To many Nigeria observers, the already complex economic problems of Nigeria have been made more complicated by the developments and events in the last ten days or so on the international politico-economic scene. Uncertainty as a result has increased manifold. The events are important because they have strong policy implications for Nigerian policymakers. Among the events, the most dramatic one is the proposed bailout of Greece. If it results in further liquidity flush in Europe over the next 3-6 months, its implications for prices and interest rates in Europe could significantly dent the flows of capital into Africa and other developing and emerging countries. Many discount this possibility and point out that it is more helpful to watch out whether European recovery would be a reality. So far, it has been tardy and uncertain and this implies lowering of dependence on crude oil as a source of energy.
Second, reports about the economic slow-down of the Chinese economy seem to have been endorsed by many China analysts including the IMF. This would reduce effective demand for crude oil.
Third is the continued improvement in the domestic energy supplies in the US, notwithstanding the high costs of shale oil and the insignificant demand for crude oil as a source of energy. Nigerian crude, the Bonny Light, has not figured in the total US energy supplies since the middle of 2014. Most reports on the US business indicate that technology advances are taking place in the generation of shale oil in the US. It is expected that shale oil production costs would as a result decline over the medium term. The current Saudi Arabian strategy to out-price shale oil by pumping in large amount of crude supplies as a part of the OPEC strategy would hardly recognize the role of technology and productivity as a factor that will lead to rapid development of shale oil at competitive cost as an alternate source of energy to crude oil in as quick a time as a year from now. In fact, within the next 5-10 years China and Russia, according to some reports, would also begin generating shale oil.
Finally, the conclusion of the Iran nuclear deal has led to a speculation of lifting of sanctions on Iran in quick time. Some analysts think that Iranian oil will enter the market only after a year because of obsolescence of the critical machineries required for restoring Iranian oil refineries to optimal production capacities. One, however, should not be surprised if this belief turns out to be an exaggeration. In any case, the Asian markets, closer as they are to Iran, will absorb whatever flows from Iran in the next 3-6 months.
The main challenges for Nigeria’s policymakers are several. They are in fact more in the nature of dilemmas that need to be resolved. First, any sharp drop in crude oil prices would mean potential surplus crude oil on hand. In any case there will be surplus capacity in the production of crude oil. Will the policymakers see that crude oil is absorbed domestically and if so, how will they do it and how long will it take for absorption to take place? If they decide to absorb potential surplus domestically, it can be done only by developing oil refineries within the country on a priority basis. Will the policymakers invest in developing the old and obsolescent oil refineries on a priority basis? This might mean that as refineries increasingly produce petroleum products over a three-year period, domestic use by the transport sector as well as manufacturing units will have to increase correspondingly. If the domestic demand is not realized, the policymakers will have to consider exporting the petroleum products to African and Asian markets. Such an approach will reduce imports of petroleum products. But in the immediate period, the fall in the share of oil exports in total exports (which is roughly 90 per cent) will have to be offset by increase in non-oil exports.
Will the policy planners think of preparing a blueprint along with local entrepreneurs and some of the already existing foreign investors to help identify the products that would constitute non-oil exports? For the sake of analytical convenience, assume that the blueprint is prepared. Yet the question is how much of investment would be needed to develop exportable non-oil goods and whether public sector should at all enter into such an investment plan. This is a crucial dilemma because policymakers know that while the institutional mechanisms to protect public investment in commodity producing sectors from any risks are weak, they would not know how to avoid and repel political pressures to jump into the fray.
There is yet another problem. Will Nigeria’s non-oil export items be internationally competitive when it is well known that costs on account of labour employment, power, transportation and other materials together with low productivity are very high? How will the costs be sharply brought down?
It is time that Nigerian policymakers face squarely the daunting task of undertaking economic reforms on an extensive scale. More often than not, announcements of reforms are done without a clear enunciation of implementation strategies, processes and procedures. Their dilemma would be the following: should they have such an extensive exercise for each of the years of a 3-year medium term or go by the traditional practice of merely announcing reforms piece meal over a period of 6-12 months? Some would argue that preparing an extensive reforms package itself would take time, maybe even 3 months from now and hence it is best to pursue the traditional practice in the matter. Granted that this is true, will the policymakers at least unveil a few scenarios of policy actions that would be undertaken to counter the problems that would arise should crude oil prices dip from the current level of US$55-60 per barrel? In fact, most energy balance sheet indications suggest that crude oil prices would fall in the remaining part of the current year.
It is best to prepare at least three economic scenarios based on crude oil prices of US$50 a barrel, US$45 a barrel and US$40 a barrel along with policy actions needed to counter such price outcomes. Of course, the scenarios could be with reference to the time-frame. In the short run of the next six months the US$45-50 per barrel should not be ruled out. For the year ahead, even the US$40 a barrel would be worth considering as a plausible scenario. This exercise is something like a spreadsheet work and can be done expeditiously by any professional economist once the policymakers determine, not merely indicate, the policy packages to take care of the challenges that scenarios of lower than the current oil price present. The rub however lies in the fact that very rarely policymakers decide on the policy packages without worrying about the political costs and benefits that each of the policy measures would entail. In the case of Nigeria, the costs could be high given the weak institutions and the general indifference to follow the universally recognized best economic governance principles. Besides, there is no certainty that legislators will buy in the proposed policy packages without their stamp of approval. Their concerns however can be assuaged to a considerable extent if the wider public is informed of the rationale of the packages and of the implementation procedures that would be set in place through media and other communication channels and reactions sought. Will policymakers take such a step? If they do, the public policy space would get legitimacy in terms of representing the voice of the vast majority of people. Such an action would also open up doors to transparency in policymaking.
The IMF has already estimated the GDP of the country to decelerate to less than 5 per cent in 2015 which is way lower than the trend growth rate of about 7 per cent in the last ten years or so. The IMF estimate, however, could be a point of reference for more appropriate investment planning for the rest of this year and next year. This will point to the need for extracting as much saving as possible from the falling income and investing in activities that generate incomes and employment.
Whichever scenario is considered as realistic, public expenditures under each of the activity areas may not grow at the same trend growth rates of the past five to ten years. Public policymakers would have to therefore make sure that given the revenues, the expenditure pattern is prioritized to ensure that internal security is not compromised and social sectors do not suffer from want of funds. They also have to ensure that expenditure leakages are plugged and tax reforms are undertaken simultaneously. The Federal Government should also be prepared to consider selling some of its shares in the non-profitable public enterprises and restructure its debt as part of a package of fiscal structural reforms. Notwithstanding such decisive efforts, public sector deficits could still go up.
One of the major questions that would arise would be the extent to which public sector deficit could be tolerated. Two issues are of pertinence here: the inflation and the size of the public debt. The margin of tolerance of inflation that would accelerate when public sector deficits increase cannot be as high as at present (of about 9 per cent). Some studies on Nigeria have placed the threshold rate of inflation at 8 per cent when oil prices were generally favourable to the fiscal and external sector outcomes. It is now time to revisit this subject with assumptions that reflect the current and prospective situations.
Public sector deficits could continue to be high in the medium term in which event public debt would rise. So far the debt-to-GDP ratio has been within manageable limits but could rise sharply should crude oil prices dip to US$40 and lower. Along with studies on the threshold rate of inflation, it would be necessary to study debt sustainability issue under different scenarios. The issue of debt sustainability should not be taken lightly in the case of Nigeria which is fiscal vulnerability in the event of oil price dips is high and there is no buffer in the form of diversified economy. Both these studies would provide some insight into the question of limits to financing of public sector deficits over the medium term.
Ideally, it is best to communicate tax, expenditure and government debt market reforms along with the creation of a fiscal implementation group. The group would closely monitor the fiscal adjustment plan in the short run as well as in the medium term. The group may contain two external experts from the Central Bank of Nigeria (CBN) and academia and meet at least once a month. The reports of the group may be placed in the website of the Finance Ministry for wider public information. The reports would also help monetary authorities in their monetary planning and policy formulation.
Apart from the fiscal policy area, the Federal Government has to bring about other structural reforms without delay. The purpose of the reforms is to promote the agenda of public policy to develop the private sector and reduce the role of the public sector to one of a guide, provider of infrastructure, a regulator and an upholder of the principles of the rule of law. Private sector’s financial needs are bound to be sharply high given the need for a large economic diversification so vitally needed to improve competitiveness and to enlarge the role of non-oil activities in the domestic economy and in the external sector.
So far the strategy of financing the private sector needs has been to provide finance through financial institutions in particular commercial banks and microfinance institutions. The CBN has supported development financing through a variety of ways apart from refinancing. But the CBN support cannot be indefinite and limitless. Beyond a point, the liquidity implications of such a support could explode into a high degree of inflation and could lead to considerable financial sector stress.
The Government has to recast its strategy and consciously improve upon the existing incentive structure for the private sector. A number of dilemmas present themselves here. The policymakers will have to consider the incentive structure activity-wise.
There is a view that Nigeria can develop agriculture and animal husbandry sharply so that it can stop importing agricultural and meat products and can start exporting as well. This is possible with land reforms and some technological advances in the area of cultivation practices, agrarian management and animal husbandry. But to generate employment on a sustainable basis to the growing young population, dependence on agriculture as the main activity is not a viable proposition. This is a historical truth emanating from the experiences of many countries.
Manufacturing therefore has to be the main focus of policy preference. Here too one has to make a distinction between agro-industries and others. Agro-industries serve Nigeria’s immediate needs of reducing imports of agricultural products and generating employment with relatively low investment. But once petroleum refineries are set up on a firmer footing, petro-chemical products would emerge and industries based on such products would have to emerge. For this to happen, skill formation is needed as much as external financing. Reforms therefore have to also cover educational and vocational training area.
Let us cite a few examples of some of the areas of manufacturing where Nigeria has skills and natural advantages but have not been consciously developed as a part of state policy. For example, Nigeria can easily enter the garment industry for not only domestic consumption but also entering international markets. Bangladesh benefited from developing ready-made garment industry. Again, industries like soap, perfumes, cement, steel products (with modernization of the existing steel plant), small machineries (with the help of steel foundries that do exist based largely on the available iron scrap) and software generation are some of the areas that may be kept in view for providing incentives.
Domestic investment flows, foreign investment flows, collaborations and partnerships and development of venture capital start-ups and simplification of procedures for starting new businesses would claim top slots in the scheme of things. Will the policymakers clearly specify the terms of collaborations and foreign direct investments in these areas? If foreign capital is needed, then it is also necessary to revisit the issue of current account convertibility in the balance of payments. That will give some confidence to foreign investors about the country’s commitment to be less discretionary with regard to transactions on current account of the balance of payments.
Once this is done, capital account liberalization would have to be designed to impart flexibility in the application of the rules without allowing the authorities to be less binding to the rules prevalent at the time of the transactions. Will the Federal Government touch the convertibility issues or take refuge in the argument that foreign exchange reserves are limited and could cause large outflows? The limited amount of foreign exchange reserves is not likely to be a constraint if the announcement of current account convertibility is synchronized along with announcements of other structural and macro-economic reforms and policy implementation mechanisms.
Domestic partnerships and collaborations can be fostered if the Federal Government allows pension funds and insurance companies to participate in buying stakes in or in extending credit within specified limits that would be reasonably sufficient for these companies to reap benefits by way of dividend pay-outs and interest receipts.
Undoubtedly, large domestic credit creation or large foreign capital flows would throw up liquidity management challenges to the CBN. But this is not likely to be a major issue if it is properly anticipated and prior actions are taken to contain the problems that arise from excess liquidity generation.
The Federal Government has much to do in the next few months for economic regeneration to a higher growth path. Its credibility would depend on how transparent it would be with regard to policy initiatives and building up of institutional framework for quick and efficient implementation of policies.
A Vasudevan
Vasudevan was special adviser to the CBN governor between November 2010 and June 2012. He worked as monetary operations adviser on IMF assignment at the CBN between December 2006 and December 2009. He is currently Honorary Senior Fellow with a Research Centre in India.
