Friday, March 20, 2015 5:42 PM / FDC
The plunge in oil prices is having a dramatic effect around the world as winners and losers emerge. Weaker global oil consump-tion and increasing global oil supply spurred by the US energy boom have conspired to send oil prices to lows not witnessed since 2009. Consumer nations have been smiling all the way to the gas pump while producer nations like Venezuela, Nigeria and Russia are being bruised badly. According to the International En-ergy Agency (IEA), even the previously booming US shale indus-try is also likely to be tested if sub-$50 per barrel prices persist.
For Nigeria, the fall has ignited a chain reaction which threatens its macro-economic stability. Oil revenues and foreign exchange receipts are on the decline while external reserves have dwindled. These events have forced monetary and fiscal adjustments. The Central Bank of Nigeria (CBN), in November 2013, raised the benchmark interest rate to 13% p.a. in addition to what is now a 28% naira devaluation. On the fiscal side, austerity measures have been announced such as proposed expenditure cuts for 2015, salary cuts at the executive of 25% and changes to the 2015 – 2017 Medium Term Expenditure Framework (MTEF).
The 2015 budget proposal, following a fourth revision, has been submitted to the National Assembly by the Minister of Finance. The revisions were to the benchmark oil price, moved from $73pb to $65pb and then to $52pb, the exchange rate, moved from N165/$ to N190/$, and capital spending, increased to N700bn (15% of GDP) from N387bn initially proposed. According to the Budget Office, the downward revisions were necessitated by the precipitous and continued plunge in oil prices – down by over 50% between June and December 2014. Less than 16% of Nigeria’s Gross Domestic Product (GDP) is accounted for by oil but its contribution to government revenues is over 75%.
Budget Break Down
Full details of the budget have not been made public. From what is accessible, lower oil prices have apparently translated directly to proposed spending cuts and lower revenue projections in the 2015 budget. The aggregate expenditure is budgeted at N4.457tn, down 7.76% from 2014. While revenues are down by 3.43% from 2014 at N.3.602trn. This breaks down into N1.918trn of oil revenue and N1.684trn of non-oil revenue, a ratio of 53:47. These lower estimates are considerate of reduced subsidy spend-ing for 2015 coupled with the devaluation rebate (more naira for dollar earned).
The highest allocations went to the education (N521.27bn) and defense (N358.47bn) sectors. These are followed by the police (N312bn), health sector (N258.bn) and foreign affairs ministry (N44.5bn). The allocation for agriculture is 67% lower than its 2014 figure of N66.6bn.
In terms of recurrent expenditure, it has been estimated at N2.616trn with the rising wage bill and pension claims continuing to constitute major expenditure pressure points. Approximately 70% of recurrent expenditure is accounted for by personnel costs and 8% by pensions. Personnel costs have risen over the past nine years growing from about 32% of the entire budget to just over 40% proposed for 2015. With the addition of SURE-P, debt service and statutory transfers, aggregate recurrent expenditure comes to N3.971trn, 85.8% of budget.
The spending cuts really begin to hit home when crucial capital spending is analyzed. At N700bn, it is 42% lower than N1.208trn initially proposed in the Medium Term Expenditure Framework, and 54% short of the 2014 budget figures. No other component of the proposed budget makes Nigeria’s vulnerability to oil price shocks more apparent. This drastic fall in capital spending suggests a reduction in the number of capital projects to be executed. It thus weakens the much needed revenue support required to bolster inclusive growth and development in 2015, or to lower the infrastructure deficit, which is the key constraint to non-oil growth.
The projected deficit is down to 0.79% of the GDP (low by inter-national standards) from 1.24% in 2014. The cost of debt servicing is up by 32.4% to N943bn (34% higher than capital expenditure) from N712bn in 2014. And this will be financed via new borrowings worth N570bn at a higher interest rate than the N624.22bn borrowed in 2014.
Oil price: $52pb
Oil Production: 2.27mbpd
Exchange Rate: N190/$
Projected GDP growth rate: 4.8%
The proposed oil price and exchange rate benchmarks, albeit more in touch with reality than their previous assumptions, may eventually prove unrealistic. Brent crude has averaged $54.12pb so far this year – 4% higher than the budget benchmark. This benchmark, although more realistic than the $65pb it was adjusted from, does not give sufficient room to build buffers. Given current oil industry dynamics, this benchmark was clearly marked with optimistic expectations of a 2015 oil price range of $50 - $70. Further price drops or sustained periods of sub-$50 prices would inevitably lead to further adjustments to the benchmark or even expenditure cuts. It is worth noting that fellow Organization of Petroleum Exporting Countries (OPEC) countries Venezuela, Iran and Angola have assumed benchmarks of $40pb.
The lower oil benchmark price does not get any further support from the production level benchmark. With an average production rate of 1.9mbpd over the past two years, the 2.27mbpd bench-mark is overly optimistic, particularly as the challenges of oil theft, bunkering, and production shut-ins persist. Furthermore, current global oil industry dynamics may compel OPEC to ensure strict compliance to production quotas by member countries. This would mean Nigeria would have to scale back on its production, leading to a further decline in government revenue.
Adjusting the exchange rate assumption from N165 to N190/$, which is N10 (5%) below the current interbank market rate of N200/$, is a step in the right direction.
Achieving GDP growth of 4.8% may be easier said than done if the recent review of global growth projections by Bank of America published last month is anything to go by. The growth forecast for Nigeria was cut to 3.5% in 2015 citing lower oil prices and its im-pact on government revenue, external reserves and the currency.
The federal government has stepped up measures to boost non-oil revenues to make up for falling oil revenues. By strengthening tax administration, the government hopes to plug leakages, widen the tax base and improve the efficiency of tax collection. The government aims to earn an extra N160bn in 2015 and an aggregate of N460bn over the next three years according to the Federal Inland Revenue Service (FIRS). Stopping the abuse of import waivers is projected to bring an additional N36bn in tax revenues to the table in 2015.
The government also announced its intentions to ensure the full compliance of MDA’s in their statutory obligations of remitting 25% of their gross independent generated revenues. Other measures include a surcharge on luxury items estimated to raise N23bn.
At N2.08trn, net non-oil revenue after costs and deductions would need to grow 53% to close out the gap left by the N1.11trn short-fall in oil revenues. And additional N160bn (14%) merely scratches the surface. The effort by the by the federal government, though commendable, is not sufficient.
Capital spending is to bear the brunt of plunging oil prices as the increasing cost of governance once again takes up the lion’s share of Nigeria’s proposed budget. Deficit financing is higher than new investment as a result of the increasing fiscal gap. The debt sustainability ratios show a deteriorating trend. Debt as a percentage of fiscal revenues has increased to a staggering 31.4% (2015 estimate). Some analysts are under the illusion of using the debt to GDP ratio as an indicator of the debt burden. The reality is that debt service is a much more efficient indicator.
The oil price benchmark at $52pb has been set with optimistic expectations of an average price of oil above $50pb for 2015. While we believe this is achievable, a further decline in prices could be on the horizon if Iran’s nuclear deal with the West succeeds. This would allow it to add 5mbpd to the global oil markets.
On the currency side, an appreciation of 5% is required to achieve the exchange rate benchmarks while the GDP growth benchmark would require prices to recover to $100pb in 2015, which is a huge doubt.
The big questions are: will oil prices fall any further? In the event that they do, will the proponents of the budget be willing to make further adjustments to the benchmark oil price assumption? Or will it be met with further cuts to capital expenditure? The answer to these questions will be answered in due time. At the moment, the baseline assumptions still make for an unrealistic budget.
In summary, the new level of revenues is not short term and the budgets for the next three years are likely to be at these levels. Nigeria will need to reduce its expenditure, a feat that is easier said than down.
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