lacking systemic anchors grapple with the repercussions of a strong US dollar and supply chain disruptions.
and then