Russian, Ukraine war is triggering cost of kerosene, natural gas, aviation fuel- CPPE

The full text of year 2022 first quarter economic review by the Chief Executive Officer (CEO) of a private sector advocacy and economic think tank, Centre for the Promotion of Private Enterprise (CPPE), Dr Muda Yusuf.

The review focusses on key developments in the Nigerian economy in the last quarter and highlight the implications of these developments for investments and the economy. The review covers the major macroeconomic variables such as the Gross Domestic Products (GDP), the Naira exchange rate, the inflation rate, the debt sustainability and the fiscal viability of government, among others
CPPE identifies and reviews the major headwinds to economic growth and business performance in recent months. Some of these headwinds include the worsening security situation in the country, the escalating energy cost, exchange rate depreciation, liquidity crisis in the foreign exchange market and the spiking inflationary pressures.

THE HEADWINDS TO ECONOMIC GROWTH
The major headwinds to investment performance and economic growth in the last couple of months include the following:

The worsening foreign exchange crisis reflecting in the sharp and continuous depreciation of the Naira exchange rate. The parallel market rate had depreciated by over 15% in the past three months reaching a low of N590/dollar currently. Meanwhile, the official exchange rate remains fixed at N416/dollar. This also signposts the widening gap between the parallel and the official market rate with its attendant distortions in the economy. The operating exchange rate for economic players remains the parallel market rate because the investor and exporters [I & E] window is not liquid.
The second dimension of the foreign exchange problem is the liquidity challenge in the Investors and Exporters window. The twin problem of the precipitous currency depreciation and the worsening liquidity crisis in the foreign exchange market constitute major headwinds to economic performance and investment growth. These forex challenges are fueling inflation, aggravating the cost of operations & costs of production, accelerating business mortality and eroding the confidence of investors.

Escalating Energy Cost. This has both global and a domestic dimension. Diesel cost has spiked by about 200% in the last six months. The prices of aviation fuel [Jet A1] and natural gas have similarly skyrocketed. The crisis became exacerbated by the collapse of the national grid leading to a sharp drop in electricity supply from the grid and consequent load shedding. The situation became unbearable for both households and investors. There were series of blame games among players in the electricity supply chain – the DISCOs, the GENCOs, Transmission Company, the Gas suppliers and power ministry.
The consequences of these were the escalation of production and operating cost across all sectors. Cost of transportation, especially haulage cost similarly spiked because most haulage trucks are powered by diesel.
Many businesses were not able to pass on the increase in energy cost to their consumers. Many investors have scaled down their operations, while several others have suspended operations.

The third major headwind is the worsening insecurity in the country. The state of insecurity has reached a frightening level deserving of a state of emergency declaration. The omens are very bad. The bandits and terrorists are becoming more daring, bolder and audacious. They operate with a baffling impunity. This trajectory portends serious adverse implications for economic growth prospects and investment outcomes. We cannot retain, scale or attract investment in an environment that is not secure. This is true of domestic and foreign investments.
The situation continues to pose very serious challenge to lives and livelihoods. Investors’ confidence has been greatly undermined with investments across all sectors being adversely affected. When investment is in jeopardy, livelihoods are negatively impacted. Worsening insecurity is adversely impacting lives and undermining livelihoods. This is taking a huge toll on both the social and economic life of the nation.
Major macroeconomic indicators suggest that the Nigerian economy is floundering and is being further weakened by these headwinds. A stumbling economy cannot afford these multiple shocks. The government therefore needs to take urgent steps to pull the economy from the brink.

REVIEW OF GDP GROWTH PERFORMANCE
According to the National Bureau of Statistics [NBS], Nigeria’s GDP grew by 3.40% in 2021, year on year. This marked the highest GDP growth rate since 2015. The quarterly GDP figures indicates that the economy grew by 3.98% in the fourth quarter of 2021. This was also the fifth consecutive quarterly GDP growth recorded in the economy.
The sectoral disaggregation of the annual GDP data shows that while some sectors grew, others contracted. Sectors that contracted include oil refining which contracted by (47.94%), crude oil production (8.3%), textiles and apparels (1.27%), wood and wood products (1.54%), pulp and paper industry (0.32%), accommodation and food services (0.45%). It is instructive that the biggest contraction was in the oil and gas sector, reflecting the collapse of domestic petroleum refineries, increasing crude oil theft, inappropriate policy environment, stifling regulatory setting and dwindling investors’ confidence.

GDP GROWTH, POVERTY REDUCTION, ECONOMIC INCLUSION AND JOB CREATION NEXUS
Laudable growth performance is one thing, translating the growth to improved welfare, job creation, poverty reduction and economic inclusion is a completely different matter.

The last few years was characterized by worsening poverty situation, high inflationary pressures, massive erosion of purchasing power, high energy prices, escalating production cost, sharp currency depreciation and many more.

These are critical developmental metrics on the basis of which the performance of the economy should also be measured. Therefore, going forward, policy makers should prioritize these key development indicators. Citizens welfare and investment productivity in the economy matter even more than the GDP numbers.

CBN E INVOICING AND E EVALUATOR POLICY

The CPPE notes the desire of the Central Bank of Nigeria to digitalize the international trade processes. Leveraging technology normally boosts efficiency and enhances productivity. However, this initiative has generated concerns among stakeholders in the international trade process.

The view of the CPPE is that the E invoice and E evaluator policy will only worsen an already bad international trade transactions process. The policy will increase transaction cost, entrench red tape, increase uncertainty, escalate business disruption, weaken investors’ confidence and heighten corruption risk. There is a strong correlation between red tape and corruption.

The increasing incursion of the CBN into the trade policy space is an aberration in our economic management system and a serious cause for concern to the business community. Issues of import valuation and classification are statutory functions of the Nigeria Customs Service, with the Finance Ministry as the supervising organ.

The decision of the CBN to now undertake valuation and product price benchmarking of imports and exports is a duplication of the statutory responsibility of the Nigeria Customs Service. It will create an additional regulatory compliance burden, bureaucracy and costs for the business community.

The international trade process is already characterized by enough challenges already. Investors are contending with overlapping regulation, excessive documentation, weak application of Technology, physical examination of cargo, extortion, inadequate cargo handling equipment, stifling bureaucracy, difficult transportation logistics, challenges of access to the ports and weak dispute resolution system. We should therefore be seeking to alleviate these pains, not add to it.

FOREIEGN EXCHANGE POLICY
The sharp and increasing currency depreciation in the parallel market remains a cause for concern. It is a trend that should not be allowed to continue and all necessary steps need to be taken [and urgently too] to stem the slide and volatility. These developments should not be ignored. It is as much of a concern to investors consumers as it is to producers and other stakeholders that create value in the economy. It calls for an urgent review of the current foreign exchange policy. The current rigid stance of the CBN on the foreign exchange policy is hurting investors, creating distortions and retarding the recovery prospects of the Nigerian economy. For most businesses, the parallel market is now the default foreign exchange market.

We reiterate our proposition that we should adopt a flexible exchange rate policy regime. Let me clarify that this is not a call for currency devaluation. Rather, it is a pricing framework that reflects the demand and supply fundamentals. It is a model that is sustainable, predictable and transparent. It would reduce uncertainty and inspire the confidence of investors. It would minimize discretion and arbitrage in the foreign exchange allocation mechanism.

Devaluation on the other hand, is a policy choice often adopted to boost export and discourage imports. Countries adopt this measure, not necessarily because they have a foreign exchange or balance of payment crisis; but as deliberate trade policy strategy to make their exports cheaper.

The benefits of a flexible exchange rate model are as follows:
i. It enhances liquidity in the foreign exchange market.
ii. It reduces uncertainty in the foreign exchange market and therefore enhances the confidence of investors.
iii. It is more transparent as mechanism for forex allocation.
iv. It eliminates discretion in the allocation of forex.
v. It reduces opportunities for round tripping and other sharp practices.
vi. It enhances the credibility of the foreign exchange market.
vii. Reduction in the multiplicity of exchange rates.
A fixed exchange rate regime on the other hand creates the following outcomes:
i. Widening gap between the official and parallel market exchange rates creating room for roundtripping and associated malpractices.
ii. Collapse of liquidity in the foreign exchange market resulting in acute scarcity.
iii. Mounting trade debts.
iv. Increasing factory closure as many manufacturers are not able to access foreign exchange for raw materials and other inputs.
v. Many investors are not able to meet offshore obligations.
vi. Mounting inflationary pressures
vii. Sharp drop in capital inflows
In the light of the foregoing, the following policy options should be adopted to fix the current forex crisis in the short to medium term.
i. Adoption of a flexible exchange rate regime. This would improve liquidity in the forex market, reduce uncertainty and enhance investors’ confidence.
ii. Deepening the autonomous foreign exchange market through the liberalization of inflows from Export Proceeds, Diaspora Remittances, Multinational Companies, Donor Agencies, Diplomatic missions etc. Market rates should be allowed to prevail in the autonomous window.
iii. Accelerate reforms to boost private investment in domestic petroleum refineries to stop the current massive forex outflows for the importation of refined petroleum products.
iv. Fix the structural problem in the economy to enhance regional and global competitiveness of Nigeria products in order to boost exports and strenghten import substitution.
v. Incentivise investment in the gas sector to take advantage of the current crisis in the global energy market. We have one of the largest gas reserves in the world.

IMPACT OF INFLATIONARY PRESSURES ON THE ECONOMY
The Centre for the Promotion of Private Enterprise [CPPE] notes the marginal acceleration of headline inflation from 15.60% in January to 15.70% in February 2022, according to the inflation report released by the National Bureau of Statistics [NBS]. This was a mere 0.1% increase. Food inflation, rather curiously, decelerated marginally from 17.13% in January to 17.11% February 2022. Core inflation sub index accelerated from 13.87% in January to 14.01% in February 2022.

The technical computation of the inflation figures the NBS is not in dispute. However, the reality of the impact of the intense inflationary pressures over the past one year is at variance with the official inflation data.

For the basket of goods consumed by most households, prices have jumped by between 30-100% over the past one year. The same is true of businesses. The pressure of spiking inflation on household budgets has been intense and distressing. Purchasing power has been massively eroded, real incomes have collapsed, and the poverty situation has consequently worsened.

Businesses have been similarly impacted as they have been experiencing a slump in sales, turnover and profits margins. The impact on small businesses is even more severe because of their limited capacity to absorb economic shocks.

The spiraling inflation dynamics deserves an urgent policy response at the highest level of government. The impact on citizens welfare is severe. The effect on SMEs is troubling. There is worsening social discontent, driven by poverty inflicted by inflation.

Meanwhile, the key drivers of inflation include high and increasing energy cost; worsening currency depreciation, escalating transportation cost, high import duty on manufacturing inputs, illiquidity in the forex market, bottlenecks in the logistics chain, security concerns and low productivity resulting from structural challenges and weak application of technology. Central bank financing of fiscal deficit is also a major driver of inflation.

To tackle inflation, these key drivers would have to be addressed. All forms of taxes and levies on the importation of petroleum products should be suspended to give a respite on the spiking energy cost. There should also be deeper stakeholder engagements across sectors to develop an enduring strategy on the way forward.

THE ECONOMIC IMPLICATIONS OF THE RUSSIAN INVASION OF UKRAINE.
The Russia Ukraine war has disrupted global oil and gas supplies which resulted in sharp increases in energy prices globally.

The cost of the major energy products had increased significantly – diesel, aviation fuel, natural gas and kerosene.

This is taking a toll on cost of production, cost of business operations, haulage costs and consequently on profit margins. The inflationary outcomes will affect affordability of some of many products, leading to further worsening of poverty.
We will see an increase in subsidy payment as the landing cost of petrol increases.

Regrettably, we remain a major importer of petroleum products. Therefore, when oil prices increase, subsidy payment also surges. Only recently the estimate of subsidy was put at N3 trillion by the NNPC.

That was before the Russian invasion of Ukraine. The story would have changed now. We should expect subsidy payment exceed the N3 trillion by the end of the year, depending on how long the sanctions and invasion lasts. This of course has very serious implications for our budget and government finances.

If crude oil price remains at current levels, and the PMS price remains fixed, the country may be teetering on the brink of bankruptcy. Current subsidy payment regime is simply not sustainable. The deregulation dialogue needs to urgently resume to save the economy from further deterioration.

The outlook is that the scale of petroleum products smuggling will increase because of the impact on relative prices of the hike in crude oil price. The price differential between the cost of petroleum in Nigeria [which is heavily subsidized] and the cost of petroleum in other countries is widening by the day.

Thus, the incentive for smuggling has increased. Therefore, the amount of domestic petrol consumption which is currently above 60 million litres per day is likely to further increase.

That will put further pressure on the NNPC to be able to supply petroleum product for domestic consumption and this may lead to a return of fuel queues and the proliferation of black markets for fuel.

There are also profound implications for the fiscal operations of government. Ideally as oil price increase, oil producing countries should be taking advantage of it because that will normally mean an increase in foreign exchange earnings and an increase in revenue.

But regrettably, Nigeria is a peculiar case. We have dysfunctional policy and regulatory environment in the oil and gas sector. Which is why the surge in crude oil price, rather than be a blessing, penalises the Nigeria economy. This is the paradox we are confronted with. This is because of the inherent higher subsidy cost. This would escalate the fiscal deficit and increase public debt, which will translate to increased borrowing.

The Debt service component of finances of government will increase as the government struggles to finance the deficit. We are likely to see increased credit to government by the Central Bank of Nigeria which will further increase money supply leading to higher inflation and further depreciation in the exchange rate. These are the unfortunate fiscal outcomes of the current developments. We are likely to see a much more fiscal pressure on all levels of government.

The FAAC allocation is already considerably depleted as a substantial amount of NNPC’s resources is being committed to subsidy payment. Already there were reports that NNPC was not able to make any remittance to FAAC in February on account of the burden of subsidy costs. There are also reports of agitations by the governors. The situation may remain so for some time if crude oil price remains at current levels.

This of course has implications for the fiscal sustainability of states, especially the states that are heavily dependent on FAAC allocations. Their capacity to meet their obligations is already being impaired – capacity to pay salaries, capacity to pay the pensioners, capacity to fund infrastructure, capacity to pay contractors.

DEBT SUSTAINABILITY
The rising debt profile of government raises serious sustainability concerns. The Debt Management Office had reported that total public debt was N39.56 trillion as at December 2021. 11.3% of this debt is owed by the states and FCT.

However, when we take account of borrowings from the CBN and the stock of AMCON debt, the debt profile would be in excess of N50 trillion.
Although government tends to argue that the conditions was not a debt problem, but a revenue challenge.  But debt typically becomes a problem if the revenue base is not strong enough to service the debt sustainably.  It thus becomes a debt problem.

Government actual revenue can hardly cover recurrent budget.  Which implies that the entire capital budget and part of recurrent budget would are being funded from borrowing. This is surely not sustainable.

We cannot continue to increase borrowing on account of the relatively low Debt/GDP ratio. We do not service debt with GDP, but with revenue. Close to 40% of our GDP do not contribute appreciably to revenue.

We need the political will to cut expenditure and undertake reforms that could scale down the size of government, reduce governance cost, ease the fiscal burden on government and boost revenue. It is important to ensure that the debt is used strictly to fund capital projects, especially infrastructure projects, that would strengthen the productive capacity of the economy. Additionally, emphasis should be on concessionary financing, as opposed to commercial debts which are typically very costly.

It is imperative for the country to operate as a true federation which it claims to be.  The unitary character of the country is making it difficult to unlock the economic potentials of the subnational.

It is perpetuating the culture of dependence on the federal government. It is necessary to scale down the size of government and cost of governance.

We should note that fiscal sustainability is driven by both cost and revenue. Therefore, managing the major drivers of cost and revenue is imperative. As far as possible, the government should pushback in sectors or activity areas where the private sector has capacity to deliver desired outcomes.

We should see more concessioning and privatisation at all levels of government. This would allow for the infusion of more private capital into the infrastructure space.

REFORMING THE PETROLEUM SECTOR
Urgent steps need to be taken to consummate the reform process with the full activation of the Petroleum Industry Act.

We acknowledge and commend the renewed efforts by government to tackle the problem of insecurity in the oil producing areas. The area has witnessed unbridled pipeline vandalization, illegal refineries, oil theft, attacks on oil installations among others.

In the meantime, all charges, import duty, levies and taxes on importation should be suspended to moderate the cost of fuel as an interim measure. The ultimate solution is to revisit the deregulation engagement with stakeholders to pave way for a market driven, private sector led investment framework, with the government playing a regulatory role.

This is the option we have as country to stop the bleeding, the distortions, the smuggling and loss of investment that our petroleum downstream sector had suffered over the years.

With current subsidy trajectory, subsidy cost would not be less than N4 trillion by the end of this year. This is clearly a major source of disruption and dislocation for the finances of government at all levels.
A private sector led oil and gas sector will bring the following benefits to the economy:
1. It will free resources for investment in critical infrastructures such as power, roads, the rail systems, health sector, education sector etc. The deficit in all of these infrastructure areas are phenomenal. Fixing infrastructure will greatly improve productivity and efficiency in the economy and impact positively on the welfare of the people.
2. It will unlock the huge private investment potentials in the downstream oil sector especially in petroleum product refining. This will ultimately reduce importation of petroleum products and ease the pressure on the foreign exchange market as well as the burden on our foreign reserves.
3. It will eliminate the patronage mentality, rent seeking activities and corruption that currently characterise the downstream oil sector.
4. It will create more jobs for the teeming youths of the country in the downstream oil sector as investment in the sector improves.
5. It would reduce smuggling of petroleum products outside the country. Instead we would see legitimate export of refined petroleum products to neighbouring countries by oil companies which would earn foreign exchange and strengthen our balance of payment position.
The investment opportunities in our Oil and Gas sector are huge, considering our crude oil reserves and the even bigger prospects in gas. We have a population now estimated at over 200 million people. That is a big domestic market for energy, presenting huge opportunities for the downstream investments.
The summary is that the dominance of the public sector in this space has considerably subdued the progress and development of the oil and gas sector, and by extension the Nigerian economy

POWER SECTOR REFORM
The power sector reform has not delivered the desired outcomes. The citizens expectations were not met. The entire experience has given privatization a bad name.

There are issues of due diligence, technical capacity, financial capacity, political interference, metering issues, estimated and arbitrary billings, payment defaults to the generating companies, commercial losses, electricity theft, technical losses, cost reflective tariff and the economics of the private sector investment.

We also have concerns about the capacity of the Nigerian Bulk Electricity Trading [NBET] Plc to effectively play its role of providing liquidity to support the electricity supply chain. Evidently, there are diverse internal and external variables impeding the achievement of the desired outcomes of the power sector reform.

It is thus imperative to have a more holistic approach to the multifarious challenges hampering power delivery. There should be greater emphasis on off grid solutions in order to ensure the decentralization of the power sector.

The current model of high dependence on the national grid has not worked well to serve the economy. The country is too vast for the highly centralized regime of national grid. The continued ownership and control of the transmission component of the power supply chain is also a challenge to grapple with.

We should ensure the rapid promotion of renewable energy solutions through the enactment of policies that will make it more affordable. The current high cost of acquiring renewable energy installation has been a major impediment to the access of this energy solution.

For instance, the cost of solar panels and batteries are very prohibitive. We submit that import duty and taxes on solar equipment, solar batteries and inverters should be scrapped to improve access to renewable energy solutions. The implementation of the energy mix programme of the government needs to be accelerated.

Power sector is critical to the economic development of the country.  We are sometimes faced with a conflict between development objectives and commercial objectives.

I believe the government still needs to provide generous fiscal incentives for investors in the sector because of the economic development and social impact of an improved power sector performance.

Dr Muda Yusuf, is the Chief Executive Officer, of private sector advocacy and economic think, Centre for the Promotion of Private Enterprise (CPPE)