According to the World Bank’s recently published development update on Nigeria titled “Resilience through Reforms“, a number of factors led to Nigeria reporting a smaller GDP contraction of -1.8% in 2020 (vs -3.2% forecast when the pandemic began) exiting the recession in Q420. These include prompt government intervention, the lifting of pandemic restrictions and a rise in crude oil prices. While the Bank acknowledged that reforms implemented in 2020 (electricity sector, VAT and gasoline subsidies which have now re-emerged) were crucial in expanding the federal government’s (FG) fiscal space, it also stated that additional reforms are required to drive faster economic growth beyond 2021.
The Bank projects Nigeria’s GDP to recover to 1.8% in ’21f under its baseline scenario, which assumes that the 2020 reforms are sustained. This scenario ignores two major drivers of macroeconomic imbalances: exchange rate management and high inflation. In this instance, accelerating inflation and significant parallel market fx premiums will present barriers towards meaningful growth beyond ’22f. We forecast faster GDP growth of 2.8% for this year.
In its best-case scenario, the FG implements fx management reforms, such as the easing of import and fx trade restrictions and embarks on a phased inflation control programme. In this scenario, it also forecasts GDP growth of 1.8% in ’21f as growth reforms are offset by inflation control measures. If the policy measures are sustained, GDP growth will reach 2.5% in ’22f, and surpass population growth in ’23f. In a risk scenario, the bank sees growth of 1.1% in ’21f.
The Bank recommends that the CBN clearly define its monetary policy priorities and objectives, with price stability as the primary goal, resume open market operations (OMO) on a transparent schedule, and stop using the cash-reserve ratio as a tool for liquidity management to finance quasi-fiscal CBN operations.
While it applauded the CBN’s efforts to unify the exchange rate by adopting the NAFEX rate for all formal transactions, it would prefer to see greater exchange rate flexibility and less CBN interventions. Oil companies should be able to sell foreign exchange revenues to IFEX bank participants, according to the report. Enhanced flexibility would lead to a more efficient foreign exchange market, with the CBN’s role limited to smoothing out large fluctuations.
According to the Bank, the CBN’s prompt action through regulatory forbearance and interest rate lowering initiatives helped Nigeria’s banking industry avoid a credit crunch. However, it warns that as the forbearance expires in ’22f, banks’ asset quality ratios are likely to deteriorate.
The report also sees the electricity sector as a clear priority for reforms. It notes that c.43% of Nigeria’s population lacks access to the grid. Despite recent tariff hikes, the prevailing tariffs cover only c.80% of cost.
The FG’s subsidy to the sector amounted to c.NGN524bn in 2019 or 0.4% of GDP and higher than the NGN428bn budgeted for the health sector. The Bank calls for a move towards cost-reflective tariffs and financial and policy interventions by government and various stakeholders.
On the fiscal side, greater attention should be given to revenue mobilisation and fiscal consolidation measures. The elimination of fuel subsidies and tax reforms such as increase in sin taxes, levies on electronic money transfer, and the rationalisation of tax exemptions such as the pioneer status could potentially help increase Nigeria’s tax-to-GDP ratio in the medium term from 4% to 7%. It notes that raising excise taxes from c.20% (ad valorem) to c.50% (via a combination of ad valorem and specific taxes) should bring Nigeria closer to its regional peers and result in additional tax revenue of c.NGN955bn in the first year of implementation.