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December 13, 2023/World Bank
Important reform decisions have been taken for Nigeria to avoid a fiscal cliff, and temporary compensation is being provided to help the poorest and most vulnerable households
In May and June 2023, the incoming administration undertook two critical policy decisions, which have resulted in price and exchange rate adjustments in the second half of the year. While the reforms were essential for Nigeria to avoid a fiscal cliff and enable faster growth, they have brought difficult economic adjustments. When the previous edition of the Nigeria Development Update (NDU) was published at the end of June, major policy changes had just been announced by the new government, including ending the gasoline (premium motor spirit, PMS) subsidy, and shifting to a unified, market-reflective foreign exchange (FX) rate. Since May, retail gasoline prices have increased by an average of 163 percent and the Nigerian naira (N) has depreciated against the US dollar by 41 percent in the official market and by 30 percent in the parallel market. The sharply higher price of gasoline and other imported goods has contributed to inflation, which increased from already elevated levels to 27.3 percent year-on-year (yoy) in October.
Targeted cash transfers are helping to cushion the adjustment to higher gasoline prices. Recognizing the need to help especially poor and vulnerable households to cope with the shock of one-off price adjustments, on October 17 the Government announced that it would roll out cash transfers of N25,000 (about US$32) per month to 15 million recipients and their families (directly benefiting over 67 million Nigerians) for three months. The total costs of these transfers to provide relief to Nigeria’s most poor and vulnerable are similar to what Nigeria was previously spending every three months on the subsidy. Previously, the unsustainable spending on the subsidy was fueling economic imbalances (especially, fiscal deficit monetization and rising inflation) that were worsening poverty outcomes and pushing Nigeria toward a full-blown crisis.
The Government is making progress on implementing the announced reforms
On FX policy, progress has been made on implementing the policy for a unified, transparent, and flexible exchange rate. On October 12, the Central Bank of Nigeria (CBN) reaffirmed that it was committed to achieving a flexible exchange rate based on freely priced transactions between willing buyers and willing sellers in the official market (renamed the Nigeria Foreign Exchange Market, NAFEM). Also on October 12, the CBN lifted the ban on the use of FX to import 43 product categories. The end of the ban— which was first imposed in 2015—is an important step to removing policy-induced segmentation in the FX market distortions, while having the pro-poor effect of reducing the prices of basic goods (see Part 2 for a closer look). Finally, the CBN has begun to clear the backlog of overdue forward obligations that had accumulated under the previous foreign exchange management approach.
Monetary policy has begun to tighten. On October 27, the CBN lifted the cap on banks’ use of its Standing Deposit Facility (SDF) (currently at the Monetary Policy Rate [MPR] minus 300 basis points [bp]), which was previously set at N2 billion per bank. This strengthens monetary policy transmission by allowing the bottom of the MPR corridor to anchor short-term market rates, since it provides banks with a remunerated option to place excess liquidity. On October 30, the CBN conducted large open market operations (OMOs), mopping up N400 billion in liquidity at relatively high clearing yields, including 17.5 percent for one-year T-bills. Market interest rates have also risen sharply. For example, the one-year interbank T-bill fixing surged to 19 percent on November 13, up from about 10 percent before the OMOs.
On fiscal policy, budget planning for the next several years is consistent with sustaining the fiscal savings from the subsidy reform and mobilizing more revenues. The Federal Executive Council approved the medium-term expenditure framework (MTEF) and Fiscal Strategy Paper on October 16, which anticipate a rise in non-oil revenues in the medium term due to several tax policy measures, and plan no financing for gasoline subsidies for 2024–2026. In addition, a supplemental budget for 2023 was signed into law on November 8, increasing spending1 and raising the debt issuance ceiling by N2.2 trillion (about US$2.8 billion, or 0.9 percent of GDP). This included N400 billion for the cash transfers.
However, the reforms are yet to be completed to fully realize the economic benefits
The FX market has remained volatile and is still in a period of continuing adjustment to the new policy approach. Following the announcement to merge all the official FX windows and reaffirmation of the willing[1]buyer-willing-seller (WBWS) mechanism at the official FX rate, there have been significant fluctuations in the exchange rate, in both the official and parallel markets. While the parallel market premium fell significantly in July 2023 following the announcement to merge FX windows, it re-emerged in August 2023 and, in October, even briefly rose to pre-June levels. The premium changes significantly on a daily basis, as the official exchange rate has fluctuated up to 26 percent in one day and the parallel market rate has also been volatile.
Revenue gains from the FX reform are visible, but more clarity is needed on oil revenues, including the fiscal benefits from the PMS subsidy reform. Nominal oil revenue gains have been evident since June. These are mostly categorized as “exchange rate gains”, suggesting that they are due to Nigerian naira depreciation. Except for the exchange rate-related increases, however, there is a lack of transparency regarding oil revenues, especially the financial gains of the Nigeria National Petroleum Corporation (NNPC) from the subsidy removal, the subsidy arrears that are still being deducted, and the impact of this on Federation revenues. It is also unclear why retail petrol prices have not changed much since August, despite fluctuations in the exchange rate and global oil prices.
Inflation remains at record high levels for Nigeria. Most recently, inflation rose to reach 27.3 percent (yoy) in October 2023, partly driven by the one-off price impacts of the removal of the gasoline subsidy. The impact of this inflation is especially hard on the poor and vulnerable. The Government has initiated targeted cash transfers to mitigate some of the impact on the most vulnerable households. In addition, a holistic approach to reducing inflation, including through tighter fiscal and monetary policies, is also needed.
The near-term priority is to enhance the reform effort with a closely coordinated mix of fiscal, monetary, and FX policies to reduce inflation and achieve macroeconomic stabilization.
On the fiscal front, it will be crucial to sustain the savings from the PMS subsidy reform. The high cost of the gasoline subsidy was weakening Nigeria’s fiscal position, in turn leading to a rapid increase in deficit monetization through CBN Ways and Means financing and fueling inflation. It is important that the subsidy is not reinstated, and that continued progress is made to ensure market-reflecting pricing. Removing the PMS subsidy creates an opportunity to open up the gasoline market, enabling other market players apart from NNPC to import gasoline. This would yield benefits to consumers from market competition, and more revenues to the Federation account, ultimately flowing to all tiers of government. However, to fully reap this benefit, there is a need to allow PMS prices to adjust periodically in line with market fundamentals (i.e., in line with the exchange rate and international prices, similar to the pricing of diesel). To gain more clarity on how gasoline is being priced in the context of the Government’s decision to remove the PMS subsidy, there is a need to enhance the transparency of NNPC, and to regularly publish information that explains prices at the pump.
The Government needs to also continue implementing revenue-led fiscal consolidation. In the absence of such consolidation, debt levels will escalate, along with debt servicing costs. To prevent such a situation, it is important that revenue mobilization efforts continue. For oil revenues, this includes continued efforts to increase oil production, reducing distortions in PMS pricing, and ensuring that oil revenues flow appropriately to the Federation, which will require more transparency and accountability regarding NNPC revenues. For non[1]oil revenues, this includes reforming the value-added tax (VAT) regime, implementing green excise taxes and other socially and environmentally beneficial taxes, and making improvements in tax administration. In addition, prudence needs to be exercised in expenditure decisions, with a clear focus on prioritizing expenditure efficiency.
On the monetary front, the policy stance has begun to tighten, but significantly stronger action is still needed to curb inflation. The new management at the CBN has implemented some tightening measures, including narrowing the asymmetric corridor in the SDF, removing the cap on banks’ SDF deposits, and increasing the volume and rates of OMOs. While these are welcome measures, further tightening is likely required to effectively control inflation. The MPR remains negative in real terms (-1.0 as of October 2023 in the baseline inflation projection), broad money supply (M2) growth is still elevated (34.6 percent yoy in September 2023), and monetary policy transmission is still hindered by the CBN’s development finance schemes and ongoing financing of fiscal deficits through Ways and Means. The CBN has signaled clearly its intention to end quasi-fiscal activities, and refocus on targeting lower and stable inflation and, moving into 2024, the effective implementation of the new approach will be key.
On exchange rate policy, additional measures can be taken to increase market stability. The CBN has reaffirmed its commitment to the WBWS mechanism, yet liquidity in the official (NAFEM) market has remained thin. Further monetary policy tightening is expected to help underpin the value of the naira. However, there is also a need to increase FX supply in the market. Facilitating FX flows, especially from all exports, through the NAFEM can help provide additional volumes in the official window that can help provide stability. In addition, clarity on the CBN’s net reserve position, and on the CBN’s continued progress in clearing the FX backlog, would also strengthen market confidence.
