Tuesday, November 18, 2014 6:32 PM / FDC
The continued fall in oil prices and the effect on fiscal and monetary stability has generated uncertainty amongst investors. In July, Angola, the second largest oil producer, took some hard steps to insulate its economy against the impact of the oil shock, including a reduction in subsidies.
The Nigerian Minister of Finance recently announced the first tranche of fiscal austerity measures aimed at mitigating the implications of lower oil prices on fiscal and external imbalances. While this step is commendable and in the right direction, fiscal measures are necessary but not sufficient to cure the shocks associated with this precipitous oil price decline. A blend of fiscal and monetary policies is more likely to accomplish the task of maintaining financial stability at a time of market volatility. Fingers remain crossed as to what other adjustments the CBN will announce at the MPC meeting next week.
Austerity Measures Announced as Therapy for Oil Shock
When global oil prices started to decline sharply in September, the markets and investors were taken by surprise. Some governments started implementing austerity measures such as budget cuts, while others tarried to see how far prices will fall. Brent crude price has fallen 32.76% from its peak of $116pb in June to $78pb and may have further to fall before rebounding towards the sub $80 levels. The Nigerian economy relies heavily on oil revenue, therefore a decline in oil prices poses significant risks to the fiscal and external balance of the economy. In the meantime, the CBN has commenced initial implementation of some monetary adjustments, while others will be announced at the next MPC meeting on November 24/25.
Is the dose Enough to Cure– Fiscal Imbalances
Oil proceeds account for approximately 70% of Nigeria’s fiscal revenue. Notwithstanding the relative stability in Nigeria’s oil production of 1.9mbpd, which is 17.39% below the 2014 benchmark of 2.3mbpd, a 32.76% decrease in oil prices will result in a further deterioration of the fiscal imbalance. Nigeria has a fiscal deficit of approximately 1% of GDP, a resultant effect of a rebased GDP. This is projected to widen beyond the fiscal target of 3% of GDP as revenue shortfalls intensify. In Q2’14, the government’s retained revenue decreased to N864bn from N912bn in Q1, while September FAAC disbursements declined by 4% year to date; these events occurred when oil prices were still above $110pb. With oil prices fluctuating between a band of $75 and $79pb, government allocations will reduce further as revenues decline.
And– The External Gap
Approximately 94% of Nigeria’s exports are from oil and gas receipts. Over the years, Nigeria has maintained a surplus balance of trade position, currently estimated at $41.4bn. A sustained decline in oil prices could result in a 70% reduction in the balance of trade surplus and completely erode the current account balance. This is because typically when exports fall, imports remain stubbornly static, thus creating a trade gap. The level of Nigeria’s external reserves, of which a significant amount is from portfolio funds and hot money, has depleted approximately 14% year to date. Portfolio inflows have reduced since the start of 2014 and are expected to decline further with the end of the U.S. Fed tapering. The excess crude account is down to $4bn and may be drawn down by 50%, according to the Minister of Finance. The combination of lower oil revenues and portfolio funds could push the balance of payments into negative territory.
A Cocktail of Measures
The Minister of Finance recently outlined some austerity measures as part of the government’s fiscal policy adjustments to mitigate the implications of lower oil prices on the fiscal and external balance of the Nigerian economy. These belt tightening measures form the first tranche of a series of fiscal policy adjustments to be implemented if oil prices continue to fall. Some of the measures include the following:
· 6% downward revision in the 2015 budget benchmark oil price to $73pb from $78pb
· Upward revision in the collection target for FIRS
· Reduction in international travel and training within the public service
· Surcharge on luxury items such as private jets and alcoholic beverages
But an Under-dose can Lead to a Fiscal Relapse
The government’s move to mitigate the impact of lower oil prices is a step in the right direction. But how adequate and effective are these measures? A 6% reduction in the 2015 budget benchmark oil price to $73pb at a time when oil prices are trading between $77- $78pb is cutting it too close; it is also under the assumption that oil prices may not fall below $70pb in 2014. Not only have oil prices fallen below the 2014 benchmark of $75pb but there is a high possibility that they would fall further, below the proposed 2015 target of $73pb. If this happens, Nigeria has no savings. In addition, the government might require a supplementary budget for 2014 if revenues decline sharply.
The benchmark price is set to determine the level at which savings accrue to an economy. Any price above the target price is considered as savings or used to build up the external buffers. So far, Nigeria has been unable to build up its external buffers even when crude prices were as high as $120pb. Therefore a $5 (6%) reduction in the benchmark when compared to the 30% decline in oil prices is like a drop in the ocean and although necessary, may not be sufficient to plug the leakages. The government’s suggestion to increase taxes in an economy wherein tax compliance is low may be an exercise in futility as it is highly unlikely that the government will be able to generate enough revenue to fund the budget deficit. The other measures outlined by the Minister of Finance are more academic than practical and are unlikely to have any significant impact.
The federal government has taken the first step in the right direction. However a blend of fiscal, structural and monetary policy adjustments are required to effectively mitigate the dire effects on the Nigerian macro-economy.
The Longest Journey Starts with the First Step
Whether the austerity dose is adequate or not, the acceptance of the need for fiscal therapy in the face of a sharp decline in oil prices is a great achievement. In macro-economic lexicon, it is said that the mental adjustment of acceptance is more difficult than the fiscal or monetary measures that you eventually adopt. This is good news for Nigeria as she seeks to become insulated from shocks and economically competitive.
Disclaimer/Advice to Readers:
While the website is checked for accuracy, we are not liable for any incorrect information included. The details of this publication should not be construed as an investment advice by the author/analyst or the publishers/Proshare. Proshare Limited, its employees and analysts accept no liability for any loss arising from the use of this information. All opinions on this page/site constitute the authors best estimate judgement as of this date and are subject to change without notice. Investors should see the content of this page as one of the factors to consider in making their investment decision. We recommend that you make enquiries based on your own circumstances and, if necessary, take professional advice before entering into transactions. This article is published with the consent of the author(s) for circulation to the online investment community in accordance with the terms of usage. Further enquiries should be directed to the author whose e-mail is Financial Derivatives Company Limited [E-mail: firstname.lastname@example.org ]